Since the late ‘90s, the investment community has viewed commercial real estate as a virtually infallible investment vehicle. Self-storage properties were always considered a relatively safe bet because of their limited management responsibilities and maintenance … until the lending crisis and housing slowdown unfolded in the summer of 2007. Because of shifting capital markets, your exit strategy is more important than ever.
Last year, economic uncertainty caused investors to pull out of the commercial mortgage-backed securities market, and several funds announced problems with sub-prime mortgage holdings. Following this collapse, a number of Wall Street investment banking firms experienced similar downturns, battered earnings and losses. This downturn has changed some attitudes in the real estate investment community, and elevated the risk associated with acquiring self-storage assets.
To mitigate such risk, self-storage investors must conduct their due diligence and analyze a property’s financials more carefully before closing. They should ask a number of questions related to the facility’s operations, including:
- How long am I going to hold this property?
- How am I going to exit this deal?
- What is my strategy?
Using the example of a private investor buying a $10 million asset, the new owner must first determine a hold period and then analyze net operating income. Let’s say the investor establishes a hold period of five years and then determines the facility requires significant capital improvements and new management. While $10 million may be priced above comparable properties in the market, the acquisition will ultimately be profitable after the owner upgrades the facility and hires a new management company.
After capital improvements are implemented, the owner will be able to raise occupancy and achieve 10 percent rent increases over the life of that five-year term. At the end of five years, the overall property value should increase between $1 million and $2 million.
Ins and Outs
Sophisticated investors have always used an exit strategy, while many private investors historically purchased self-storage assets without much foresight and planning. When institutional investors buy a property, they determine a specific hold period, normally seven to 10 years. The strategy is different depending on the property’s condition: Some are rehab projects, some are in lease-up, and others are stabilized. The property could be worth less in five, seven or 10 years if market conditions change or the owner fails to make needed capital improvements.