This month, I gathered a roundtable of experts to discuss the state of selfstorage in the Western United States. Let’s hear what local experts have to say about their respective cities and regions. Our panel of brokers includes: Richard Arnold, Arnold/Forcum & Associates, Portland, Ore.; John Battle and Clifford Crowe, Lee & Associates, Carlsbad, Calif.; Larry Hayes, Hayes & Associates, Missoula, Mont.; and Joan Lucas, Joan Lucas Real Estate Services, Denver. Because of the unique economic times in which we find ourselves, I have contributed comments on the national market as well.
Why should investors in other real estate types think about investing in self-storage?
Arnold:Besides the lower maintenance costs and the ability to put their eggs in many baskets, investors should consider self-storage for the greater return they can achieve than from most other types of real estate. Buyers are currently purchasing other real estate showing returns of 7.5 percent to 9 percent, whereas buyers acquiring self-storage properties are showing debt-free returns of 9.5 percent to 10.5 percent.
Battle:Self-storage as a real estate investment vs. other property types offers many advantages: low maintenance, virtually no roll-over expense, no long-term tenancy, and no barriers to entry, especially in many areas of the West.
Crowe:Those self-storage facilities that have sold in Southern California are yielding to the purchaser approximately 1 percent or more yield than office, retail or industrial products, and 2 percent to 3 percent more yield than apartment investments.
Lucas:It’s the good news/bad news story. Potential investors should think about getting into self storage because it is an industry that seems to be relatively (but not totally) recession-proof; it provides great returns on investment with lower overhead, repair and maintenance than other types of real estate. Two people can manage a property that is 45,000 square feet. When a customer moves out, the manager sweeps out the unit, closes the door and waits for the next guy to come along. And lenders still have money available for this type of product. The bad news is there are very few good, well priced properties on the market. Hence, those properties that are on the market are often priced at aggressive cap rates.
Hayes:Self-storage is still providing a better return on investment than most other real estate investments. In our area, it is providing a 2 percent to 3 percent better return than apartments or NNN (triple-net) properties.
A percentage point or two may not sound like much, but it is a 10 percent or 20 percent increase in cash flow!
What kind of returns can an investor reasonably expect before and after debt service?
Battle:Returns in California before debt service range from 8 percent to 9.5 percent, depending on location, age and competition. After debt service, the cash-on-cash returns vary widely, depending on whether the financing on the property was placed within the last six to 12 months. If that is the case, the returns would be in excess of 10 percent.
Crowe:You can expect an 8.5 percent to 9.5 percent capitalization rate (annual return before tax) and 10 percent to 12 percent cashon- cash return, assuming 25 percent down and 6 percent financing. While these returns are great in California today, I’m encouraging some of my buyers to look out of state, where they can get higher cap rates and higher returns.
Hayes:Depending on the quality of the facility, an investor can expect between 9.5 percent and 11 percent. A facility with a 10 percent return based on cash, leveraged 75 percent over 20 years with 6 percent interest, would give a return in the 14 percent range.
Lucas:Let’s say a property is sold for $1.4 million. It kicks off $140,000 in net operating income (NOI) per year. The investor will usually put down about 25 percent of the loan amount, leaving a balance in the amount of $1,050,000. His NOI the first year is $140,000, and he puts $350,000 into the deal, so his cash-on-cash return for the first year (before debt service) is 40 percent. How cool is that? However, then we calculate return after debt service. Let’s assume the buyer gets a $1,050,000 loan at 6.75 percent, with a 20-year amortization and a five-year balloon. His annual approximate debt service would be $96,000 (before taxes) per year. Therefore, if the site was netting $140,000, his after-debtservice cash would be $44,000. Cash-on-cash return is then 12.6 percent.
These low interest rates may make cash on- cash returns astonishingly high for those of us with long memories in the real estate business. It was only about four years ago we had a negative spread of NOI return to debt service constantly creating negative financing leverage.
What impact is the change in the capital gains tax rate going to have on the market?
Arnold:The lowering of the rate should make all investments more attractive.
Battle:It should make the decision to sell easier, since it won’t be nearly as costly to sell if one does not do a 1031 tax-free exchange.
