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Determining Self-Storage Value in Europe

Tim Edghill and Chris Stevens Comments
Continued from page 1

But because storage is a retail business, the importance of the management team increases in line with the risk related to sales/leasing. In this way, the quality, experience and capability of a facility’s managers act as a “guarantee” for an investor that can’t rely on traditional real estate returns.

Real estate investments traditionally rely on long-dated leases with term-specific rent reviews to lower a property’s periodic cash flow; when the economics of divesting the property become more attractive, the property is sold. By contrast, self-storage operators can actively and periodically manage rental rates. Yield management combined with the physical management of space is why self-storage easily outperforms traditional real estate.

The Issue of Valuation

As a property-centric retail business, self-storage is unique, and surveyors have tried to assess facility value using standard property-valuation methods. But because storage businesses are operational platforms, it can be argued that corporate-valuation techniques are more appropriate, even for a single site.

Perhaps the most widely adopted valuation method is discounted cash flow (DCF) analysis, which is used to value all types of assets. Both surveyors and mainstream investors seem comfortable with this technique.

However, the inputs are open to manipulation to produce the desired result. Most influential is the discount rate applied to future cash-flow receipts, which provides the present cash-flow value. The discount rate estimates the required return of an incoming investor; typically, this is a function of the weighted average cost of the buyer’s capital (i.e., the weighted average of debt and equity finance). Perhaps the more controversial component is the value of the property at the end of the investment period, or the terminal value.

The discount rate is comprised of three elements: the risk-free rate of return, the risk premium and implied revenue growth. The risk-free rate of return is typically a long-dated government bond (30-year term) and relatively easy to quantify, fluctuating with the bond market and strength of the national government where the property is located.

The risk premium is the most difficult and subjective component to estimate, as each investor will have a different return requirement depending on an investment’s perceived risk. Therefore, it is only by comparing the relative returns produced by other investment classes that an investor/surveyor can deduce the risk premium. In addition, most forecast cash flows will include an allowance for the risk surrounding cash-flow growth and the resulting terminal value. Similarly, this risk can prove difficult to quantify.

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