By way of explanation, consider two luxury cars from different manufacturers. Both may have similar purchase prices but one may include a maintenance program, offer greater safety, cost less to operate and attract a higher price upon resale. One may cost less over the period of ownership and be a better value, which would not be apparent looking just at the purchase price.
In a similar manner, two self-storage facilities may seem equally attractive and be offered for sale at the same capitalization rate, but one may offer a higher return over time than the other and, therefore, a better value. If one focuses solely on the capitalization rate method, that difference may not be apparent.
Let’s use the same self-storage property that generated a NOI of $180,000 this past year. Assuming one could buy the property for $2 million and hold it for seven years we can calculate an IRR based on a few assumptions. If we assume that revenue and vacancy grow at 4 percent per year, expenses increase at 2 percent annually and the property is sold at the end of the seventh year at a 9 percent capitalization rate with a cost of sale of 5 percent, the IRR equals 14 percent.
The very same property valued at a 9 percent cap rate as a snapshot could provide the buyer with a 14 percent return over the time the property was owned assuming our hypothesis is correct. That return could be even higher if the buyer borrowed part of the purchase price.
While this is an over simplified example for the purposes of this article, many more factors such as loan parameters, cost of capital, changing occupancy, changing expenses and revenue can be factored into the analysis. A commercial real estate professional should be able to provide a specific analysis for your property.
There is no one right way to determine the value of any property or product, but these two methods offer insight into the rationale and approach used in the commercial real estate industry. Of course, no sales transactions will occur until a buyer and a seller agree upon a value. The two mathematical methodologies discussed above should help bring together a meeting of the minds.
Dale C. Eisenman is president and broker in charge of Midcoast Properties Inc., and is a licensed real estate broker in Georgia, North Carolina and South Carolina. He specializes in the self-storage industry as an investor and a member of the Argus Self Storage Sales Network, a national brokerage organization specializing in marketing self-storage facilities. To reach him, call 843.342.7650; e-mail email@example.com; visit www.midcoastproperties.com.