Next Gen

Charles Ray Wilson Comments
Posted in Articles, Development
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We have all heard people refer to self-storage facilities as being first, second, third or even fourth generation. I’d like to talk about what might be the next generation of self-storage: small facilities with no on-site management. We normally see these types of sites in rural areas where land is readily available and less expensive. But I’ve noticed a trend toward new starts that involve smaller facilities and direct construction costs of far less than $1 million. And they’re not just being built in remote rural communities. In many instances, they’re approaching major metropolitan areas.
  • Smaller facilities just might be the newest opportunity in today’s competitive self-storage environment. If it were feasible to make them work in urban markets, imagine what else might be possible:
  • Existing operators could build small satellite facilities that share operating expenses with an existing site.
  • First-generation facilities could renovate, eliminating the resident manager’s apartment and all on-site management, upgrade electronic security systems, and target unit mix to a specific local demand, allowing them to compete with newer sites.
  • Investors such as attorneys, accountants, contractors and other entrepreneurs could use their existing offices to serve as the center of operations for small satellite facilities that would share operating expenses.

Which brings us to the million-dollar question: Is it financially viable to build this type of small, automated facility in a major market like Los Angeles, for example? I think the answer is yes. Following is a demonstration of why.

A Sample Site

Let’s take a look at a sample project and potential income using two different approaches: replacement cost and direct capitalization. We have a 15,000 square-foot facility on a 40,000-square-foot site. Instead of on-site management, it has a kiosk and heavy electronic security. The unit mix is designed to serve the specific needs of the local market. The facility has 150 units ranging in size from 50 to 150 square feet, with the average unit size being 100 square feet.

Cost Approach. To estimate the cost to develop this hypothetical facility, I relied on Marshall & Swift Valuation Services for estimates of direct construction costs. The base building specifications are:

  • Construction class—(S) Steel
  • Quality—Low-cost
  • Number of stories—One
  • Height per story—14 feet (base)
  • Total floor area—15,000 square feet
  • Base cost—$16.39 per square foot
  • Current cost adjustment—1.06
  • Location adjustment (Los Angeles)—1.14

The final direct cost (base cost multiplied by the current cost adjustment multiplied by the location adjustment) is $19.81 per square foot.

In addition to direct building costs, there are indirect costs: real estate taxes, legal and accounting fees, lease-up, facility setup, and technology (kiosk and state-of-the-art security). Of these, lease-up is the largest. It represents the revenue lost during the time between when the doors first open and stabilized occupancy is reached. In this scenario, I assumed lease-up would take approximately six months. The estimate for setup and security takes into consideration the added cost of a kiosk and its monthly fees as well as extra security cameras and alarms.

Replacement-Cost Approach
Direct Costs
Building Costs 15,000 SF @ $19.81 PSF = $297,150
Site Costs 25,000 SF @ $3 PSF = $75,000
Subtotal $372,150, or $24.81 per net rentable SF
Indirect Costs
Real Estate Taxes $6,468
Legal and Accounting $3,722
Lease-Up $115,000
Setup/Security $100,000
Subtotal $225,190
Subtotal Improvement Costs $597,340, or $39.82 per net rentable SF
Entrepreneurial Incentive 20% of improvement costs plus land = $239,468
Subtotal $836,807, or $55.79 per net rentable SF
Site Costs 40,000 SF @ $15 = $600,000, or $40 per net rentable SF
Total Replacement Costs $1,436,807, or $95.79 per net rentable SF

 

Income Approach. To prove the financial feasibility of this hypothetical project and model the direct-capitalization approach to value, I used third-quarter 2004 operating performance reports for Los Angeles, produced by Self Storage Data Services Inc.:

  • Rental Rate—The monthly rental rate for a ground-level, nonclimate-controlled, 10-by-10 unit in Los Angeles was $150. To be conservative, no ancillary income is included in our example, even though late fees would be collected as usual at our sample site.
  • Vacancy—Facilities in Los Angeles were operating with a 7 percent physical vacancy rate. To be traditional, I used a 15 percent vacancy rate in our model.
  • Gross Income—Potential annual gross income for 15,000 square feet at $1.50 per square foot is $270,000. If you subtract vacancy at 15 percent, you have an effective gross income of $229,500.
  • Expenses—Total expenses were based on the analysis of hundreds of larger facilities and adjusted to reflect the lack of an on-site manager; but they included 5 percent for an off-site manager and maintenance personnel. Total expenses were $4.41 per square foot of net rentable area, or 29 percent of revenue. Subtract this from your effective gross revenue, and you get a net operating income of $163,405.
  • Cap Rate—As of press time, cap rates for traditional investmentgrade facilities in Southern California were in the mid to high 7 percent to low 8 percent range. I used a 9 percent cap rate to reflect any perceived risk. At this rate, and with our net operating income, we end up with a final value of $1,815,611, or $121.04 per rentable square foot.
Direct Capitalization (Income Approach)
Scheduled Gross Income 15,000 SF @ $1.50 PSF = $270,000
Subtract 15% Vacancy $270,000 - $40,500 = $229,500 (Effective Gross Income)
Subtract Expenses $229,500 - $66,095 ($4.41 x 15,000 square feet) = $163,405 (Net Operating Income)
Overall Value $163,405 / .09 (9% cap rate) = $1,815,611

Development Yield

Using a cost approach, our facility value is $1,437,000, or $95.80 per square foot. Using the income approach, the value is $1,816,000, or $121.13 per square foot. These leaves a 26 percent spread, providing an additional entrepreneurial cushion of about $380,000. That brings the profit to higher than 50 percent, more than twice the profit on traditional facilities.

Development yield (net income divided by total construction costs) is 11.4 percent ($163,405 divided by $1,436,807), which suggests the project is, in fact, feasible. When we go back into our examples and use a more realistic vacancy rate, add modest late fees, and consider sharing expenses—such as advertising, maintenance personnel and administrative—with other facilities, projections get very exciting. The point is if our hypothetical project can work in Los Angeles, where land costs are $15 per square foot and real estate taxes are more than $1.50 per square foot, it should work most anywhere.

A Final Solution

At this point, not all of you are convinced of the feasibility of this innovative concept. But there are markets in which it will work. In fact, it has been working for some operators.

Small, unmanned facilities may be an additional source of income to supplement existing self-storage operations. They can also be a source of revenue for professionals in other industries—without a need to invest large amounts of capital. Finally, they could be the answer to those first-generation facilities trying to compete with the “sizzle” of newer sites.

Charles Ray Wilson, CRE, MAI, is president of Charles R. Wilson & Associates Inc., a firm specializing in the valuation of self-storage facilities nationwide. Mr. Wilson also owns Self Storage Data Services Inc. (SSDS), a research firm based in Pasadena, Calif. For more information, call 626.792.2107; e-mail craywilson@ssdata.net.

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