By Chris Weismiller
As self-storage grows within the commercial real estate industry, new investors are increasingly entering the market. Many are starting from scratch with no prior knowledge of the business. If you’re in this situation, this article will help you navigate the buying process.
Before You Invest
When considering an investment in self-storage, first ask yourself:
- What do you want to get from your investment?
- What’s your long-term goal for this property?
- Are you investing solely for an income stream, or to eventually sell the site for a larger profit?
There are many reasons people choose to invest, and it’s important to have a plan and an exit strategy from day one. This will align your goals and implement a process to be successful and manage costs.
When looking at property for purchase, first consider the functionality of the site. Is it big enough to run efficiently from a financial perspective? Is it a class-A facility in top shape or a “fixer-upper” that will require a little TLC to turn a profit? It’s important to gauge the potential of the facility so you know what to expect. The easiest way to do this is to examine its size, expansion capabilities and expense ratio. Let’s look at each.
Property size. The scope of a facility is important because different sizes require different operating procedures. Remember, the less rentable square footage you have, the less income you’ll make. If you buy a site that’s too small, you run the risk of it not being financially feasible. If you do opt for a smaller site, consider running it via an automated kiosk rather than a flesh-and-blood property manager. This can save as much as $50,000 annually. For a small facility, that’s a lot of cash flow.
Expansion capabilities. Examining the future potential of a facility is also important because adding to an existing property will allow you to create more rentable income. It’s cheaper to build self-storage than other types of real estate. A small investment in an expansion could double your profit in the long run.
Expense ratio. Facilities should ideally run at an expense-to-income ratio of 30 percent to 40 percent. If you’re seeking to invest in a low-performing facility to turn it around and make a profit, look closely at the expenses. Are there things you can cut or places where you can save money? Can you raise the rent to grow income? There are many facilities that seem to be under-performing or a bad investment; however, with the correct management, they can be successful.
We’ve talked about property characteristics to consider, but it’s also important to be aware of red flags. The below items can be more hassle than they’re worth, causing delays in the sale process, which can generate more issues. Avoid properties with the following challenges:
- Environmental contamination: For example, there could be an oil tank on the property or an adjacent parcel that’s slowly leaking onto your site and contaminating the soil. As the new owner, you’d be responsible for fixing this problem. This can delay the sale and cost a lot to remediate.
- Easements: Make sure you understand what, if any, easements are on the property as well as the associated process and costs. For example, an easement for water or draining needs to be properly documented. If it isn’t, it could lead to the need to create a new easement for entering and leaving the property, which will cost you time and money.
- Zoning: Find out if all connected parcels, including expansion land, are properly zoned for self-storage. Also, ensure the zoning permits the total square footage of any potential expansions.
- Capital expenditures: Understand which capital improvements the seller has completed as well as any deferred improvements and repairs, such as a new roof. If there are a lot of deferred items, or they’re high-ticket items, it can cost you extra up front.
- Tax reassessment: Understand the tax laws in the area, as property taxes vary in each location. It’s best to contact the local property assessor who handles self-storage and discuss how the sale will directly affect the property’s assessed value.
- Leasing vs. owning land: Make sure the seller owns the land and isn’t leasing it. A lease will complicate things and add more parties to the mix. The more groups connected to this process, the less control you and your broker will have.
Due diligence is a critical aspect of any real estate transaction. This is when you’ll investigate whether a property is worth the money and risk involved. Most due-diligence periods range from 30 to 45 days. Once this period has passed, your earnest-money deposit becomes nonrefundable, so make good use of the time. The process should consist of numerous inspections, audits and third-party reports to verify the property is a suitable investment.
For this process, you’ll want a transactional attorney on hand to review legal documents and investigate pertinent issues. He’ll need to look over things such as the purchase and sale agreement, title-insurance binder, zoning compliance, and environmental reports. You’ll also want him present at closing (on the day of escrow, when deeds are filed and funds are received, etc.). It’s best to work with someone who understands the self-storage industry and has experience in real estate transactions.
First, you’ll need to ensure everyone knows and agrees with all deadlines set forth in the contract. People often assume everyone is on the same page, but contracts typically include legal language that specifies how dates should be counted.
After securing a great attorney and setting up a timeline, evaluate the property’s physical condition. When you conduct a site visit, pay attention to the condition of the roof, asphalt, unit doors, fire-sprinkler systems and HVAC units, as those will cost you the most if they need repair or replacement. In addition, you’ll conduct an environmental audit. You’ll also want to confirm any financial information and other documentation provided by the seller and conduct an in-person, onsite lease audit.
Lastly, investigate the financing of the sale. You need to know if the purchase will require you to assume the seller’s current financing or secure a new loan. You may need to demonstrate your ability to obtain funding. If you must finance, work with a qualified mortgage intermediary who’ll contact several prospective lenders to get you the best loan terms. Be prepared with any paperwork a lender might require to keep things moving.
While investing in self-storage can be beneficial, there are important steps you need to take early in the process. Follow the advice above and you’ll make the right investment decisions and be successful.
Chris Weismiller is vice president at SkyView Advisors, a national investment sales, debt and equity and advisory firm focused exclusively on self-storage. He assists owners and sellers through a range of advisory services, including acquisition, disposition and recapitalization strategies, asset valuation, joint-venture structures, and debt and equity financing strategies. For more information, call 813.579.6363; visit www.skyviewadvisors.com.