Crowe:Historically, a capital gains tax cut has meant a stronger market, more new issues and economic growth for a long time. More product should come on the market due to less tax. In California, owners have not had a good alternative for improving their investment and, therefore, have held on to what they own. The lower capital gains rate may influence more owners to sell.
Hayes:Historically, because the after-tax dollars are greater, reduced capital gains have been a positive incentive to sell.
Lucas:I think it will stimulate more 1031s.
I agree there are no negatives to the reductions in the capital gains rate; however, the time limitations on the law provide a little uncertainty for the future and may force some owners to sell sooner than later.
Is financing readily available?
Arnold:Yes. Decent properties and strong borrowers can readily obtain 10-year fixed loans at or below 7 percent.
Battle:There is an ample supply of capital for financing of ground-up development and investment sales.
Crowe:Yes! In the mid-5 percent to low-6 percent range.
Hayes:In our area, money has been available to strong buyers.
Lucas:Yes, there are several banks and lenders in Colorado that are making good loans right now. It’s often difficult to find a lender who will do small loans—that is, $500,000 up to $1 million. But I have seen deals made in this price range.
We are going to look back on these days and say, “Why didn’t we borrow more and buy more real estate?” It is so obvious we may be missing part of the uniqueness of these times in history.
Considering the potential returns, are buyers being too picky?
Arnold:I don’t believe so. There is a lot of demand for any good, well-managed selfstorage property.
Battle:The problem is not that buyers are being too picky but the lack of product to buy, at any price. Most of the deals that hit the general market are snatched up within a matter of days. There is a pent-up demand for self-storage facilities throughout the West.
Crowe:In the California market, there are plenty of buyers. Since they cannot find product, they seem to have adjusted to what the market is and are prepared to step up to the table for it. Any prudent buyer is going to do his due diligence, make sure everything is as represented, and make sure he can meet his expectations.
Hayes:Buyers are not picky, they’re “spoiled.” They are probably remembering the good old days.
Lucas:How can you ever be too picky when it comes to your own financial situation? We have all seen a dramatic loss in our “worth” in the last several years. I encourage everyone to be cautious.
You can’t play in this world of wonderful interest rates unless you have a property.
Are sellers just too greedy, or are there any“greater fools”?
Arnold:I don’t believe real sellers, as contrasted with those who say “Everything’s for sale for the right price,” are too greedy. Some are ill-informed. I have found few owners who discuss selling their properties who have any idea what is going on in the market. If they want to sell, they pay attention to the information we provide. If they will only sell for a stipulated figure, they probably aren’t “sellers.”
Battle:The biggest objection to selling owners make is, “What do I do with the money?” They are enjoying excellent cash flow that is very difficult to replace with a bigger or better project. Unless they are really motivated to sell for reasons such as estate planning, partnership problems, etc., they will not sell.
Crowe:The peak in the market sales price (maximized returns), is mostly determined only in hindsight. But if I were to pick a time to sell and maximize my return in California for self-storage facilities, I would say now would be a good time.
Hayes:I don’t think many sellers realize what an ideal time it is to sell. When interest rates return to historically higher levels, self-storage properties are going to require larger down payments, provide lower cash returns and bring lower prices.
Lucas:Unfortunately, I know some sellers who are just pricing themselves right out of the market due to their inexperience and lack of knowledge on what it takes to put a deal together. And they don’t want to listen and learn. The bottom line is they aren’t really sellers. They sit there with a facility priced too high, on which they get a lot of inquiries, but never get a deal put together. As brokers, we don’t want to work with them because we know a deal can’t be made. It is a waste of everyone’s time, and can hurt the long-term salability of the property.
The irony is that the best time to sell is the same as the best time to buy. A great mentor of mine always said, “Make your own deal, not the other guy’s.” His advice sure keeps you from passing on a good deal by hoping to take future profit away from the buyer. He has to have something too!
Michael L. McCune has been actively involved in commercial real estate throughout the United States for more than 20 years. Since 1984, he has been owner and president of Argus Real Estate Inc., a real estate consulting, brokerage and development company based in Denver. In January 1994, he created the Argus Self Storage Real Estate Network, now the nation’s largest network of independent commercial real estate brokers dedicated to the buying and selling of self-storage facilities. For more information, call 800.55.STORE or visit www.selfstorage.com.