The Best of Times – The Strangest of Times!
May 01, 2020 | by Ken Nitzberg
The past two months have been among the strangest I have ever experienced and perhaps the most difficult for our country since World War II. As 2020 began we were eagerly looking forward to having a great year for our portfolio of self storage properties that today totals more than 2,900,000 square feet in 41 stores with more than 17,000 tenants in 13 states. Devon was coming off a record year in 2019 and saw no headwinds that would have prevented us from achieving another great year for our capital partners, our employees and our shareholders. Then the coronavirus hit.
As we moved into February and then March 2020 the country experienced increasing levels of COVID-19 infection, increasing hospitalizations and deaths. Mayors, City Councils, regional health officials, and Governors began issuing Emergency Orders and proclamations, many of which impacted how the self storage industry can operate our businesses.
SHELTER IN PLACE: The new order changed the way Devon, and all other self storage operators, conduct their business. Prior to the numerous “shelter in place” orders, approximately 35% of our new tenants were sourced from “walk-ins” that literally walked into the door of one of our stores and rented a unit. Through April 15 our walk-in count is down over 75% as citizens in all the states in which Devon operates were complying with the shelter in place orders.
ESSENTIAL BUSINESS: Most states have required all “non-essential” businesses to close. In some jurisdictions self storage is considered an “essential” business and operations continue without interruption (albeit in strict compliance with the new social distancing guidelines), while other municipalities have issued executive orders with such ambiguity that it is difficult to determine exactly what the rules might be, and in some jurisdictions self storage is specifically designated as “non-essential” and therefore the sites must close. Devon has elected to keep its stores open but close our rental offices to walk-in traffic and in circumstances where direct interaction with a customer is required; site managers have been trained to comply with the social distancing mandates.
LEASING ACTIVITIES: Like most operators, over the last several years we have spent a great deal of time, money and focus on transitioning our technology and marketing efforts to generating more online rentals. Of the new tenants thru April 15th approximately 75% now come from the internet. We hope that the online sourcing of these new tenants will allow us to maintain, and maybe even increase, occupancy in some places during these turbulent times. Devon has spent many years and invested hundreds of thousands of dollars to make our web site and internet access as efficient and easy to access as possible. It is now quite apparent that those efforts are paying dividends.
The company had a very strong month in March with respect to new leases, coming in more than 30% ahead, on a same store basis, from gross leasing activity in March 2019. That leasing has continued, although not quite as strong, in April. In addition, our move-outs have declined by 21% over the past 30 days, thus effectively increasing our net occupancy even during this very difficult time.
COLLECTING RENTS: Our primary concern as we continue through these uncharted waters continues to be that our tenants, especially if any significant number of them have lost their jobs, would not be able to pay their rent. Many of the various government emergency orders have required landlords, such as Devon Self Storage, to defer or waive rent and to not evict (in our case auction) delinquent tenants. We have worked tirelessly to move as many of our tenants as possible to an auto-pay platform whereby they provide us with a credit card which we can simply charge at the beginning of each month. A year ago, we were at approximately 28% penetration with respect to autopay but as of April 15th we have moved that up to 60.1%. This has greatly enhanced our ability to keep our receivables as low as possible.
FLEXIBLE RENT PLAN: In April Devon rolled out our Flexible Rent Plan. Essentially it offers a rent waiver of 20% to 100% of a tenant’s monthly rent for up to four months. After four months the tenant is expected to return to paying the full contractual rent and to amortize the deferred portion, without interest, over the next 12 months. During the deferral period the tenant would still have full access to their unit and would not be subject to having their unit auctioned. The objective is to keep the tenant so that when we hopefully return to a more normal economic environment, we will be able to retain the tenant. It is much less expensive to work with our tenants and keep them than to experience the cost of having to replace a lost tenant. Interestingly, as of April 15th we had only 8 tenants out of 17,000+ tenants that had taken advantage of the plan.
OPERATIONS: Beginning March 15th Devon instituted a program of no rent increases and no auctions for delinquent tenants. The myriad of emergency proclamations from the Governors of the 13 states in which the company operates sometimes prohibited rent increases, both residential and commercial, and the same with respect to evictions. Since none of our facilities are 100% occupied, we do not need to evict a delinquent tenant to free up a unit to rent to a new tenant. Alternatively, Devon took the position that it was better to wait than to potentially face a legal challenge from an auctioned tenant. We are in the process of contacting tenants that were in auction status prior to the emergency declarations to see if our new Flexible Payment Plan would be a viable option for them. The dual objectives of avoiding legal issues due to unclear and sometimes conflicting government orders with respect to evictions and the possibility of salvaging the tenant when the economy comes back make these efforts paramount.
STORE LEVEL CHANGES: Effective March 15th we closed all our store offices. Our store managers, albeit only one at a time, are still in the respective store office, but we locked the door placing a sign on the door that instructed an existing tenant that was arriving to pay rent to simply drop the rent check or cash into the mail slot or, better yet, go on-line and pay with a credit card. Individuals looking to rent a unit were also directed to go on-line to Devon’s web site where they could rent a unit directly. The company made every effort to provide a safe working environment for our employees and a safe environment for our customers. We were very pleased with the response from our existing tenants and our new tenants to these operating modifications.
