By R.K. Kliebenstein
There are three basic approaches to valuation that are commonly recognized in commercial real estate. The first is the income approach, which we discussed in detail in the September issue. The second method of evaluation is the "cost or replacement approach," and the third is the "sales-comparison approach." This discussion will help you understand these last two approaches. While they both play minor roles in the overall valuations of the facilities, they also can be benchmarks in determining value for insurance purposes as well as other non-traditional acquisitions or refinance disciplines.
Cost or Replacement Approach
Perhaps the easiest method of supporting valuation at cost or replacement is a per-square-foot calculation with a factor that represents the average cost to rebuild self-storage. This is perhaps the most simple method, although not the most accurate. It has the greatest utility when being applied to an existing facility, but becomes much more difficult and less objective as one considers this for a vacant land/development site.
If your goal is to obtain a rough idea, and extreme accuracy is not important, one could easily call any of the major self-storage building contractors and ask them what is the average cost per square foot for building self-storage facilities in a specific locale. Add the cost of land, and you have a value--albeit not a very accurate one. Nevertheless, if this is juxtaposed to your current site, you will get a rule-of-thumb valuation.
The cost approach can be very accurate when properly applied, for example, on a new or proposed facility. The challenge in using the cost approach on an existing, or particularly old building comes in trying to estimate total accrued depreciation.
Additionally, it can be said that the cost approach is a reflection of cost and not value in up markets. Most institutional investors and lenders today are starting to ask for the cost approach as they wish to know a couple of things only the cost approach can tell them.
First, they want to know they are not overpaying or over-lending, because no property is worth more than the cost of obtaining an equally desirable substitute property. Secondly, they want to test the question of highest and best use, which they can do only by knowing the land value. Thirdly, they need to know the insurable value, which is based upon costs.
Most investors want to know the ease of entry into a market. The availability and cost of competitive sites would be disclosed by a cost analysis, as would the cost of building a modern and highly competitive facility.
Contact with self-storage and/or building construction companies can often provide the greatest amount of useful information in determining a valuation through cost approach.
To become more precise or to measure this valuation in a development application, let's first start with land replacement. Land replacement has several factors that must be identified in the valuation process, including the following:
Traffic Count Demographics
- Size of Parcel
- Proximity to Development
- Neighborhood Attributes
- Availability of Utilities
- Environmental Issues
- Deed Restrictions
- Ease of Obtaining All Entitlements Necessary to Construct Self-Storage
One could spend a great deal of time analyzing each of these, but let's focus on the most important:
Traffic Count. The benchmark for traffic count in a 24-hour period is approximately 10,000 cars. Anything less than 10,000 devalues the property and traffic. Inversely, a traffic count of more than 10,000 enhances the value. It should be noted that the count itself is not the only factor. Other considerations include the speed of traffic, size of the window or opening through which the site is viewed, barriers to access, ease of ingress/egress and signage restrictions.
Demographics. While there are no absolutes in demography that point to a successful self-storage facility or the value thereof, one would only point out that population counts within a market area should be approximately 25,000. Equally important in the analysis of how many are in the population count are the number of self-storage facilities that serve that population count. Other key demographic indicators are persons per household, median income per household, median income per capita, median age of household, percent of renters vs. owners, and number of units in the structure.
Neighborhood Attributes. Perhaps the most important contribution the neighborhood makes to the valuation of the facility is the composition of its populace.
Sales Comparison Approach
While this may be the least significant of the three methods, the sales comparison approach, commonly referred to as the market approach, is also a good barometer, particularly from the perspective that no property has value unless--like any commodity--it can be sold in the open marketplace. The market approach simply indicates what comparable properties have sold for in "arm's length" transactions, which means the sale has occurred without the pressures of either buyer or seller having any previous responsibility or future responsibility to one another. That is to say they are not related parties or entities.
There are three overall market approach factors that can be analyzed in comparing the subject facility to those that have been sold. The first method is a comparison of price per square foot. It should be noted that facilities with less than 40,000 square feet are of an entirely different nature, and few comparisons can be drawn to facilities with greater than 40,000 square feet--a caveat to the latter rule-of-thumb to smaller facilities (less than 40,000 square feet) with very high rental rates.
The second methodology in the market approach would be an EGIM comparison or, more simply put, what facilities have sold for. The EGIM is simply a times-earnings ratio, for example, the sales price divided by the total collections from the previous 12 months. All discussions in the previous article about cap rates are applicable here. But, keep in mind: One should only analyze the cap-rate comparison if all of the facts of the income approach are known.
The third methodology is overall sales price. That would be to say that given cap rate, replacement costs, price per square foot, size and location, the price for one self-storage facility could be compared to another.
The most critical element in the market approach is verifiability of data. While listings and offerings may be good benchmarks in themselves, they are not significant enough to derive valuation. It is the sold transaction that governs all market approach discussions. That information should be verifiable through either the source (buyer or seller) or through a credible third party who has had access to documentation provided by buyer or seller to determine value.
A good relationship with an MAI appraiser who may be able to share this data would be significantly helpful in determining the market approach of valuation to a property.
One Final Word
A professional real-estate appraiser should play a significant role in determining a value for your property. Be very selective with whom you engage for the appraisal process. Check the certifications and designations, but also have the appraiser establish credibility through experience. Nothing like the tried-and-true experience in performing 40 or 50 self-storage appraisals can be substituted. It is not a belief among institutional buyers or financiers (generally) that a local MAI appraiser has any advantage over an appraiser who works on a global basis and has in-house databases and access to sale information. It should be noted that most local appraisers do not have the resources of a national appraiser, but that those appraisers who specialize in self-storage appraisals will often use the services of a local appraiser to get specific information from the venue of the subject property. Finally, it may be in your best interest to seek the services of an appraiser who has specialized in self-storage real estate.
The valuation process by an owner is often the most difficult because it lacks objectivity. The purpose of this reading is never intended to replace the professional appraisal, but simply to give storage owners a view of valuation from an institutional purchaser and former financiers' perspective.
R.K Kliebenstein is the director of acquisitions for The Amsdell Companies of Cleveland. Prior to his current assignment, he worked for Westar Management in Las Vegas, where he was responsible for new store marketing. His tenure in real estate dates back to 1979, with a focus on self-storage since 1990. Mr. Kliebenstein may be reached at (800) 234-4494, ext. 227.