Moving to the Next Phase

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It's no secret that a lot of thought needs to be given to breaking ground on a new self-storage construction project. And before one spade of dirt is turned, a wise developer will have completed a thorough feasibility study to determine just how realistic the project looks. But even the most detailed feasibility study will not guarantee success. Risk is part of every project, but fortunately, there are ways to ease the risk factor of constructing a new self-storage property. One way is phasing, the preplanned strategy to build or expand a facility one step at a time, where a developer builds a facility, watches business roll in and, if supply cannot fill demand, build additional units to keep up with that demand.

Taken at face value, phasing may seem more expensive, and it can be, but the operator who phases will have the valuable knowledge of tested waters with phase one and will have a better idea if more units are necessary to satisfy the market.

Moving to the Next Phase

The next step to determining if a facility would benefit from phasing is to look at demand. If the facility is full, the phone continually rings with perspective renters and price increases are being absorbed by the market, it may be time to expand. All indicators show that the facility can handle more occupancy. Now that you've been down this road before, building the next phase should be easier than starting from scratch in an untested market.

"Overall, it pays to build a project in phases if you've got any decent-sized project--by that I mean a project that's 50,000 or 60,000 square feet or above," says Neil Gaunce, a sales representative for Tacoma, Wash.-based Tech-Fast Metal Systems. "You can come in with a 30,000-square-foot first phase, then balance it out with a second or even a third phase."

Unit mix may provide the most difficult area of the new phase, but the facility's own rental-unit pattern is probably the best determining factor in this issue. Compare the average percentage of rented spaces in each size to the percentage of units built in those sizes. It should be easy to see which unit sizes are most in demand.

"Normally, I see variations in the second phase," says Gaunce. "The original plan usually lays out the unit mix for the whole project. But when we go into the second phase, we will see a change where you'll have a big demand for larger units or smaller units. And drawing on paper is easier to shift than in the field after the project's been built. It makes more sense to wait for the demand to tell you what you need, than it does to guess at what you're going to need. The client base doesn't always do what we want it to do."

The next step should be to examine how fast the facility's units are renting. Let's take, for example, a 40,000-square-foot facility with an average unit size of 100 square feet. A unit occupancy of 80 percent that has rented an average of 13 units per month over the past two years should be filled up in about six months.

For construction time, a good gauge is to figure a month and a half for every 10,000 square feet, plus one month for development. If you're not sure about committing to another building and are considering rearranging the current unit mix in the existing building, keep in mind that it takes as much work to do the latter, and if it entails moving and replacing doors, it can be expensive.

John Wilson, CEO for Houston-based American International Construction, says the time to put up the remaining phases hinges on work done in the initial construction phase.

"Sometimes people do all the dirt work and underground and not the building. Other times, people don't do anything. What you're phasing will be determined by the lead time on what you have to get done," says Wilson. "If all you have to do is finish the interior of a building, that takes about three weeks, so you can wait until the last minute. If it's a multi-building job and you have buildings that aren't developed completely, then it might take eight weeks. It all depends on what you've left for the phase work."

Be sure to do your homework on the competition around you and check with the local zoning department on the status of vacant pieces of land surrounding your target area. That blank piece of land on the corner could shape up to be your biggest competitor.

The Advantages and Disadvantages of Phasing

The concept of phasing is not new. In fact, it has been used successfully by all kinds of real-estate developments around the country. It is essentially "master planning" a project by determining the number, size and locations of add-on projects long before they will be built.

When separating one phase from another, it's basically where the developer chooses to draw the line. Knowing the advantages and disadvantages of phasing is a huge plus.

The Advantages

There are several advantages to phasing. At the forefront, phasing allows the developer the flexibility of already knowing his market and what the needs of the facility are. The earlier phase can serve as market research for the operator to understand what kind of unit mix is required for the next phase. If the operator gets more calls for a specific unit size not available in the first phase, he can add that or other sizes in the expansion.

"Most people start out with a fairly standard unit mix and as the demand and customer base grow, it will tell them what to build for the second phase," says Gaunce. "That way they're coming into the second phase with a more assured client base instead of guessing what it might be. It is formulating a business plan that has depth to it and some assurance that there is going to be some return on the investment."

Wilson says another option is to phase in climate control. "If you make 20 percent of the units climate controlled spaces in the initial phase, but don't know whether it should be 40 percent in the remaining phases, as you fill up the first phase, you can make a decision as to how much climate control you need in the second phase," says Wilson.

Another advantage of phasing is that it minimizes risk, initial capital and overall debt. By building in phases, an operator can avoid tying-up capital and paying interest on a large facility that at the time can only absorb 75 percent of its capacity. As for unit mix, why build a facility that may need adjustments at a later date, at extra costs?