CORPORATE OFFICE: Devon’s corporate office in Emeryville, CA has just 10 employees as many of our corporate officers work from satellite suites all over the country as we are a national firm. All the corporate office employees have been sheltering in place at their homes. However, we still must pay bills, cover payroll, make mortgage payments, generate reports to our capital partners and respond to questions from our tenants. To the extent those activities can be done while working at home we transitioned and equipped certain employees to a telework environment. However, certain activities could only be done at our corporate office, such as paying invoices, which in Devon’s case involves issuing hundreds of checks each month. Fortunately, our very dedicated and professional staff, especially our accounting department, has shouldered through and implemented a staggered work schedule (to maintain the social distancing mandates to the extent possible) and thereby keeping the company current and ensuring that our venders do not go unpaid.
ACQUISITIONS: Our acquisition activities for new assets, both existing and conversion properties, have slowed dramatically. We are still seeing deals from brokers and principals, but at a reduced rate. Furthermore, those potential acquisitions that we had already put under a Letter of Intent (”LOI”) or a Purchase & Sale Agreement (“PSA”) have effectively been put on hold for at least 60 – 90 days. We are facing two challenges: 1) Most if not all city and county offices are closed, so if we require zoning changes and building permits there is no one present in the respective offices to process our applications; and, 2) The third-party due diligence firms we use for such reports as Phase I environmental reports, property condition reports, and HVAC reports are simply not available. We have gone back to the sellers in those circumstances and asked for extensions. At this point all the sellers, without exception, have agreed to extensions as they are also aware of the unique circumstances we are all working under.
FINANCING: We have not had to obtain any new loans since the start of the pandemic. We do know that many of the usual lenders we have worked with in the past have pulled back with a “wait and see” attitude. Presently we have two construction loans with one lender that is actively funding draw requests while we have not yet made a draw request from the second lender. However, the third-party inspections from the active lender to validate our loan draws have, in some cases, been “virtual” and thus are somewhat spotty at best. That said, although the financing market seems uncertain today, rates for the most part continue to be at historical lows and debt capital continues to be available for qualified borrowers.
WHERE DO WE GO FROM HERE? Devon believes that when the economy returns to what was considered “normal” prior to the COVID-19 pandemic that the self storage industry will likely be forever changed. What might those changes look like?
INTERNET: As an industry we have been moving more and more onto the internet platform, but this pandemic, especially the shelter-in-place orders, have pushed the industry further and faster into the age of the internet. It is Devon’s opinion that we will never go back to sourcing 35% of our tenants via walk ins. That is a thing of the past as everyone is now much more internet comfortable. Those owners that do not move aggressively into the internet world will simply be left behind.
NEW CONSTRUCTION: The self storage industry has been on a very aggressive growth pattern driven by new construction for the past five years coupled with cash rich new investment groups entering the sector. Devon believes that growth will slow dramatically due to a tightening of the debt markets. Many of those newly constructed facilities that have been over-built in terms of cost per square foot with very aggressive rent up assumptions will not achieve those projections. It is Devon’s opinion that we are likely to see a situation much like what the industry experienced in 2008 to 2012 with many facilities reverting back to lenders and eventually being put on the market at much reduced prices. It will be a great buying opportunity for those firms with cash and management skills and Devon looks forward to participating in those buying opportunities.
REGULATORY ISSUES: Many cities are now imposing development restrictions on the self storage industry ranging from zoning limitations to less desirable locations to outright banning of new self storage facilities in their communities. Cities want real estate assets that employ their citizens and generate sales tax (read retail), provide housing (read apartments), and pay high real estate taxes (read office). Self storage does none of these things thus we are a least favored new development for most cities.
VIOLATIONS: It is unfortunately normal in any situation like the current pandemic with many newly imposed and sometimes confusing government regulations that some operators will either consciously or unconsciously ignore those regulations. Hopefully municipal oversight will not react by imposing new onerous regulations or penalties on the entire industry as a knee-jerk response. Operators that are auctioning tenants’ goods or imposing large rental rate increases (price gouging) can cause the entire industry to be penalized. We are hopeful that will not happen, but we hear of such excesses literally every day.
THE HAVES VERSUS THE HAVE NOTS: Devon believes that the gap between the “mom & pop” operators with one to three stores and the larger operators with 25 or more stores will continue to widen and to do so at an accelerating pace. The smaller operators cannot afford to cover the costs of moving to the technology platforms that will be required to be competitive going forward and, perhaps more importantly, they don’t know how to do so.
THE SELF STORAGE INDUSTRY: Thus far in the pandemic the self storage industry has fared, on a relative scale, very well. If you compare the move in the valuations of the various industry segments (office, multi-family, retail, industrial, self storage) by reviewing the performance of the asset specific public REITs, self storage has again proven to be the most recession proof of all of the asset categories. The best way to make money is to first not lose capital and that is what our industry segment is doing today.
CONCLUSION: If a self-storage operator today does not embrace technology, they simply will not be able to compete going forward. These past two months have been the perfect example of how each operator must change to survive or be left behind. At Devon Self Storage we look forward to and welcome the new normal for the self storage industry.