How to Value, Price and Sell Your Facility

A self-storage cheat sheet

By Burt Gay

Net-Operating Income Determines Value

As with anyother investment, the value of your self-storage facility depends upon its income--not itsnumber of units or even its square footage. If you doubt this, look at the graph below.Multiply net income (found along the horizontal axis) by roughly 10 and you will see thesales price per square foot (on the vertical axis). Net operating income of $2, $4, $6 and$8 per square foot is equivalent to $20, $40, $60 and $80 per square foot, respectively,of selling price. Notice how many self-storage facilities cluster around $4 per squarefoot of income and $40 per square foot of value. In fact, the average self-storagefacility sells for just under $40 per square foot according to the Self Storage Almanac.

How does net income per square foot relate to your self-storage facility? If you rent10-by-10 units for $50 per month, that is equivalent to $600 per year or $6 per squarefoot. If your expenses run one-third of collections, a 40,000-square-foot facility earns$4 per square foot and is worth about $1.6 million.

How Do You Calculate Net Income?

An income statement from a seller usually shows actual historical income. However, itmay show what income would have been if circumstances had been better. There are nogenerally accepted accounting principals or rules a seller cannot break in presentingincome.

Buyers and sellers create different income statements for the same facility because oftiming and operating differences. Buyers will own facilities in the future when expensesmay be different from the past. For example, property taxes may rise if the sale of thefacility triggers a new tax assessment. Buyers and sellers also incur different expensesdepending on how they operate the facility. For example, local sellers may personallysupervise their on-site managers while out-of-state buyers or lenders must hire managementfirms for this purpose. Buyers may charge different late fees or may shut down truckrentals. One of my sales fell apart when a buyer assigned no value to $31,000 of annualtruck-rental income that he planned to shut down.

Chart 2, "Typical Self-Storage," demonstrates an example of two differentincome statements. It is an average facility (40,000 square feet) with average rents ($6per square foot) and has the potential to collect $240,000 per year.

Note 1. Truck-rental income may be reduced or eliminated becausetruck-rental distracts managers from self- storage and may disappear when the managerleaves.

Note 2. "Other" income (late fees, box sales, locks, etc.)may be reduced to some arbitrary percentage of revenues that a particular buyerhistorically collected, e.g., 6 percent.

Note 3. Vacancy expenses may be increased to market levels--typically10 percent, although vacancy on a national basis averages 12 percent.

Note 4. Property tax may be adjusted upward to equal the sales pricetimes the tax rate.

Note 5. Off-site management expenses of 6 percent may be added to hirea management firm to oversee the investment and account for the owner's time if heperformed this function himself.

Note 6. Repairs and maintenance expenses may be normalized to $.10 persquare foot to reserve funds for repairs and preclude owners from increasing income bydeferring maintenance.

Note 7. Capital improvements expense of $.10 per square foot may beadded to fund major improvements that a facility will eventually require to remaincompetitive.

Notice that both income statements exclude interest expense so that facilitiespurchased with debt can be compared to ones purchased for all cash. Also notice there isno depreciation expense. However, lenders and buyers add reserves for repairs and capitalimprovements that offset the absence of depreciation. In this example, the buyer haseliminated $40,000 of revenues and added $30,000 of expenses. He has cut net income by$70,000, and his perception of value may be $600,000 to $700,000 below the seller's.Unless the buyer, seller and lender have similar perceptions of income and value, theremay be no sale.

Improve Your Income

Because every dollar of current income is magnified into almost $10 of sales price, itis worthwhile for a seller to maximize income before marketing begins. Income that iscreated before the marketing package is prepared is "current" income, whileprospective income (which is more tenuous) is relegated to a "proforma"(assumed) income statement.

Why does this matter? Sellers often say, "My rents are below market, but you canraise them." Buyers then reply, "If that is really true, why didn't you raisethem yourself?" One self-storage owner retained a prominent brokerage firm to sellhis facility without success for a year. He then tried to sell it at auction withoutsuccess. Then he tried to sell it himself. As a last resort, he gave me the listing and itwent under contract at full price on the first day of marketing. How? I got him to raiserents, recalculated income and showed a higher cap rate. Unlike the stock market, whichlooks forward, real-estate buyers generally look back and give more credence to actual orcurrent income. Here are some actions to consider:

What Cap Rate Is Appropriate?

