Buying or Building Self-Storage: How to Maximize Your Investment Through Design, Phasing and Market Analysis
|Copyright 2014 by Virgo Publishing.|
|By: Benjamin Burkhart|
|Posted on: 02/01/2012|
I'm often amazed at the things self-storage owners or developers do when designing their self-storage projects. During a recent self-storage sale, a potential buyer thought he could achieve a particular upside since the facility was only operating at about 70 percent occupancy. The building was big—more than 100,000 square feet—on a terrific four-lane urban street with lots of traffic and high visibility. But upon closer inspection, we discovered the office was inside the gate, and there was no parking, not even a place to pull off of the road and into the property. The developer/owner had made a crucial mistake that might forever limit the asset's potential: terrible access.
In designing a self-storage project, an owner of developer can shoot himself in the foot by trying to maximize square footage or unit mix while forgetting that his intention is to maximize his investment. Whether you're building a self-storage facility from the ground up or looking to buy one, it's important to understand the market and create the right investment strategy.
The Market Drives Design
A greater number of units always makes a project look better on paper. Of course, on paper, we can be tempted to make big assumptions about demand, lease-up and future potential. However, bigger is not always better.
Developers often ask questions like, “How many units can I get on a three-acre site?” That’s a loaded question with no definitive answer. In a project's infancy, the temptation is to use a ballpark estimate for what can be built; if that looks satisfactory, maybe the developer proceeds. This is the wrong approach.
Some developers approach projects with a target square footage in mind. I often hear “80,000 square feet” stated as if that’s a reasonable target. Keep in mind as you design that not all markets will absorb that much store. A lot of newer, larger facilities fail to reach target occupancy because the project is just too big. If only 30,000 people live within five miles of your site, a 60,000-square-foot facility is probably pushing the envelope.
It always comes down to supply and demand. We need complete market analysis and reasonable investment modeling before we even begin to consider project size. The actual demands of the market should drive the key surface elements of facility design including size, unit mix, curb presentation, office, climate/non-climate, access and signage.
Phasing a new project is, in most cases, the right decision. Every market is unique in consumer demand, seasonal trends and economic incentives that influence rental velocity. When you understand market demand on these levels, you can make better decisions about when and how to launch your new product. While market demand isn’t the only consideration in construction phasing, it should be pretty high on the list. If you over build your first phase, you may never recoup the lost interest cost. If you under build, you risk losing competitive traction or leaseup speed.
For example, in one particular market, monthly move-ins average 25 per month, and the average tenant rents for six months. During the summer months, rentals may be as high as 40 or more per month. During off-peak months, the market leader uses an incentive, offering the second month for free and discounting street rates at about 10 percent. This information helps you understand what to expect from leaseup and can help you develop a reasonable phased approach to building.
In this example market, it’s prudent to expect net rentals in year one of operation to reach or slightly exceed 180 units. This type of information can help guide your design process and investment strategy. If you know your market will only net 150 units in the first year, 200 to 250 units might be a reasonable phase one, even if the overall, long-term expectation is the market will absorb 500 units.
I’m not trying to oversimplify the decision-making process. Developers create and attract many incentives to build more units in their first phase: price of steel, economies of scale in construction, and finishing a project. But if you know your market will only absorb 150 units the first year, you have to weigh the economic cost of over building—and there is a cost.
When you sit down to pencil out the costs and benefits of phasing a project, don’t lose sight of the development as a whole. Are there site-work items you can more easily absorb in phase one? How can you keep the future construction of additional phases from hurting your ongoing business? What are the key triggers and considerations for moving ahead with the next phase?
For all you investment nerds, don’t get paralyzed in all the details and never move. Just know that when you understand how demand moves and how it will drive our business, and then plan to respond to that demand, you create sound strategy for maximizing your investment, not just your site.
Lipstick on the Pig
Self-storage buyers often ask questions like, “What are some of the better markets for self-storage?” and “What is the best way to invest in self-storage businesses?” Well, here’s the big secret: There is no secret. It’s hard work, and it takes a lot of time.
Finding good sites or acquisition opportunities can be grueling and overwhelming, especially without the right focus, team and tools. Maximizing investment in an existing self-storage business is asset- and market-specific. For the small operator to make a good investment in an older self-storage operation requires taking a comprehensive look at the physical site, specific micro-market dynamics, and the prevailing business model and financials. With these details, you can determine the overall investment picture and identify the risks and possible upside of acquiring and managing the asset.
As I go from market to market, I see a lot of older sites, often in good locations, with a poor operations and management profile and obsolete physical features. It was easier 20 years ago to find a quality location for self-storage. Some of these operators, while innovative in bringing their product to the market, have been surpassed by current customer demands. This can create an opportunity for buyers who can develop and implement the right vision.
Often it doesn’t take a whole lot to improve a self-storage acquisition. In almost every U.S. market, I see stores lagging behind their true potential. When facility managers are complacent and the necessary site maintenance is overlooked, the asset begins to die. But some of these dying assets could be opportunities for buyers interested in doing the work and breathing life back into the business.
Every asset is different and every market unique. But it’s not uncommon to see weaker stores in healthy markets charging lower rates. These stores often lag behind the market leaders in achievable rental rates and occupancy, and yet customer demand trends toward the leaders. A $10 rental rate difference between the market leaders and weaker stores isn’t unusual. For a potential buyer, though, this might represent a huge upside.
With an acquisition, you’re not always stuck with the mistakes of the previous owner. In fact, it may create some opportunities. Renovating an office, repairing driveways, creating better access, training a good manager, replacing signage, or adding a move-in truck, landscaping, a security display, exterior lighting, or other aesthetic or management enhancements to an older property can make it more attractive to the demanding customer, and enable older stores to achieve stronger rental rates and higher occupancy.
Today’s customer demands a better product than what was built 20 years ago. But again, it doesn’t take a whole lot more to do things right.
For example, take a 400-unit store operating at 75 percent occupancy and charging, on average, $80 for a 10-by-10 unit. Let’s assume the average unit size is 100 square feet and actual monthly rent is averaging $24,000 (300 occupied units at $80). Also, we’ll put this asset in a market whose leaders report 85 percent occupancy. Using some reasonable assumptions (8.5 percent cap rate, 38 percent operating expenses), perhaps we can acquire this asset for $2.1 million.
Our due-diligence reveals a $200,000 renovation budget might realistically allow us to achieve a 5 percent increase in rental income. If our upgrades allow us to boost occupancy from 75 percent to 80 percent, we achieve an increase in asset value of nearly $400,000. If our improvements enable us to reach 85 percent, which isn’t unrealistic, we’ll see an increase in asset value of about $600,000—a pretty good return on investment.
And the quality and longevity of our investment increases as we sharpen our competitive edge. When I run long-term, hold investment returns on these types of scenarios, it’s not uncommon to see the internal rate of return increase by 3 percent to 5 percent.
Getting into this type of asset, however, takes a lot of work. It’s work to find it, work to analyze the opportunity, and it’s work to make it better. But it can be worthwhile when you’re committed to doing things right. We have to understand how the demand in our specific market guides our investment strategy for moving an asset up the competitive ladder.
Whether you build or buy a self-storage project, develop your vision, pay attention to the details, understand your market, and then commit to the necessary work that will get the most out of your self-storage investment.
Benjamin Burkhart is a professional self-storage consultant who provides developers and owners with detailed market and financial analysis and helps them create sound investment strategies. To reach him, e-mail firstname.lastname@example.org ; visit www.storagestudy.com .