This week, I had the following conversation on X (f/k/a Twitter), which reflects a recent industry shift in REIT pricing strategy:

For the better part of two years, I would check the online rental rates of the facility which was a stone’s throw from our first DXD development project.

In 2020, 10x10 rates were at $130, and by 2021 had made their way to $180.

In the summer of 2022, there was a dramatic shift in the web rates for new customers. 10x10s at times were going for $80, and this was their last unit left.

We knew this facility (managed by Extra Space Storage) was highly occupied; the website consistently showed “Only 1 unit available” for the three or four sizes they had available that day.

So what changed?

The facility was essentially still fully occupied. The non-REIT competitor rates in the area had not changed.

Initially, I thought it might be an anomaly—an algorithm made a mistake. But as I called others in the industry, I heard the same thing: Extra Space used to be a web rate leader but is now pricing as or more aggressively than Public Storage, which was historically the most aggressive amongst the REITs.

Extra Space’s same-store revenue in Q2 was UP 2.7% versus last year, while its occupancy went down to 94.2% from 95.2% from the previous year, and as you can see in the chart above, introductory web rental rates are down significantly.

We believe the missing component that isn’t as visible is that the revenue strategy has shifted behind the scenes to increase rents faster and more aggressively.

We now believe that Public Storage and Extra Space Storage are approaching revenue management in a similar manner. This means offering lower rents initially, but more aggressively increasing rents on tenants after they move in. Because >50% of customers tend to stay for at least 12 months, Extra Space grew revenue with lower occupancy and drastically lower web rates.

Why does this matter?

A change in strategy impacts how we think about the variables involved in underwriting our deals here at DXD.

Since the web rates are more like teaser rates that change aggressively after three or six months, the street (web) rents are much less representative of what we can achieve if we build a new store and start leasing it up.

Here’s an example of a facility we are starting construction on shortly.

Web rates are closer to $200 for a 10x10, while the actual in-place rates that are being achieved are closer to $400. This is a mature REIT facility, so there have been many years of rental rate increases on existing tenants, but it illustrates our point: facilities are achieving higher rates (in the short and long term) that are higher than the web rates would indicate.

While we use the existing web rates to understand what tenants will be paying on day one, we expect these rents to change and will likely achieve something north of that web rate. How much higher? That's difficult to say, and part of the art in modeling deals today.

We believe that Extra Space Storage and Public Storage are very careful about experimenting with rental rate increases such that it has a net positive impact on revenue. But this can mislead a developer in analysis. It could cause achieved rental rates to be underestimated in underwriting.

An important takeaway from this: developers could end up building fewer projects in the short/medium term (which is an excellent thing for the industry).

Self storage development tends to attract merchant developers that used to build office or retail, but it is becoming clear that to be a great self storage developer, you need to live in this space to catch nuanced strategic changes made by the REITs.

If you have an interest in learning more about deals we are pursuing at DXD Capital, feel free to reply to this email or click here and we would be happy to discuss.

Cory

Co-Founder DXD Capital, Radius+, ManageSpace​