Financial Feasibility of Records Storage
|Copyright 2014 by Virgo Publishing.|
|By: Jim Oakley|
|Posted on: 04/01/2002|
Until now, the underlying profitability of records storage has little surfaced or been presented in a comprehensive cash-flow model. Moreover, the financial advantage of codeveloping records storage with self-storage needs to be made clear. The purpose of this article is to provide general insight, via cash-flow models, into the profitability of records storage when added to self-storage.
First, the Concept
Records storage--more aptly called "records management," as it involves indexing, retrieval and a plethora of other services--is an out-of-site, out-of-mind business, the potential for which is little known. Started in the 1940s, it has become a mature industry with several professional organizations: PRISM International (formerly the Association of Commercial Records Centers), the Association of Records Managers and Administrators, and the Institute of Certified Records Managers, which provides certification. These organizations collect very little by way of operating statistics worldwide; however, the most interesting rule of thumb is existing customers of commercial records businesses increase their storage by 15 percent to 20 percent annually.
Why is records storage used? The average file cabinet holds about eight boxes worth of files. The same cabinet consumes about 9 square feet of floor space. If you are paying $15 per square foot annually for office space, these eight boxes cost you $135 per year to store or $16.88 per box per year. The average cost to store a box in a commercial records center is $3.75 per year. This translates into a monthly box average of 31 cents for storage, plus 15 cents in service fees (indexing, retrieval, etc.).
Building a Cash-Flow Model
A typical facility can generate 1,000 to 3,000 new boxes for storage each month. One industry expert claims that with an aggressive marketing plan, well-trained salesperson, diligent and consultative sales method, and managed sales cycle, the results can be 100,000 cubic feet of storage within as little as two years (one storage box equals 1.2 cubic feet).
Although this fast track is possible, the cash-flow model in this article assumes a conservative 1,000 new boxes monthly. Typical expenses have been included to arrive at net operating income. Exhibit A demonstrates projections for a 63,000-square-foot self-storage facility combined with a 110-by-110-foot records center. (Note: For the sake of brevity, this article makes several assumptions not shown here. A full statement of assumptions, including construction costs, loan parameters, income and expenses, is available upon request at www.mrfeasibility.com.)
Good News and Bad News
The bad news is it can take two to three years for a stand-alone records-storage facility to become profitable. At the end of year two, the stand-alone facility in Exhibit B has a negative cash flow of $41,641. However, the good news is if the same records-storage facility is a part of a self-storage project, it shares some of the operating expenses. The self-storage operation provides enough cash flow for both during the initial two years, while the records storage is gaining air speed, so to speak. See Exhibit C.
The Impact of Records Storage
Below is the income stream from our same exhibit, with and without records storage. A hypothetical sale is established in year five to measure the full potential of the project. The initial investment for the land and start-up is $500,000. In the records-storage cash-flow model, the construction costs for the building and racks have been added to the construction loan.
Without records storage
With records storage
In the above example, there is more than a $2.5 million increase in profit to the bottom line, which is surprising. A lot is due to the fact that existing customers stored additional boxes at a growth rate of 15 percent to 20 percent. This gives the industry a unique self-generating annuity. Special attention is called to the increased cash flow in years three to five. Notice the permanent loan has been brought online at the beginning of year three in the records-storage case. Often, a records-storage facility will not efficiently support a permanent loan until this time.
Two Big Impact Factors
A big impact on the bottom line comes from loan proceeds (the permanent loan coming online). Also, the downstream sale is very significant. Both these factors pivot on establishing market value, first at the end of year three, and then at the end of year five.
With commercial real estate, market value is most generally determined by a capitalization rate. The exhibit model uses a 10 percent cap rate; however, it should be observed that records storage is more of a business venture than a real estate investment and involves much more intensive management. Although there are several ways of valuing small-business ventures--for example, a simple way is to multiply earnings by three to five--such earnings are before interest and taxes. When there are assets such as real property or inventory, they are added to the value. The end result of such valuation is often less than using a cap rate. When records storage is added to a self-storage project, there is a tendency for a lender to establish market value with a cap rate for lending purposes. This is of great advantage to the developer. It changes the profitability outlook completely.
Some Critical Observations
In Exhibits B and C, loan payments do not occur until month 13 of operation. This occurs because interest reserve is used to make loan payments. Interest reserve is the loan's capacity to make its own payments for the first few months of rent-up. (These payments are added to the principal balance of the loan.) The interest reserve is the total amount of all the loan payments that can be added to the principal balance. This ceiling is negotiated with your banker and is best acquired when the loan package includes a monthly map of interest-reserve use during rent-up. The efficient use of interest reserve is critical to the positive cash flow of the project. See Exhibit D.
Focusing Your Loan Package
If you are going to create a loan package, the examples cited in this article point to the importance of three key points:
1) Have a monthly financial map showing the need for a specific interest-reserve amount. (This will keep your cash flow positive for the first two years.)
2) Be prepared to show why it is important to bring permanent financing online at a later time. (Generally, the records-storage project will not support a viable permanent loan until somewhat later than self-storage.)
3) Be sure your financial package shows the lender the "before and after" impact of adding records storage to your facility. You'll stand a better chance of the lender using a cap rate to establish value for your loans.
Jim Oakley is a pioneer and national authority in computer-modeled feasibility. His methodology was taught at Arizona State University and its Center for Executive Development. He has addressed major national organizations including the National Association of Corporate Estate Executives and the National Association of Real Estate Educators. His articles have appeared in Inside Self-Storage, Professional Builder and Lodging magazines. Mr. Oakley consults from Prescott, Ariz. For more information, call 928.778.3654; visit www.mrfeasibility.com.