A good time to buy into this hidden gem

Over the last few years, the problem has become worse. Data from the Department for Levelling Up, Housing, and Communities reveals that 3.1 per cent of British homes are overcrowded. The figure is down from an all-time high of 3.5 per cent in 2020 when pandemic restrictions kept many families indoors all under the same roof, but the general trend is upwards.

In large part, this is due to a lack of suitable housing in the right places. The shortfall of homes means more people living in smaller homes, given bigger homes are harder to come by. And with the housing crisis showing no signs of going away anytime soon, self-storage operators have stepped in to offer their own solution: space as a rental service.

This is the underlying bull case for the UK’s self-storage real estate companies, and increasing investor interest in the sector has been justified by providers' booming operational growth. Lok’n Store (LOK), Safestore (SAFE) and Big Yellow Group (BYG)'s respective 2022 earnings per share were four, five and six times higher than they were just five years before. By market cap, Lok’n Store is by far the smallest of the trio. However, while it might sound counterintuitive in the context of self-storage, size is not everything. What it lacks against its peers in terms of scale or brand awareness, it makes up for in growth potential.

Lok’n Store is currently trading at a greater premium to IFRS net asset value (NAV) than its peers because the equity market has priced in this potential. Currently, though, this premium is the lowest it has been since April 2020, the point at which its share price slumped in the immediate aftermath of the first Covid-19 lockdown. What's more, on an adjusted NAV basis, a method that factors in the value of its leasehold properties, Lok’n Store is trading at a hefty discount to NAV. All things considered, now looks like a good time to buy in.

Space race

Just as British homes have become more crowded, so too have self-storage units. According to the UK branch of the Self Storage Association (SSA), occupancy of the UK’s self-storage real estate surged from 62 per cent in 2011 to 83 per cent a decade later in 2021. Like self-storage companies’ share prices and British overcrowding data, this figure peaked in 2020 as crowded homes and homeworking caused a record number of Brits to seek out space to stash their belongings. But the long-term trend shows that British demand for self-storage is outpacing the development of supply.

While a lack of space at home is not the only thing driving this demand, it is certainly the biggest factor now that the pandemic-era upheaval in individuals' living circumstances has unwound. According to the SSA, 54 per cent of self-storage customers cited space issues – either too much clutter or not enough square footage – as their reason for needing the service. Meanwhile, 26 per cent said the space was needed for moving home, 12 per cent said a life event such as death was the reason, 8 per cent said renovation, with students needing to store items during the university holidays accounting for 1 per cent.

Increasing awareness of self-storage space as an option has helped boost interest in providers' businesses, too. The percentage of Brits who can name one or more self-storage operators has increased, albeit slowly, from 40.8 per cent in 2016 to 45.3 per cent in 2022. Once again, this has come down from a record high of 45.7 per cent in 2020, but the long-term trend of awareness is clear.

On the one hand, Lok’n Store has not been a great beneficiary of this increase in brand awareness. Currently, just a single per cent of those surveyed by SSA UK could name Lok’n Store as a self-storage brand, compared with 4 per cent for Safestore and 20 per cent for Big Yellow.

On the other hand, the majority of Brits still cannot name any self-storage operators and the same survey indicated that brand awareness is less important than physical presence. When asked how they became aware of their nearest self-storage, the vast majority of people said they saw their building on the roadside. This suggests there is still an opportunity for Lok’n Store to muscle into the market: its peers are not as dominant as they look, in part because their brands do not count for as much as might be supposed.

Lok’n Store is also unique from a structural perspective. Unlike its two rivals, the company is not a real estate investment trust (Reit). This means it does not benefit from tax savings like Reits do, but it also means it does not need to generate 75 per cent of its income from rent or pay out 90 per cent of its income to investors. While its forward dividend yield of 2.4 per cent is understandably below the 3 per cent-plus on offer from Safestore and Big Yellow, the payout is growing: the company's interim results last month saw it increase its interim dividend for the 11th time in a row.

The company says it prefers non-Reit status because it means the shareholders benefit from inheritance tax relief. Investors may disagree about the pros and cons of holding Reit status but, either way, by sticking as a non-Reit, Lok’n Store offers something the larger self-storage operators do not.

Takeover target?

There are disadvantages to being a smaller company. According to figures from FactSet, Big Yellow and Safestore have a better return on assets and a higher operating margin than Lok’n Store. LOK has been improving on both scores as its portfolio grows, but for now, its smaller collection of assets means the company is not as efficient as the other two.

The flip side to this, of course, is that Lok’n Store has a lot of potential to improve.

The company could even be a takeover or investment target. Businesses in the market for partnerships or company acquisitions are often looking for an organisation in which they could generate greater operating efficiency through size or capital injection. Private equity firms, another Reit, or another self-storage company could all benefit from joining forces with Lok’n Store.

The company's development pipeline is core to its investment case: the company opened a new store in February and plans to open three more this year, with another scheduled for Spring 2024 and planning permission granted on a fifth. It has also submitted planning applications for another five. In total, joint broker Peel Hunt estimates these stores will add  70 per cent more space to the freehold and leasehold portfolio as it stood at 31 January this year. Even with debt costs making capital expenditure more expensive, the broker sees the pipeline adding as much as 15p per share to earnings after interest and tax.

Yet perhaps a bigger question than efficiency or growth plans is the depth of demand for self-storage. All three operators in the space have been buoyed by the decade-long bull run as awareness has risen and space at home has fallen, but figuring out how deep the demand underpinning this growth goes is tricky. Lok’n Store likes to point to the US, which it says has 10 times the supply per capita and a market at 90 per cent occupancy. The argument goes that as people become aware of self-storage, they will use it more. Half-year results for the six months to 31 January bear this out. Despite the pressures of a slowing housing market, same-store occupancy rates rose 2.6 per cent year on year. As Peel Hunt said in January about the sector as a whole, the anticipated post-pandemic rollover in demand "has not materialised" as of yet. 

Still, it’s impossible to know for sure whether the UK will follow the US. Cultural factors might mean the growth ceiling for British self-storage is lower than the American one. This is something investors should bear in mind. The demand for self-storage is driven by a combination of trends that are hard to measure.

Still, for now, this demand is most certainly there. And given its expansion plans, Lok’n Store still has the potential to surprise.