My grandpa use to say, “Talk is cheap, but it takes money to buy whiskey.” Today, there is a lot of talk about how much investors are willing to pay for self-storage, and a lot of confusion about just what is selling, who is buying and how much they are actually paying.
Judging from the following data, what’s selling is just about every type of self-storage facility, from those with less than 5,000 square feet to others with 350,000 square feet. They range in age from new to more than 30 years old. Some sales involve converted industrial buildings of more than 50 years old. As to who is buying, the answer is anyone who can find a facility to acquire. Investment demand has never been greater.
This article looks at data from 195 self-storage facilities that transferred ownership between January 2003 and April 2004. For the most part, they were single-property acquisitions by individuals and some major players, including institutional investors and REITs. I selected facility data randomly from publicly available sources. I have not personally verified the numbers, but the publishing source has reportedly confirmed the facts with the buyers, sellers or brokers involved. As the map shows, the sales occurred in major markets across the country. As the data demonstrates, you cannot listen to or rely on a single source for answers to questions like “What is the current cap rate?,” “How much are people paying?” and “What markets are hot and which are not?”
One of the more interesting bits of information to be found in any sale is the capitalization rate, or “cap rate.” Unfortunately, due to the difficulty in obtaining the data to calculate cap rates, they are seldom reported. In my sample, only 38 of the 195 transfers (19 percent) reported a cap rate. Those rates ranged from 5.26 percent to 12.70 percent, and the average was 9.14 percent (the median was 9.00 percent). This range represented cap rates based on the trailing net income as well as the buyer’s pro forma income. Therefore, the average or median disclosed from the data is misleading and of little help in determining the cap rate for any particular facility.
You can follow the trends and talk to the experts, but the truth is, selecting the proper cap rate to reflect the risk of a property is difficult. The reason is simple: There are numerous variables; reporting is inconsistent; and methodology for calculating the rate is different and usually does not disclose the investor’s motivation.
Most major investors require brokers to sign confidentiality statements, which prohibit them from disclosing the purchase price or net operating income, so calculating the cap rate is not possible. Therefore, unless you have access to the actual data, what is available from the marketplace usually involves someone’s opinion, which is not very solid ground on which to determine value. Investors should always check the price they agreed to pay (based on a cap rate) to see how it compares to the facility’s replacement cost.
Sale Price per Square Foot
While everyone is quick to agree the cost approach is not an appropriate method to value existing self-storage facilities, check out the premium some investors are paying over replacement costs. Twenty-two percent of the investors paid more than $75 per square foot. In most instances, they will tell you there are barriers to entry, meaning it is very difficult to find land to develop, the entitlement process is expensive, or no existing buildings are suitable for conversion. The following chart illustrates the prices paid per square foot of net rentable area of my sample.
Assessed Value per Square Foot
Another interesting facet of this analysis was the range of assessed value per square foot of facilities at the time they transferred. Keep in mind many taxing jurisdictions trigger a reassessment upon transfer. Therefore, the risk of real estate taxes going up should be reflected in the cap rate.
For instance, if two identical facilities were offered for sale but one was subject to a tax reassessment upon transfer, would you be willing to pay the same price for both? Of course not. With all else being equal, you would pay less for the one subject to the possible tax increase. Therefore, the cap rate on the one facility would be much higher to reflect the risk of increased expense. There are operators who purchase facilities not knowing taxes will increase and, as a result, their returns are marginal.
Ever wonder how much the age of a facility impacts its selling price? In our sample, age had very little effect (see the following scatter diagram). When comparing the age of the facility to the price paid per square foot, there was no statistical correlation, meaning age alone did not impact how much someone was willing to pay. That makes sense, given that tenants in older buildings typically paid the same rent as tenants in newer buildings.
In the diagram, each dot represents an actual sale. Thus, a facility that was only 1 year old (red dot) sold for slightly less than $20 per square foot. Another facility that was 50 years old sold for more than $120 per square foot (yellow dot). All else being equal, age does not have an impact on price.
Some interesting statistics emerge when studying individual markets, particularly when paying attention to the cap rates in a given area relative to the purchase price per square foot. As noted earlier, very few sales report the cap rate. In the markets represented on the following chart, only 27 of the 116 sales (23 percent) included cap-rate information. Other sales in these same markets demonstrate a wider range of cap rates, so unless you have access to a larger sample of sales, you could be misled. The sampling shown is too small to draw any meaningful conclusions, but is intended to demonstrate the wide range in various markets. (See the table below.)
An investor buying a portfolio of facilities in each of these markets would probably base the purchase price on a cap rate below the lowest of the rates demonstrated here. This just points out the importance of knowing not only your local market conditions and whether your facility is investment-grade, but also who the buyer would be before you can determine the proper cap rate.
It is not easy to determine the proper cap rate for a specific facility. Cap rates on individual properties vary by market, given local conditions. Rates on portfolios, however, are generally the same, given geographic diversity. Investors, who buy portfolios of several facilities at a time, take the strong performing facilities along with weaker ones at the same cap rate.
With the intensity of self-storage development, the determination of future risk is made even more difficult by unknowns in future tenant demand. Investors should put less weight on cap rates, given the variables involved in their calculation and the inconsistency in how rates are reported, and give more consideration to the price paid per square foot.
There are two cap rates for each transaction. One is based on a facility’s trailing 12 months of net operating income. The other is based on the buyer’s pro forma net operating income. For investment-grade facilities, there are two distinct buyers, individuals and major players, both having different motivations.
Charles Ray Wilson is President of Charles R. Wilson & Associates Inc., which specializes in the valuation of self-storage nationwide. Mr. Wilson also owns Self Storage Data Services Inc., a research firm. Both companies are based in Pasadena, Calif. For more information, call 626.792.2107; e-mail firstname.lastname@example.org.