The Cost of Storage Development
|Copyright 2014 by Virgo Publishing.|
|By: RK Kliebenstein|
|Posted on: 09/01/2005|
The recent explosion of self-storage building has left many developers— seasoned owners as well as neophytes—questioning if it is a prudent time to build. The primary issue is risk vs. reward. The days of yields in the 14 percent to 16 percent range are over. Even the industry standard of 13 percent is unlikely in the current environment. What is driving down returns? Higher costs—for land, development and construction.
Much of the increase in land costs is attributable to a robust real estate market—a “seller’s market” in many locations—and the fact that storage developers are competing with major retailers for sites. Rolled up with the purchase price of land are hard and soft development costs. Hard costs include things like land fill, demolition, grading, traffic access and utilities. Soft costs include environmental testing and monitoring, legal fees for zoning and permitting, engineering and others. These are just a few of the indirect expenses affecting projects.
Financing fees are also increasing. “As the Feds have continued to raise short-term interest rates, it has become more expensive for developers to pay back construction loans,” says Eric Snyder of Buchanan Storage Capital. “In many cases, the interest rate on a long-term, fixed-rate loan is lower than that on a short-term construction loan.”
Finally, direct construction costs can diminish returns. Many municipalities now demand more aesthetic facilities with stone, brick, block or siding. These “gingerbread” additions increase spending. Building requirements for fire, wind, flood, mold and seismic activity also heighten expenses. Understanding the difference between firewalls and sprinklers, for example, and getting good advice from an architect, can aid in strategic decision-making at the early stages of development.
“We hear from many lenders and owners that the self-storage market is generally overbuilt. This is confirmed by the facilities on which we are funding permanent loans—the properties have topped out in the 70 percent occupancy range,” admits Snyder. “However, we are still funding loans for owners who have capitalized on a unique location and leased up in less than 12 months. In other words, these opportunities are much more difficult to find, but they exist.”
While stabilization can be a challenge in some markets, a healthy project, created with the assistance of qualified self-storage consultants and professionals, can achieve absorption. There are several key factors to measuring stabilized occupancy. All these considerations are relative to the strength of the market:
1. How long it takes to reach the target level.
2. How long the target level can be maintained.
3. How much discounting occurs and whether it impacts economic vs. physical occupancy.
4. How much equity is required to fund the construction loan, and the anticipated return on investment.
Thanks to assertive lenders, stabilization is less critical to financing than in the past. “Permanent lenders have become much more aggressive in their takeout of construction loans, so a developer only needs to achieve stabilization for three months prior to loan funding,” says Snyder. “In the past, lenders required 12 months of stabilization prior to funding a permanent takeout loan.”
Is It Boom or Bust?
The bottom line is location. A poor location will likely destroy the possibility of rich rewards. It’s critical for developers to understand site selection, particularly as it pertains to self-storage. Traditionally successful locations carry new risks in the face of increasing competition, which can result in an overbuilt market.
Most “boom busters” correspond with institutional-grade sites, which are readily sold to aggressive self-storage buyers. They leave tremendous opportunity for entrepreneurs to find niche markets, developing vertically rather than horizontally, as many institutions are likely to do. Sometimes a site’s value has to be created. Developers shouldn’t let this “opportunity” hinder their pursuit, though they should ensure the site is saleable.
“The key to development in today’s environment is homework, homework and more homework,” advises Jim Chiswell of Chiswell & Associates LLC, a self-storage consultant. “Site selection cannot be left to chance, or abandoned because you already own the land. Also, it isn’t enough to have deep pockets. The basic formula for new-project success is still in place. Opportunities in our industry still exist, but using caution and getting advice upfront from self-storage professionals has never been more important.”
The Path Less Travelled
Seeking out conventional markets in which the basic tenants of site selection easily apply is a sound approach. However, if you are flexible, there are less-traveled paths with higher risks but promise for rich rewards. Some of these opportunities include:
A reputable consultant should be able to guide you through the labyrinth of risk analysis, alerting you to higher hazards.
Is it too late to set sail with self-storage? Not for hard-working , innovative, research-driven entrepreneurs who are willing to test the principles of supply and demand. Do your homework. Do more homework. Be well-capitalized. Don’t rush into transactions. Create value. Build wealth.
RK Kliebenstein is the president and CEO of Coast-to-Coast Storage, a self-storage consultancy firm. From feasibility studies to financing, Mr. Kliebenstein has a wide range of experience and expertise in development and acquisitions. He can be reached at 877.622.5508, ext. 81.