A financial advantage of phasing can be seen in financial institutions that provide interim financing for development of self-storage facilities. They may view a phased project as a way to minimize risk, which sometimes can be the deciding factor in getting a loan.

In fact, some loan agreements can include provisions to provide financing during all phases of the project. Often, loans with phase financing include performance clauses, which give the developer the OK to continue with expansion as soon as certain details are met on the original or previous phase, such as a steady occupancy rate, among others. This type of financing--committing one or more phases of a project--will reduce risk and also makes financing and closing costs less expensive.

A big plus is that revenues created through a phasing project can be applied to future expansion. By way of example, the developer of a 20,000-square-foot initial phase of a 40,000-square-foot project--with later plans to add four, 5,000-square-foot phases--can keep debts low and use the money generated from the existing property directly on the next phase.

"If the developer builds the whole project (at one time), they're starting out with it 100 percent empty, and it's obvious that it is going to take some time to fill up," says Gaunce. "But they are also paying interest on that money the entire time. What they are doing (by phasing) is being smart investors by using their money and limiting the interest payments on the whole project until they actually need that additional space. They're working the program like it should be worked, as a financial investment, rather than dumping money in it and hoping it fills up."

The Disadvantages

As good as phasing a facility can be, like anything, there is a downside. Mainly, the disadvantage lies in the inescapable fixed costs that sit with the initial phase until the others are built. The costs are broken down into categories such as office/apartment, security/access-control systems, business start-up and some site-development costs.

An example would be an office/apartment that costs $60,000 and adds $2 gross building square footage to a 30,000-square-foot-project. Conversely, the same $60,000 office/apartment adds only 80 cents to the gross building square-footage rate of a 75,000-square-foot project. It requires 30,000 to 35,000 net-leasable-square feet to afford the development cost of the office/apartment in most markets.

Combined with the high overhead needed for the initial start-up stage, the break-even occupancy requirement will be high. Most likely, it won't be until the next phase is completed and leasing begins that the fixed costs will begin to spread over both phases.

And there are times when construction costs will also be more expensive when phasing buildings later than during the initial construction time period.

"A disadvantage is sometimes you have to pay for a premium for the additional cost of the second phase and you run into a situation where you're bringing in crews for a second time," says Gaunce. "A lot of times you're paying more for labor and you may pay a little more in freight for oddball shipping quantities."

Conclusion

Self-storage development should be rooted in detailed market research. Market demands for storage space and unit sizes should be studied, along with the square-footage requirements needed to carry the up-front fixed costs. Also, don't use the extra units in hopes of pulling the accounting ledgers into the black. Make sure the initial phase will be stable on its own before moving onto any other phases.

Sometimes developers hold off on building the office/apartment or installing the security systems until a later phase. It's a choice that has to be made by the developer, but should never jeopardize the first phase or give an advantage to any competition in the area.

Phasing in the self-storage industry has many advantages. It can lessen risk, up-front capital and debt requirements, and is accepted by most financial institutions. Like anything though, it has to be properly planned and executed before the advantages are earned.

Tips on Phasing

Whether you've been down the self-storage road before or are a first-time developer, any phasing or expansion project needs to be carefully researched. You can't eliminate the risk completely, but being prepared through solid research and knowing all of your options can only make life easier in the long run.

  • Conduct a thorough feasibility study.
  • Check out how the competitors are doing. Are they close to or fully occupied? What are their most popular unit sizes?
  • Does your initial phase make enough income to stand on its own? Jaime Lindau, sales manager for Tracte Building Systems, says the break-even point for the initial phase is generally 80 percent occupied. "Normally, a bank wants it 70 percent occupied before they're going to let go of some money to build the next phase," he says. "So in reality, when an operator pulls the trigger on the second phase, they haven't made money yet."
  • Is your financing secured to embark on another phase, expansion?
  • Have you considered RV and boat storage as a viable option if the market demands such a service?
  • If you've run out of contiguous property space, consider a satellite operation--one in which you build an additional phase on property down the road, but still manage it from the original office.
  • If you're trying to cut a few corners on an overextended budget, you might try to phase security systems or climate control in at a later time when finances become a little less tangled. Keep in mind, though, you'll save a bundle if you at least install the wiring and duct work during the construction process.
  • Build as much of the future phases as possible in the initial phase. "We recommend people do all the underground work for the whole project because then you don't have to bring in the big bulldozers anymore," says Lindau. "We've had a number of people who build one building to start, but put two slabs in. Then the next time, they build another building and put two more slabs in again. That way, they kind of hop-skip themselves."
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