By Dale C. Eisenman
Self-storage owners frequently want to know, “What are current cap rates?” What they’re really asking is, “What are our properties worth in today’s market?” Before we can answer that question, we need to understand two things: First, the commercial real estate market is dynamic, and second, self-storage does not exist in a vacuum.
To determine the value of a self-storage property, you must understand the income it has already generated and what it will provide moving forward. While appraisers typically value commercial real estate by the income approach, the replacement-value or -cost approach, or the comparable sales approach, this article will focus on the income approach, for this is what motivates buyers almost exclusively. Property condition, location, competition and other factors all enter into how a facility performs.
The Commercial Real Estate Market
Just like the stock market, the market for commercial real estate is constantly changing. For example, assuming a stable supply of self-storage properties for sale, from time to time, there’s more capital available on favorable terms than others, which may lead to more demand, more activity and higher prices. Other times, there’s less available capital (debt and equity), which may lead to less demand and lower prices.
For most investors, commercial real estate represents a financial investment and should be seen in financial terms. Buyers are looking for an adequate return as compared to alternative assets. More specifically, the self-storage buyer is seeking to achieve acceptable return as he compares specific properties.
Self-storage should not be seen in a vacuum. It competes with multi-family, office, industrial and retail real estate in its attempt to attract buyers. It also competes with alternative investments such as stocks, bonds, CDs, etc. Investors seek adequate return on their capital. It’s of no importance to them what the seller has invested in the project or the proceeds he needs to fund his retirement. The asking price needs to be supported by the income the property generates.
Likewise, today’s buyer will not pay the seller for future improvement in income. In fact, in this market, buyers assign little or no value to expansion land or vacant units. An existing facility may be sold below its replacement cost and, possibly, below the investment made by the current owner. Why? Because a buyer will only pay an amount he feels will be justified by the expected return.
Think of it in terms stocks: Just because someone paid $55 per share for a stock last year doesn’t mean a new buyer will pay $55 or more for it this year. While it’s sometimes difficult, to determine a facility’s current value, an owner must focus on the return on investment his property will provide.
The process of determining self-storage facility value can be seen as reviewing the past and predicating the future. The first step is to gather and review information. Accurate records are critical. Begin by collecting: trailing 12 months revenue and expenses (categorized by month), the previous year’s income statement, earlier income statements, and occupancy information.
Often times, small or individual operators understate and under record revenue and overstate expenses. While there may be business or tax reasons to do so, for the purposes of determining value, you must be able to review and verify all revenue generated by the facility—rent, truck-rental commissions, retail sales, late fees, administrative fees, etc.
Equally important is to properly and accurately reflect all operating expenses. These are the costs the owner incurs to generate revenue, minus debt service, amortization and depreciation. Owners often fail to recognize items such as repair and maintenance costs, complete payroll, and others. In other cases, they include items that have nothing to do with operating the facility, which must be adjusted to provide a true and accurate picture of expenses associated with the property.
By comparing financial data month to month, the owner and potential buyer can see revenue and expense fluctuations. In many parts of the country, self-storage rentals are seasonal, as are some expenses. Comparing the last two or three years of data will illustrate trends for the property. A site that sees increasing occupancy, revenue and income is more attractive than one that shows a consistent decline.