Alex Woodard is a principal at Pegasus Investment Partners, a private partnership formed in 2020 by a group of experienced real estate and finance professionals to sponsor commercial real estate investments in the U.S. His experience encompasses a wide range of geographies, including both primary and secondary U.S. markets, investment strategies from development to value-add acquisition, and various asset classes including self-storage, multifamily, office and retail.

Pegasus’ current investment strategy is to accumulate an institutional quality portfolio of self-storage facilities in primary U.S. markets. Pegasus acquires assets in trade areas with high population density, low existing self-storage supply, and high barriers to entry. Target facilities are typically still in their initial lease-up or have below-market in-place rents.

Woodard spoke with lev.co about self-storage acquisitions and financing.

lev.co: Over the last couple decades, self-storage has actually been the best performing asset class among publicly traded REITs. What factors do you think led to this success, and can self-storage sustain this performance in the future?

Alex Woodard: The primary demand drivers for self-storage — often called the four Ds: death, divorce, dislocation, and downsizing — are not positively correlated to the business cycle, so the asset class is very resilient in recessions. Demand for self-storage has been steadily increasing in recent decades, with a third of Americans using self-storage today. The operations of self-storage facilities are very efficient, with low overhead and relatively predictable expenses. Ultimately, the success of self-storage in the last few decades comes down to the industry’s success in capturing these demand tailwinds and converting them to cash flow at impressively high margins.

Who is buying self-storage facilities?

The self-storage industry’s performance over the last few decades has not gone unnoticed. The industry has seen an explosion of buyer interest from private equity and institutional investors. Transaction volume in 2021 was more than three times what it was in 2007, before the Great Recession. The public self-storage REITs (e.g. EXR, CUBE, PSA, LSI) are always actively acquiring facilities, but private buyers have accounted for more than half of the transactions in the last five years. All this investor interest has increased valuations, with cap rates declining by roughly 300 basis points over the last decade. It remains to be seen what the valuation impact of recent market volatility and increasing interest rates will be, but it’s hard to imagine investors not finding self-storage cash flows relatively attractive in an inflationary environment with a potential recession looming.

Why did you start Pegasus?

We started Pegasus because we have conviction about the current opportunity in self-storage and our ability to capitalize on that opportunity. Self-storage is still a niche asset class, and scale is difficult to achieve. A small partnership like ours is ideal for striking the right balance between growth and investment quality.

Why does Pegasus focus on primary markets?

We have found that the most important factors when analyzing a self-storage market are population density and the amount of competition. Since self-storage is a relatively commoditized product, the demand for space is highly correlated to the amount of people in a facility’s trade area. This naturally leads us to target large population centers. However, the ability to capture that demand depends on how many self-storage facilities already exist in a trade area and how likely it is for new facilities to be built in the future. Primary markets typically have very stringent zoning codes, limited land availability, and high construction costs; all of which limit new self-storage development. The combination of high population density and limited competition that primary markets provide leads to higher rents and more stable growth over time.

What are you seeing in the self-storage debt market these days?

The field of prospective lenders has thinned since the spring. Debt funds and various bridge debt vehicles are active, but a lack of liquidity in the A-note and CLO markets is posing challenges for these lenders that are often dependent on leverage themselves to meet their targeted returns. For opportunities with limited cash flow (either due to an ongoing lease-up or value add plan to be executed post acquisition), lenders have reduced the amount of leverage they are willing to advance by 5-10% of value, and floating rate debt pricing has increased by 25-50bps.

Lenders for permanent, long-term debt are also being more selective. The 10-Year Treasury rate has fluctuated between roughly 2.60% and 3.50% over the last 120 days, which has posed a challenge for lenders that are typically focused on debt service coverage ratio. Banks, CMBS lenders, and life insurance company lenders are more hesitant to offer higher leverage, but they are still willing to quote high-quality borrowers full-term interest-only, non-recourse loans.

How do lenders evaluate value-add / lease-up self-storage properties?

Lease-up self-storage loans typically require a lender who is very familiar with the asset class. New self-storage facilities lease up at rents 10% to 20% below market, and it takes three to five years for a new property to reach stabilized occupancy. This creates a wide spread between in-place and stabilized debt yields, with significant capitalized carry costs. There are many variables lenders consider, but generally they want to see clear evidence that the underwritten stabilized rents are achievable in the market and that the assumed pace of lease-up is realistic.

How do you raise equity capital for your deals?

We raise capital on a deal-by-deal basis. We only do a handful of deals per year, which allows us to remain very selective; however, it does make committed capital structures more challenging. Raising capital is never easy, but so far it has been more challenging finding deals that can make it through our internal investment committee than securing investors once we have those deals. We have been fortunate enough to have the same equity partner for all three of our acquisitions to date.

What makes a great equity partner?

Great limited partners are the ones who can move quickly and follow through on their commitments. They understand real estate due diligence and how to close a transaction, so they can add value while not creating unnecessary bottlenecks. The best LPs have closed enough deals to be able to communicate their needs in detail up front. They will have comprehensive checklists, specific (but not overbearing) language for what they need included in loan and operating agreements, and a team that is empowered to make decisions. Once a deal closes, these same attributes should lead to a productive asset management relationship. Of course, issues are inevitably going to arise. When they do, a great LP is alongside you working towards maximizing value and navigating issues as part of the team.

Finally, how did you choose the name Pegasus?

The Pegasus is a Dallas icon dating back to the 1930s when Magnolia oil built a neon Pegasus on top of their building downtown. The Pegasus was their logo which was later adopted by Mobil when they bought Magnolia in the 1950s. The Pegasus can be spotted all over Dallas today. As a Dallas-based firm, we liked the idea of tapping into that history.