What is a self-storage facility worth? As the old adage suggests, it is worth what a buyer will pay and a seller will accept.
In these challenging times, even if a buyer and seller agree on the value of a self-storage facility, unless the buyer can pay cash at the agreed upon price, there may be a third party to consider into the equation—the lender. So maybe we should say a property is worth what a buyer, seller and lender all agree what it is worth.
What methodology can be used to determine a value that all the parties can accept? The two methods in this article are called the “snapshot” and “holding period.”
The snapshot is really the capitalization rate scenario in which annual net operating income (NOI) is capitalized at a rate the buyer/investor finds acceptable. In commercial real estate, investors are seeking an investment vehicle they believe will provide a risk-weighted return that is superior to alternative investments. Real estate is unique in the eyes of the law and in the eyes of buyers and sellers. Each commercial property offers a distinctive risk-reward ratio. Just like junk bonds offer a higher return but carry more risk than U.S. Treasury Bonds, so might one property over another.
In other words, a relatively new property in a growing area may present less risk and a lower capitalization rate than an older property in a declining area. Accordingly, the buyer, seller and lender must see that ratio or capitalization rate in a similar manner or there will be no agreement as to value and no sale. In the case of a refinancing, there may be no buyer but the valuation process is similar.
How do we determine value by using a capitalization rate? The first step is to look at the property, compare it with other similar property types, examine alternative investments and their associated returns, and look to the market place to determine an applicable capitalization rate is. Historically capitalization rates for self-storage properties have moved in direct relationship with long-term interest rates and the perceived risk associated with the investment.
Often, professionals can disagree as to their perception of the applicable capitalization rate and, ultimately, the marketplace determines the true capitalization rate. As of this writing, often-used capitalization rates fell between 8 percent to 10 percent.
To determine the value of a self-storage facility using the cap rate method, an investor must first determine the income the property will generate after the payment of all operating expenses. In other words, the investor has to determine the NOI of the property, which can be calculated using the following equation: Gross potential income (the amount that would be generated at 100 percent occupancy at market rents) less vacancy and credit loss equals gross effective income.