Formerly Struggling Houston REIT Jumps On The Self-Storage Bandwagon

When Silver Star Properties REIT, formerly known as Hartman Short Term Properties XX, began seeing four major asset classes fall off their pedestals, it cut its losses and pivoted.

The Houston-based company, an affiliate of Hartman Income REIT Management, is selling off its office, retail and industrial properties to focus exclusively on self-storage, a sector it believes is recession-resistant and ripe for aggregation as a fragmented, specialized, yet vital link in the chain.

“Everybody knows office has steadily fallen out of favor since the beginning of the pandemic,” Silver Star Chief Investment Officer David Wheeler said. “We've had challenges for quite a few years with the capital investment necessary to keep office properties performing and updated.”

Maintaining office buildings meant incurring costs from HVAC systems, elevator systems and other infrastructure at a time of falling values. When the former Hartman Income REIT realized it wasn’t financially plausible to continue to maintain and upgrade the office assets that made up more than half of its portfolio, it pulled the trigger.

“That ongoing capital investment in office properties, which is over 60% of our portfolio, has been kind of a steady drain on cash flow for a number of years,” Wheeler said.

As of December 2022, the REIT owned 44 commercial properties comprising about 6.8M SF plus four pad sites and two land developments across Texas, according to a Securities and Exchange Commission filing.

But it began running into legal and financial trouble several years ago, including an $8.4M lawsuit from Summer Energy concerning energy the company provided to the REIT’s properties during Winter Storm Uri in 2021. A court ruled in favor of Summer Energy in March 2022, though the property manager was appealing the judgment as of the latest update provided.

In July 2022, according to another filing, the REIT's board of directors suspended payment of distributions to stockholders, citing difficulty making payments on loans with variable interest rates and the need to “focus on strengthening its balance sheet and preserving cash.”

More recently, the REIT notified the SEC of its inability to file an annual 10-K form due on March 20 in a timely manner.

A shift to self-storage assets received support from “certain major shareholders,” the REIT said in February, adding the repositioning was aimed at maximizing shareholder value. At the same time, the newly renamed Silver Star reported leadership changes.

The REIT management company was founded by Al Hartman in 1983, and Hartman Short Term Properties was formed in 2009 to acquire, develop and own office, retail, industrial and warehouse properties. Hartman has now shifted from CEO to executive chairman of the board of directors, while Mark Torok, the former chief operating officer, moved into the CEO role.

Torok had previously left the firm to start a self-storage business. After Torok's being hired back last year, Wheeler said, the company made its U-turn.

“He is really the originator of the idea to pivot to self-storage,” he said. “When you look at self-storage, you see that not only does it perform well, it’s less cyclical … it’s got strong cash flow characteristics. You don’t have as much [capital expenditures] going out the door on a regular basis. In fact, those capex requirements are actually quite low relative to other commercial property types.” 

Kate Spencer, managing director at Colliers St. Louis and co-lead for Colliers’ national valuation and advisory self-storage practice, said she has seen the industry thrive in the past 20 years. Beyond being recession-resistant, self-storage thrives in good and bad times in the economy, Spencer said.

“When the economy is booming, people are buying extra things, people are moving, and there's a need for storage,” she said. “When the economy is not as strong … We call them the four Ds. So it's divorce, death, dislocation and disaster, and then some people also include density, and downsizing. So all of those things lead to a need for storage.”

The sector's performance during the 2008-2009 recession generated a spate of investor focus, Spencer said. The rise of REITs, with platforms allowing third-party management — CubeSmart and An Extra Space were two of the first — transformed investments in the industry. 

“That allowed an investor who maybe didn't know a lot about storage to purchase a facility and install a third-party management,” Spencer said. “They were able to get [high] returns because they were being run very well.”

Average rents for self-storage units were down 2.3% year-over-year in March for non-climate-controlled units, and down 3.4% for climate-controlled units, according to an April report from Yardi Matrix. The report said self-storage street rates are normalizing as demand holds steady. 

“There was an awful lot of supply built in 2022, but that supply is becoming absorbed,” said Doug Ressler, manager of business intelligence for Yardi Matrix. “With that, you see the rent deceleration. We believe that it will probably take through the second or third quarter of this year for it to stabilize.”

But coming economic winds could benefit the industry, he said. Rents are more flexible with self-storage than they are in an asset class like office, since leasing terms are shorter, Ressler said. 

Silver Star plans to alter rents as it acquires self-storage assets in secondary and tertiary markets. Wheeler described primary markets as cities that have a Super Bowl team, secondary as anywhere within an hour drive of an airport, and tertiary as everything else.

Secondary and tertiary markets are targets for Silver Star, with a substantial portion of the self-storage industry controlled by smaller owner-operators, he said. 

“There's a significant opportunity for players to aggregate a large portfolio with significant upside to it in those secondary and tertiary areas,” Wheeler said. “There's still a significant amount of institutionalization, so to speak, that could happen in space and aggregation.”

Smaller owner-operators tend to focus more on occupancy than net operating income, he said. That gives Silver Star a chance to take advantage of flexible rents.

“When you see there's 100% occupancy, the rents are probably well below what could be achieved,” Wheeler said. “So that's where you can oftentimes increase the rental rates relatively quickly in relatively substantial amounts, and suffer very little drop in occupancy.” 

Other players are also seeing opportunity in aggregation. Extra Space Storage last month announced an all-stock acquisition of Life Storage for about $12.4B. The deal is expected to close later this year, making Extra Space the nation's largest self-storage operator, surpassing Public Storage.

Public Storage owns 12% of net rentable self-storage space nationwide, while Extra Space and Life Storage own 8% and 4%, respectively, according to a Marcus & Millichap report. 

Silver Star so far has so far accumulated nine self-storage properties comprising 321K rentable SF across 2,526 units in Texas, Colorado, Florida and North Carolina, which it took ownership of by acquiring Southern Star Self-Storage Investment Co. Silver Star is looking to acquire more properties in Texas and outside of the state as opportunities present themselves. 

There is an “orderly disposition plan” in place to sell the REIT’s office, retail and industrial portfolio, Wheeler said. There is a deeper buyer pool for the industrial and shopping center properties, but there is “good interest” in the office buildings as well, he said, adding he’s confident the REIT will be able to transition out of them in the next 12 months or so. 

“We're past the front end of it, we’re into it," he said. "We've probably got a third or so of the portfolio essentially spoken for in terms of under contract or contracts working."