More Than Luck: Insight to Feasibility

Michael L. McCune Comments
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The two most useful tools in a self-storage developer’s repertoire are a rational, critical feasibility analysis (RCFA) and luck. While Lady Luck is immensely helpful, her presence is highly unpredictable. Though there are rumors that she tends to hang out with good feasibility analyses, the sightings of RCFAs are so rare, the relationship remains statistically obscure.

This article takes a critical look at what should be included in an RCFA as it relates to projected demand and pricing. This is not to say cost and timing are not important, but they are generally less subjective. Errors in estimating project costs also tend to be less frequent and life-threatening as missing the market entirely.

The Past Is Past

In the early days of self-storage, demand for the product was so deep it was like the Field of Dreams: “Build it, and they will come.” But things have changed. Now, some 40,000 facilities dot our fair land, and competition is fiercer than ever.

According to an annual investor survey conducted by Chris Sonne of Self Storage Economics, the No. 1 concern of self-storage investors is the building of too many new facilities. Ray Wilson of Self Storage Data Services Inc. has also opined in several industry forums that the “unabsorbed demand” for storage has taken root in most parts of the country. By Wilson’s calculations, there’s one storage unit for every 10 households in America. It appears the new tag line for self-storage is “Build it, and where will they come from?”

Thus, an RCFA has become a critical tool for the developer considering a self-storage project. The emphasis has switched from properly papering the loan application to finding out if the property will really work and assessing the downside risk. Please note my carefully chosen wording—it is intended to differentiate the nature of feasibility studies.

But I Got the Money!

Sadly, there are many developers who equate “getting the money” with having proved the feasibility of a project. They suffer from two very serious misconceptions: 1) lenders know something about self-storage; and 2) lenders are doing you a favor by lending you cash. Only in the rarest circumstance is the first true, and the second is never true—lenders love to rent money! The fact that you got financed doesn’t mean your project is viable. It may just mean your banker is a good salesperson. Remember, lenders on new projects aren’t as particular because they have recourse to your other assets.

What’s the Right Answer?

First and foremost, a feasibility analysis should be unbiased. Being businesspeople (and simply human), many who conduct feasibility studies want to please their clients. Consequently, their reports often reflect the customers’ prejudices, not the actual market or the project’s ability to compete in it.

When shopping for an analyst, the first thing you should do is ask how many of his last 10 studies were negative. I’m not sure what the right answer should be, but more than two or three should indicate his credibility. In my past life as a developer of office buildings, I would offer analysts a 15 percent bonus for a negative report. In feasibility studies, there are two equally right answers: yes and no. Maybe is also a no!

A Word About Numbers

There are many self-storage statistics floating around out there. Several organizations publish numbers for nearly every facet of the industry. The problem is these studies are based on mail surveys of facilities that volunteer the information. Since the sample sizes are relatively small, the information is applicable to only very broad market characteristics. Also, because the sources are voluntary, the sample may not meet the standards of randomness generally necessary in this type of study.

While the numbers look precise, they are often manufactured. For example, one source quotes total national square footage of storage as 1.46 billion. That number is the average size of the surveyed facilities (37,590 square feet) multiplied by the number of facilities listed in a purchased database (38,817). While the formula is mathematically correct and the average size appears reasonable for an urban area, I suspect rural properties are underrepresented. Therefore, total square footage may be significantly overestimated in the survey. No one knows for certain, but it’s certainly food for thought.

If total square footage is overstated, national square footage of demand per person (4.94 square feet, according to our source) could also be exaggerated. Thus, if you’re expecting to rent almost 5 square feet of storage per capita, you may be way off your mark. I’ve recently reviewed some feasibility studies in which national per-capita numbers were used as a basis to gauge local storage demand. If your feasibility report does this, you’d better find our pal Lady Luck, because you’re going to need her.

Another problem with industry statistics is they’re only marginally useful when looking at a small trade area. The variability of local market characteristics such as population density, income levels, percentage of renters vs. homeowners, prevalence of basements, etc., render comparisons to national or state information unreliable.

What Should an RCFA Contain?

Self-storage is a local business and, barring unusual circumstances, the trade area usually falls within a 3- to 4-mile radius. The demographic attributes that define a neighborhood will also define demand. Some analysts use sophisticated regression analyses to estimate demand. For example, they look at several similar markets and use mathematical algorithms to determine the variables that most affect actual absorption and in what proportion. Not surprisingly, studies show that population, number of renters and income levels are key indicators.

However, a regression analysis is a lot of work and requires expert judgments to define the market. Is this level of sophistication worthwhile? In the past it wasn’t because demand was overwhelming. Now it’s foolish not to use the best tools at hand. The task of balancing supply and demand is too treacherous.

Are the statistics created by these mathematical methods correct? They’re the same techniques used by the pollsters to predict elections. Your odds of getting the numbers right are about the same for a correct prediction, except your time frames are longer, which introduces more risk. Modern methods of calculating demand require complex math but are proven to better your odds, regardless of all the variables. They always require an element of experience, professionalism, intelligence and judgment.

How to Buy a Feasibility Study

When it comes to purchasing a feasibility study, many people bid out the process. If you want the cheapest price, this is the way to go. However, it’s not a good idea for two reasons. First, good RCFAs usually don’t cost much more than bad ones. Sometimes they even cost less, though their value is significantly higher. Second, you’re basing a huge investment on this information, so you want to be comfortable with and certain of the analyst’s abilities.

The price of a good feasibility report is minimal compared to the overall cost of the project, and it can make a huge difference. When you commission an RCFA, get recommendations from people who have used the analyst and completed their projects. Ask about their overall experiences. You should also interview your candidate analysts. What they say should be detailed and make sense. Finally, request “blacked out” sample reports. Review them to see if they are valuable or present a lot of “off the Internet” information. Some analysts try to dazzle you with volume, so look for quality, not quantity of data.

The Back Stop

After you’ve purchased a great RCFA and have the report in hand, there’s another important thing to do: Verify it. Take the report to the building and planning departments and confirm that all competing projects with permits or pending plans are noted.

Next, visit each of the competitors in the area and compare your proposed project in terms of visibility, location, traffic, amenities, pricing and occupancy. If you find the information you collect is different from that contained in the report, that’s a red flag. Things to pay particular attention to are rents and occupancy. Does the report suggest you should collect higher rents than your competitors? Have rents been declining or concessions increasing? Have occupancies been declining, or are average occupancies below 85 percent? If you encounter problems in these areas, it’s time to take a deep breath and rethink the project.

A Peek at the Downside

Self-storage projects are very sensitive to changes in revenue. Another critical step in the review of a feasibility report is the sensitivity analysis, which is easily done by rerunning the income pro forma and reducing the rent and occupancy by 7 percent. (Your analyst should be happy to provide this information.) Watch what happens to your net operating income and cash flow after debt service when you recalculate the amount of debt the project will carry. My guess is the change will cut projected cash flow by 50 percent to 60 percent.

What you are trying to learn with this test is how much error in the estimate of demand and pricing you can tolerate and still find the project risk acceptable. You may want to try other variations after you’ve seen results of the first test. There’s usually a lot of leverage in a self-storage project, both operating and financial, and it cuts both ways. At the end of the day, you must be satisfied that your projections—and their relative reliability—correspond with the margin of risk you are willing to take.

Only you can judge your level of comfort with a proposed project. Good RCFAs are never perfect, and even the best rely largely on the analyst’s judgment. Lady Luck will still play a large role in your success, but a good feasibility report will encourage her to be on your side. Remember that “no” is sometimes a better answer than “yes.”

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.self-storage.com.

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