The North-Central Corridor

By Michael L. McCune

This month, I gathered real estate experts to discuss the stateof self-storage in the North-Central United States. Lets hear what they have to say about their respectivecities and regions. Our panel of brokers includes: Bruce Bahrmasel and Matt Libman, The Preferred Realty Group,Lincolnwood, Il.; Larry Goldman, Prudential CRES Commercial, Kansas City, Mo.;Peter Hitler, Investment Real Estate Specialists, Mequon, Wis.; and Robert Off,Coldwell Banker Commercial, Cincinnati. These are interesting times, so I wantedto ask our brokers straightforward questions every owner and potential buyerwill find pertinent.

1. Is this a good time to sell self-storage?

Bahrmasel:

Now is an excellent time.Cap rates in self-storage are generally more favorable to investors than thosein apartment buildings and other investment properties. In addition, lowinterest rates have continued to buoy the market.

Goldman:

Yes, though there are somefundamental changes in the business some owners may not want to confront.Specifically, increased competition has made responsive, effective managementfar more critical. The inevitable rise in interest rates in the near futurebrings an increased urgency to sellers who are planning their short-term exitstrategy.

Hitler:

Storage facilities are stillselling at all-time-high prices. If an owner has good reason to sell, such as ahealth issue or retirement, the time could not be better. If a seller is tryingto reproduce his income in the stock market or other investments, it probably isnot a good time to sell, as alternative investments do not offer good returns atthis time.

Off:

I think now is an excellenttime to consider the sale of your self-storage facility. The economy is, byalmost all accounts, on the rise. Sales prices have never been higher andcapitalization rates more favorable. The housing market continues to be strongdespite a bump or two. Vacancy rates remain at generally acceptable levels, evenwith high levels of new construction. Money and loans are still available onfavorable terms and at low rates. What could be better? Unfortunately, everything has its time, and all real estatehas its cycles. As the old Wall Street proverb suggests, Buy low and sellhigh. Or as Obi Wan Kenobi said to Luke Skywalker, Sell now, and may thecycle be with you.

Heres an example to demonstrate what the change in caprates has done for you in the past year. If your project generates $100,000 ofnet operating income annually, your property value went up $150,000, orapproximately 15 percent, just based on the change in cap rate. And if you hadthe property financed at 75 percent, your equity went up 75 percent. Is it timeto sell? You tell me!

2. Why should potential investors buy self-storage at thistime?

Goldman:

Storage is still a favoredproduct type because of its relative ease of management and diversifi cation ofrisk, despite overbuilding.

Hitler:

The reason to buy is thesame as why a seller may not want to sell. Self-storage is offering very goodreturns when other investments are not.

Libman:

Self-storage has an overallbetter return on investment than alternative real estate investments.

Off:

Having just said now is anappropriate time to consider selling, I also think its a great time to buyprovidedyou are buying for the right reasons and at a price that makes economic sensefor your specifi c business. A few reasons buying today might make sense are youcan: 1) leverage your operating experience by turning around an existingfacility or one which is still in the development stage; 2) round out yourmarket/territory by filling in particular market hole/ void; 3) increase youradvertising, financing, expense and management efficiencies; 4) eliminatecompetition, thereby possibly increasing rental rates in your market; and 5)quickly break into a new marketplace.

The reason to buy is the low interest rates make yourinvestment work harder for you. This very positive leverage will increasecash-on-cash yields dramatically. It is clear the interest- rate environment isquickly evaporating, so not only is now a good time, it may be the last time fora while.

3. Are other types of real estate underperforming and drivingbuyers to self-storage?

Bahrmasel:

Yes.

Goldman:

Most product types,including self-storage, are producing far lower returns than in the past. Someproduct types, such as offi ce buildings and distribution facilities, areperceived to be riskier, due to corporate downsizing, bankruptcies and, in thecase of industrial properties, inventory controls.

Hitler:

Some other types of realestate are underperforming. Industrial and office properties are still soft. Theapartment market in the Milwaukee area is getting better. I have had manyapartment owners look at buying self-storage because they are tired of themanagement problems of residential real estate. The condo market is very strongin this area.

Off:

Without a doubt, all othertypes of commercial real estate seem to be operating in a marketplace whereowners are chasing fewer and fewer rent-paying tenants. Making those traditionalreal estate product types work today is worse than playing a zero sumgame.

Many other real estate types are experiencing high vacanciesand declining rents that make the underlying stability of the income less securethan well-located and operated selfstorage facilities.

4. Are buyers having diffi culty getting loans forself-storage?

Bahrmasel:

No, buyers in Illinoishave not been having any difficulty getting loans.

Goldman:

Lenders are still veryeager to lend on compelling self-storage transactions. They just may not be aswilling to accept overly optimistic projections in their underwriting as theymay have been in the past.

Hitler:

There is plenty of moneyavailable, although rates are creeping up a bit.

Off:

No, the money is out there forthe taking. Lenders are happy to talk with buyers with a good story,particularly if they are experienced in self-storage.

Not only is money available, but it is the cheapest it hasbeen in 40 years.

5. Are cap rates dropping in your market? What impact doesthis have on buying and selling self-storage properties?

Goldman:

Ironically, as the economicfundamentals have weakened, cap rates have also dropped dramatically. This morethan offsets the drop in value due to the deteriorating performancefor now.As interest rates (hence cap rates) increase while the fundamentals continue todecline or stagnate, valuations will very possibly decline.

Hitler:

Cap rates continue to fallin the Wisconsin market. I would say properties are on the market longer, but theystill seem to sell. Sellers are tougher on their price, and buyers dont havea lot of alternatives because of the lack of available properties.

Libman:

Yes, cap rates have droppedin the Illinois and Indiana markets. However, cap rates for alternative realestate investments are significantly lower than what we are seeing in storage.With this in mind, self-storage remains a very good buy.

Off:

The lower the cap, the higherthe price. The higher the price relative to the net income of the facility, themore buyer resistance increases. The higher the buyer resistance, the slower themarket becomes. Sad, but true!

All things being equal, lower cap rates mean higher values. It appears that in some places, not all things are equal. Its just like your mother told you, Life isnt always fair.

Michael L. McCune has been actively involved in commercialreal estate throughout the United States for more than 20 years. Since 1984, hehas been owner and president of Argus Real Estate Inc., a real estateconsulting, brokerage and development company based in Denver. In 1994, hecreated the Argus Self Storage Real Estate Network, now the nations largestnetwork of independent commercial real estate brokers dedicated to buying andselling self-storage facilities. For more information, call 800.55.STORE or visitwww.selfstorage.com.