By Jeffrey Supnick
With credit availability increasing, property performance stabilizing and interest rates at their lowest in decades, it’s no surprise self-storage sales-transaction volume is increasing. Here are some guidelines if you’re intending to list a self-storage facility for sale. They will help you prepare for the transaction and build more value into your asset.
In large measure, buyers and sellers are beginning to once again find common ground on pricing. Sellers feel they’re receiving appropriate value for the cash flow generated from their self-storage assets, and purchasers are paying prices in which they’re comfortable and can still realize upside potential on their investment.
While market fundamentals have improved, a prospective seller should understand today’s self-storage buyer is more disciplined and sophisticated than in past years. In addition, buyers continue to be very reluctant to overpay for properties as they may have done in the past. Former Federal Reserve Chairman Alan Greenspan, in referring to the days of the dot-com stock market bubble era, coined the phrase “irrational exuberance.” This could have also been applied to the self-storage investment market during the period prior to recent financial crisis.
During that exuberant period, there was a great deal of competition for self-storage acquisitions. Escalating operating results made up for mistakes on the part of purchasers, who were willing to pay premium prices to “win deals.” Banks were feverously doing whatever it took to make loans, and were willing to overlook more rigorous underwriting criteria to maximize loan production.
While loan availability is now up, banks are by no means taking their eyes off of the ball. In today’s market, if a buyer is overly aggressive on pricing, his banker will be more reluctant to loan on such a mispriced transaction. For this reason, it’s imperative that a potential seller has a professional, unbiased valuation of his self-storage property.
A valuation analysis should be prepared by a knowledgeable broker or appraiser familiar with self-storage, one who provides a prospective seller with a basis for gauging buyer offers. The valuation will give you an idea of what you can reasonably expect to net from a sale. It will also reveal your business market position, financial situation, strengths and weaknesses, which you can hopefully correct prior to putting the property on the market.
Since self-storage properties are purchased for their cash flow, the most appropriate method of calculating valuation is based on capitalization rate. The cap rate is expressed as a fraction or percentage which, from the purchaser’s point of view, predicts the return he’ll derive from operating the storage business, based on a particular purchase price to be paid.
To determine that rate of return, an investor needs to fully comprehend the expected income and expenses that are likely to be generated from your business. The difference between the income and expenses before consideration of debt-service payments, depreciation and income taxes is what is known as the net operating income (NOI). A great deal of confusion arises from the use of cap rates because it’s possible to state operating expenses in ways that do not fairly address true costs of operation.
What a particular owner spends to operate his property may not be equal to what a typical purchaser might spend. Normal expenses should include actual repairs made on the property, a consideration of a reserve fund for future replacement of building components based on expected remaining years of service, all maintenance expenses including do-it- yourself items such as minor repairs or lawncare, and a reasonable management fee.
It’s never too early to plan and implement operation procedures that will increase the bottom-line results of your balance sheet, even if you don’t have plans to sell your facility in the near future. The process of improving revenue often takes time to accomplish. An owner needs time to make the accounting and operational changes that will put his self-storage operation in the best financial light.