A VIEW FROM THE STREET 4419

The Price Is Right is one of those TV game shows that seem so easy anyone can do it. All you have to do is heed Bob Barkers invitation to come on down and play games in which you guess the price of common consumer items.

It sounds simple. You would think an informed consumer with baseline marketplace knowledge should have a fairly easy time of coming close to a products actual retail price. Yet its amazing how far off contestants can be.

Its not so different with self-storage real estate transactions. Property owners often think it is quite easyeven obvious to pinpoint a propertys value, especially when theyre actively involved in their local markets. However, more often than not, their estimate may be well off the mark. Perhaps The Price is Right is more of a reality TV show than we give it credit for.

Institutional Muscle Rocks Value

A key factor affecting todays self-storage pricing is the apparent split between institutional Class A property values and facilities not meeting these first-tier standards. This bifurcation is wreaking havoc on the ability of most self-storage owners to accurately estimate property values.

The divergence is largely caused by the unprecedented amount of capital flowing into real estate markets. In addition to self-storage real estate investment trusts, a record number of institutional capital sources are allocating portions of their funds to self-storage transactions. Many of these deals are joint ventures with Top 50 self-storage operators.

Institutional sources typically look for self-storage properties that meet certain yield and financial return criteria, as well as assets that will withstand the test of time. In other words, they want to buy Class A properties. Also, they usually seek larger transactions in major markets to gain the synergies of operating and marketing multiple properties. To help them with their buying sprees, they capitalize on a cost of capital that is typically more competitively priced compared with the rates paid by the majority of investors.

This institutional demand for high-quality storage properties is largely driving market pricing. Institutional muscle, combined with low fixed-rate financing options, has supported a true division between what is and isnt classified as a Class A property.

Defining Class Differences

Is it just a matter of semantics that defines the differences between class A, B and C properties? Hardly.

In late 2006, Ray Wilson, president of Self Storage Data Services (SSDS), proposed baseline definitions for self-storage facility classifications. His goal was to create industry-wide standard terms to support greater understanding of self-storage facility values.

SSDS defined a class-A facility as having an excellent location and access to attract tenants willing to pay rents in the upper percentile in the market. The facilities must be of superior construction and finish, relatively new or competitive with new facilities, and provide professional onsite and offsite management. They are typically in markets with high barriers to entry. Also, theyre characterized by above-average maintenance and security systems.

Taking this definition to a market application, it seems obvious that for higher-priced assets, perceived test of time risks should be lower. Over the long term, class-A facilities should have greater and more consistent occupancy, and a better chance of the market accepting their rent increases.

Assuming the property is newer, capital maintenance expenditures should be lower. The risk of new competition should also be lower due to available sites, as well as planning and zoning hurdles.

And finally, the ability to sell or refinance these properties at favorable terms is a reasonable expectation. As in any market, higher quality assets should yield higher prices, just like on The Price is Right where a Cadillacs actual retail price should be higher than a Chevrolets. However, with unprecedented self-storage real estate demand in recent years, weve seen some pricing that bucks this general theory.

Prices

Some lower-quality self-storage assetsthose likely defined as class-B facilitieshave yielded prices on a relative basis typically reserved for class-A facilities. Class-A assets traded with capitalization rates as low as 5 percent and 6 percent are causing even more difficulties for owners trying to estimate a fair price for a property, according to 2006 sales data research by Storage Investment Advisors (SIA).

Compounding the situation, investors still have a strong interest in acquiring properties that may not fit the class-A definition. Many of these properties are run-off beneficiaries from the demand for first-tier facilities. If you own a portfolio of second-tier class-B assets, you should be able to receive a premium for selling the portfolio.

Owners of second-tier facilities should realize, however, that buyers (typically local and regional investors) might factor perceived risks and cost of capital into the deals pricing. If your property has suffered from deferred maintenance, inconsistent operating performance or substandard historic operating results, this relative risk will be priced into the transaction. Also, the ability to resell or refinance the asset at a later date will be factored into the pricing.

Self-storage property demand and margins widen depending on the assets size and quality, and we anticipate the industry is near or at the peak of demand for real estate. If so, the bifurcation between class A, B and C properties may become even more apparent as 2007 unfolds.

Is Your Price Right?

Whether its on a game show or in a real estate transaction, theres more to pricing than meets the eye. Numerous factors in today's self-storage market affect pricing, particularly the influx of institutional capital that has helped create a bifurcation among class A, B and C properties.

Be sure to consult with self-storage property advisors and finance professionals as you proceed along the pricing valuation path, particularly if youre selling a property. Without this guidance, you may indeed be coming on downnot to win a new car, but rather in sales price because your outsized expectations dont meet market realities. 

A View from the Street is a new quarterly column by Neal Gussis and Minh Tran written exclusively for Inside Self-Storage readers about self-storage property and financing issues. Mr. Gussis is a principal with Beacon Realty Capital and can be reached at 312.207.8240 or [email protected]. Mr. Tran is a senior partner at Storage Investment Advisors and can be reached at 713.376.3107 or [email protected].