The “build it and they will come” philosophy only works when written into a movie with Kevin Costner luring scores of fans to his “field of dreams.” But the days of constructing a successful self-storage facility on some unused portion of Uncle Joe’s land are over. If you still hold on to this outdated ideal, your dream of building a storage facility could well turn into a nightmare.
The best self-storage screenplay will have you examining key real estate investment and financing criteria, as well as reviewing options of buying an existing property instead of building from the ground up.
The Retail Look Holds Sway
The industry has recently seen an influx of new investors entering the market via property-development routes. They’ve learned that gaining entry through acquisition can be difficult because of the continual decrease in cap rates and intense competition among buyers for existing storage properties. If you’ve tried to develop a property in recent years, you’ve likely realized that finding and selecting prime sites not only requires scientific and methodical research, but plenty of patience and capital for what can be a long and grueling process.
Whether you intend to build a facility for a short-term sell or long-term investment, find a site that can withstand fluctuating market conditions. These types of land parcels are referred to as “retail sites” and are broadly defined as ones with high traffic counts that would typically attract consumer retail business.
Building a storage facility on a retail site offers increased property exposure, a great opportunity to create ancillary income and, more than likely, comparable or better rental rates than if you constructed on other types of commercial parcels. But acquiring retail sites can be an expensive venture, so you’ll want to conduct comprehensive due diligence if you’re paying aggressively for a class-A location.
Among the most common mistakes developers make when building a facility is to create lease-up projections on too short of a time frame. A 45,000-square-foot facility can take 36 to 42 months to stabilize, whereas the lease-up might have only been 24 to 30 months just a few years ago. As a suggestion, pro formas presented to lenders should realistically set the expectations. You may want to present both a conservative and aggressive lease-up schedule so the lender can more practically assess the credit risk and create a loan that can handle the stress of a longer lease-up period.
Another important thing to keep in mind when constructing from the ground up is county commissioners and city officials apply strict building codes and zoning parameters to new storage facilities to make them match the overall look and feel of surrounding commercial and residential properties. Be warned: These requirements add to development fees, building materials and construction costs, and ultimately affect your long-term profitability.
Ask yourself whether the development’s overall cost will yield an acceptable return. Also, don’t forget to consider your anticipated exit strategy: Do you plan to sell right away, hold the property for a short period, or retain ownership for a longer hold?
Finding the Right Set
If building a self-storage facility seems inappropriate, purchasing a newly constructed property as soon as it’s built may be a better fit. In the past, purchasing a property at certificate of occupancy (known as “C of O”) was not as common as it is today. Modern-day buyers are much more willing to pay for a recently constructed facility’s upside potential and assume its accompanying lease-up risk.
This change of heart among the buying community to purchase properties at C of O is due to the increased competition and consolidation of properties with regional and national investors. In most cases, this process works best in markets that have significant entry barriers, generate high market rents, and provide a purchaser an added-value asset that can become profitable once stabilized.
Purchasing a property at C of O typically works best when the facility fits a buyer’s regional perspective and in markets with high barriers to entry and rents that are at least $12 to $15 per square foot. It’s difficult for a buyer to enter a new market without any properties, absorb a new facility and feed the property until it breaks even.
As the property continues to lease up and create more revenue, you will inevitably gain more value for each dollar that comes in. Research shows the most optimal time to sell a property is when it reaches 67 percent to 75 percent occupancy. This range still leaves considerable upside potential for the buyer through occupancy and rental-rate increases, but money collected after this point does not equate to a dollar-for-dollar increase in value.
Today’s buyers are more apt to believe in a property’s upside potential and give a seller credit for it. As competition rises and the ability to find quality sites becomes more difficult, buyers are paying aggressively for newer properties still in the lease-up phase. Often in those instances, buyers are either paying cash or entering into a bridge loan based on Prime or LIBOR rates.
Conduct a thorough due diligence and determine whether your script for self-storage success will focus on developing or buying a new property. There’s an unprecedented amount of competition in self-storage today, with a higher number of properties located in retail locations. Understand the demand factors driving your specific market and how your investment is positioned against current and future competition. Make an investment that will yield your desired return and withstand the test of time, maybe even become a self-storage blockbuster.
Neal Gussis is a principal with Beacon Realty Capital and can be reached at 312.207.8240 or firstname.lastname@example.org. Minh Tran is a senior partner at Storage Investment Advisors (SIA) and can be reached at 713.376.3107 or email@example.com.