Inside Self-Storage Magazine 10/2004: The North-Central Corridor

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The North-Central Corridor

By Michael L. McCune

This month, I gathered real estate experts to discuss the state of self-storage in the North-Central United States. Let’s hear what they have to say about their respective cities and regions. Our panel of brokers includes: Bruce Bahrmasel and Matt Libman, The Preferred Realty Group, Lincolnwood, Il.; Larry Goldman, Prudential CRES Commercial, Kansas City, Mo.; Peter Hitler, Investment Real Estate Specialists, Mequon, Wis.; and Robert Off, Coldwell Banker Commercial, Cincinnati. These are interesting times, so I wanted to ask our brokers straightforward questions every owner and potential buyer will find pertinent.

1. Is this a good time to sell self-storage?

Bahrmasel: Now is an excellent time. Cap rates in self-storage are generally more favorable to investors than those in apartment buildings and other investment properties. In addition, low interest rates have continued to buoy the market.

Goldman: Yes, though there are some fundamental changes in the business some owners may not want to confront. Specifically, increased competition has made responsive, effective management far more critical. The inevitable rise in interest rates in the near future brings an increased urgency to sellers who are planning their short-term exit strategy.

Hitler: Storage facilities are still selling at all-time-high prices. If an owner has good reason to sell, such as a health issue or retirement, the time could not be better. If a seller is trying to reproduce his income in the stock market or other investments, it probably is not a good time to sell, as alternative investments do not offer good returns at this time.

Off: I think now is an excellent time to consider the sale of your self-storage facility. The economy is, by almost all accounts, on the rise. Sales prices have never been higher and capitalization rates more favorable. The housing market continues to be strong despite a bump or two. Vacancy rates remain at generally acceptable levels, even with high levels of new construction. Money and loans are still available on favorable terms and at low rates. What could be better? Unfortunately, everything has its time, and all real estate has its cycles. As the old Wall Street proverb suggests, “Buy low and sell high.” Or as Obi Wan Kenobi said to Luke Skywalker, “Sell now, and may the cycle be with you.”

Here’s an example to demonstrate what the change in cap rates has done for you in the past year. If your project generates $100,000 of net operating income annually, your property value went up $150,000, or approximately 15 percent, just based on the change in cap rate. And if you had the property financed at 75 percent, your equity went up 75 percent. Is it time to sell? You tell me!

2. Why should potential investors buy self-storage at this time?

Goldman: Storage is still a favored product type because of its relative ease of management and diversifi cation of risk, despite overbuilding.

Hitler: The reason to buy is the same as why a seller may not want to sell. Self-storage is offering very good returns when other investments are not.

Libman: Self-storage has an overall better return on investment than alternative real estate investments.

Off: Having just said now is an appropriate time to consider selling, I also think it’s a great time to buy—provided you are buying for the right reasons and at a price that makes economic sense for your specifi c business. A few reasons buying today might make sense are you can: 1) leverage your operating experience by turning around an existing facility or one which is still in the development stage; 2) round out your market/territory by filling in particular market hole/ void; 3) increase your advertising, financing, expense and management efficiencies; 4) eliminate competition, thereby possibly increasing rental rates in your market; and 5) quickly break into a new marketplace.

The reason to buy is the low interest rates make your investment work harder for you. This very positive leverage will increase cash-on-cash yields dramatically. It is clear the interest- rate environment is quickly evaporating, so not only is now a good time, it may be the last time for a while.

3. Are other types of real estate underperforming and driving buyers to self-storage?

Bahrmasel: Yes.

Goldman: Most product types, including self-storage, are producing far lower returns than in the past. Some product types, such as offi ce buildings and distribution facilities, are perceived to be riskier, due to corporate downsizing, bankruptcies and, in the case of industrial properties, inventory controls.

Hitler: Some other types of real estate are underperforming. Industrial and office properties are still soft. The apartment market in the Milwaukee area is getting better. I have had many apartment owners look at buying self-storage because they are tired of the management problems of residential real estate. The condo market is very strong in this area.

Off: Without a doubt, all other types of commercial real estate seem to be operating in a marketplace where owners are chasing fewer and fewer rent-paying tenants. Making those traditional real estate product types work today is worse than playing a “zero sum” game.

Many other real estate types are experiencing high vacancies and declining rents that make the underlying stability of the income less secure than well-located and operated selfstorage facilities.

4. Are buyers having diffi culty getting loans for self-storage?

Bahrmasel: No, buyers in Illinois have not been having any difficulty getting loans.

Goldman: Lenders are still very eager to lend on compelling self-storage transactions. They just may not be as willing to accept overly optimistic projections in their underwriting as they may have been in the past.

Hitler: There is plenty of money available, although rates are creeping up a bit.

Off: No, the money is out there for the taking. Lenders are happy to talk with buyers with a good story, particularly if they are experienced in self-storage.

Not only is money available, but it is the cheapest it has been in 40 years.

5. Are cap rates dropping in your market? What impact does this have on buying and selling self-storage properties?

Goldman: Ironically, as the economic fundamentals have weakened, cap rates have also dropped dramatically. This more than offsets the drop in value due to the deteriorating performance—for now. As interest rates (hence cap rates) increase while the fundamentals continue to decline or stagnate, valuations will very possibly decline.

Hitler: Cap rates continue to fall in the Wisconsin market. I would say properties are on the market longer, but they still seem to sell. Sellers are tougher on their price, and buyers don’t have a lot of alternatives because of the lack of available properties.

Libman: Yes, cap rates have dropped in the Illinois and Indiana markets. However, cap rates for alternative real estate investments are significantly lower than what we are seeing in storage. With this in mind, self-storage remains a very good buy.

Off: The lower the cap, the higher the price. The higher the price relative to the net income of the facility, the more buyer resistance increases. The higher the buyer resistance, the slower the market becomes. Sad, but true!

All things being equal, lower cap rates mean higher values. It appears that in some places, not all things are equal. It’s just like your mother told you, “Life isn’t always fair.”

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 1994, he created the Argus Self Storage Real Estate Network, now the nation’s largest network of independent commercial real estate brokers dedicated to buying and selling self-storage facilities. For more information, call 800.55.STORE or visit www.selfstorage.com.

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