Cap rate is an investor's yield, i.e., net-operating income divided by the sales price.Cap rate is the inverse of the price/earnings ratio used in the stock market, except thatearnings are calculated differently. Just as price/earnings ratios vary over time bycompany, cap rates vary by time, geography, quality and risk. Investors expect higheryields for small facilities (under 40,000 square feet) and ones in bad locations (poorvisibility and access). They pay premiums for good demographics: rapid population growth,high density (over 100,000 residents in five miles), high household income (associatedwith high rents) and a high concentration of apartments. Apartment renters need storagebecause they lack space and move more frequently than homeowners. Buyers pay a premium ifthere is vacant land for expansion, especially if restrictive zoning presents potentialcompetitors with a barrier to entry. According to the Self Storage Almanac, theaverage cap rate for approximately 200 transactions is 10.5 percent (although the Almanacincorrectly calculates it at 12 percent).

Financing Affects Value

Theoreticians argue that financing does not affect value. Look at the counterexamplepresented in chart 3, "Financing Affects Value," and see if you agree.

In this example, financing that is only 2 percent lower in interest rate (8 percent vs.10 percent) earns 50 percent more cash after debt service. Many investors base theirpurchases upon "cash-on-cash" yield, which is net-operating income after debtservice divided by the down payment. Cash-on-cash is an investor's annual"cash-in" divided by his initial "cash-out" (down payment).

Sellers can raise their sales prices by offering attractive financing. If a selleroffers a $200,000 second loan at 10 percent interest for five years, the buyer's cash flowdrops by $20,000 per year ($200,000 x 10 percent). However, the cash-on-cash return risesto 20 percent as the down payment drops by $200,000 ($45,000/$226,000 = 20 percent). Moreimportantly, many investors who have only $250,000 to invest (and cannot afford otherlarge facilities) will make offers and bid up the price.

A Good Broker Affects Value

You can buy a stock over the Internet for a mere $12 commission, but a real-estatebroker may charge you $100,000. Why? Real estate is not a commodity with exactspecifications like books, computers, stocks or automobiles that can be readily comparedand purchased over the Internet. Real-estate income statements lack generally acceptedaccounting principals enforced by a regulatory agency and, therefore, lack comparability.How can you compare cap rates when the income statements they are based upon are prepareddifferently? Buyers focus on reliable sources of information to waste less time.

If twomathematicians are given a problem and one fails to solve it, there is no amount ofmoney--no matter how small--you would want to pay the one who failed. One-third of listedproperties do not sell at all and are like the unsolved problem. Similarly, if you hire anattorney and he loses your case, he has a negative value. Many self-storage propertiessell, but at prices below their worth. Some sellers who will not list their property witha broker will then accept an offer from a buyer represented by one and watch helplessly asthe broker immediately resells the property at a huge profit. Even self-storage appraisalsoffer no assurance of fair market value. As an example, I sold one self-storage facilityat $2,104,000 just after it had been appraised at $1,700,000 because the appraiser wasjust wrong.

The photograph above demonstrates the importance of perception. Do you see ametro-Atlanta dump site? If so, this illustrates the rule that "believing isseeing," not vice-versa. You are actually looking at a drive-in volcano on the islandof St. Lucia. You believed and, therefore, perceived it differently. Good brokerage doesthe same thing--and affects value.

Burt Gay is a self-storage broker at Marcus & Millichap, the nation's largestinvestment property brokerage firm. Last year the company's 550 brokers sold more than $5billion of real estate and, during the decade, sold $200 million of self-storage. In thefirst eight months of 2000, Mr. Gay has personally sold 14 self-storage facilities worth$20 million. Several of his sales included self- storage facilities in rent-up or inoverbuilt areas where his prior experience as a CPA enabled him to structure unusualfinancial arrangements.

Mr. Gay has been a popular speaker at numerous self-storage trade shows and for theGeorgia Storage Owner's Society. He graduated from Princeton University, received an MBAin finance from Wharton and became a CPA at Coopers & Lybrand. Last year he receivedthe Certified Commercial Investment Member designation. For more information, visit www.mmreibc.com.