How is the Fed’s Fight to Curb Inflation Impacting Self-Storage?
From the grocery store to your electric bill, consumers are hit hard by inflation at nearly every turn. As a result, the Federal Reserve spent much of 2022 trying to keep investor sentiment high while attempting to curb inflation.
How is the Fed’s plan of action impacting investors in the self-storage space? Here’s a closer look at why inflation rose so high, how the Fed is fighting it, and what investors can expect moving forward.
Why Did Inflation Rise in 2022?
To understand the Federal Reserve’s fight to curb inflation, it’s helpful to remember how we found ourselves with record-high inflation in the first place.
At its core, inflation is dependent on the balance between supply and demand. Thinking back to 2020, Covid wreaked havoc on this delicate balance. People suddenly stopped spending their discretionary income on things like eating out, vacationing, concerts, big celebrations, and travel. Instead, they stayed home and saved up. As a result, supply shot up and demand went down.
Once restrictions eased and people felt more comfortable resuming normal activities, there was an enormous shift in the supply and demand balance. Suddenly, the economy was being stimulated by pent-up consumer spending.
But global Covid safety concerns paired with a skyrocketing demand for goods and labor created a lack of supply to meet those demands.
Even now as we near the end of 2022, supply chains are still experiencing shortages. This creates bottlenecks in the delivery of goods and drives up prices. When Russia declared war on Ukraine, many already strained global supply chains were hit even harder — thus further exacerbating the imbalance of supply and demand.
As of the end of September 2022, the Consumer Price Index (CPI) indicated that the change in prices year-over-year was at 8.2%.[1] While still much higher than we’ve seen in years, the rate of inflation has slowed down since it’s record-breaking 9.1% peak in June 2022.[2]
Since we’re still experiencing supply chain shortages, geopolitical unrest, and ongoing Covid fears, why is the rate of inflation dropping? Because the Federal Reserve and other global central banks are aggressively trying to fight it.
What Is the Federal Reserve Doing to Control Inflation?
There are two ways in which the Federal Reserve has worked to combat high inflation: raising interest rates and reducing the balance sheet:
Raising Interest Rates
Before inflation started creeping higher in 2022, the Fed actually hadn’t raised interest rates in three years. However, raising rates is one of their most effective tools for fighting inflation.
As we said before, inflation is about supply and demand. A big part of demand is based on loans — mortgages, personal loans, car loans, student loans, etc. When rates are low, people have greater buying power. But when the Fed raises rates, that buying power decreases.
For example, the average 30-year fixed-rate mortgage was around 6.94% at the end of October 2022. A year ago, the average rate for the same type of mortgage was 3.09%.[3]
Here’s how impactful a rise in rates is on affordability: A $300,000 30-year fixed-rate mortgage with today’s interest rates would come to $1,984 per month. By comparison, a $300,000 30-year fixed rate mortgage with last year’s rate would have been $1,279. That’s a $705 month difference — or $8,460 per year.
All of this to say, a rise in rates can greatly impact how much people are able to spend. Throttling consumer spending should slow down demand and, ultimately, lower inflation.
Reducing the Balance Sheet
At the onset of Covid, the Fed embarked on a bond-buying campaign in an effort to keep the economy stimulated as demand for consumer spending halted. Between March 2020 and March 2022, the Fed increased its balance sheet by $4.6 trillion.[4]
Now, as the pendulum swings the other direction, the Fed is working to “normalize” its balance sheet and reduce its holdings in treasurys and mortgage-backed securities. Starting in June 2022, the Fed let $47.5 billion in assets roll off its portfolio each month, before hitting its cap of $95 billion in September.[4]
Reducing the balance sheet plays an important role in reducing available credit and, ultimately, slowing consumer spending.
How Rising Rates Are Impacting Self-Storage Investors
In an environment of less available credit and rising rates, lenders tend to be stricter with who they lend to and how much is given.
But as we saw in the first half of 2022, self-storage investment transactions are still trending up. Even as rates began climbing and capital costs increased over the summer, investor enthusiasm remained high enough to keep transactions rising. By June 2022, the number of trades over the previous 12 months outperformed the previous pre-pandemic record by more than 70%.[5]
While lenders are tightening up, they view the self-storage sector favorably for several reasons.
First, the recent history of low vacancies and rising rent rates has supported the notion that self-storage investments are both safe from recession and effective at yielding consistent returns even during periods of high inflation.
Banks also prefer to lend to those who are investing in an owner-user structure, which is common for most privately owned self-storage facilities. In the event of recession or economic downturn, banks and credit unions find these types of borrowers less likely to default.
And as with almost any type of loan, lenders will often favor investors they’ve worked with before. If you’ve already established a relationship with a lender, and you’re looking to invest in an attractive sector like self-storage, securing a loan may be doable — despite rising rates.
Wondering if Self-Storage Is Right for You?
If you’re looking for a way to create reliable passive income while pursuing investment opportunities away from the stock market, self-storage is certainly a sector to consider. Throughout the economic roller coaster created by Covid, we’ve worked one-on-one with private investors to acquire, build, and operate profitable self-storage facilities.
If you’re interested in joining our network of investors, please don’t hesitate to reach out to our team.
Sources:
[1] http://www.bls.gov/news.release/cpi.nr0.htm
[3] https://www.freddiemac.com/pmms
[4] https://www.investopedia.com/insights/how-will-fed-reduce-balance-sheet/
[5] Marcus & Millichap Self-Storage National Report September 2022