The reality is buyers are paying high prices because they’re able to borrow at somewhere between 5.25 percent and 6 percent interest, which leaves plenty of spread between the cap rates and the cost of borrowed money. As always, investors are looking to create arbitrage, taking advantage of the difference between what they can borrow and the return they’re receiving on investments. This tactic increases the rate of return on equity.
With these thoughts in mind, many investors wonder how long current interest rates will last. With the liquidity crisis of 2008 still fresh in the minds of the U.S. Federal Reserve and the ever-increasing concern about inflation, the question is when to jump.
We also wonder when the Fed and other political types will make it a priority to control inflation, i.e., raise interest rates. What we do know is as interest rates go up, prices relative to income will go down. Buyers will not purchase properties at cap rates that are less than the cost of borrowed money. Not even the best management can make that situation profitable.
Overcoming the Risks
When considering the cap-rate and interest-rate risk in the market today, you can protect your investment by ensuring you have plenty of time left on your existing loan, and the interest rate is locked or has a ceiling you feel is reasonable. Also, your ability to take advantage of perceived market conditions—for example, selling when the market is improving—will have a greater impact on your investment’s IRR than simply renting more units and improving operation.
To execute on this strategy, you must have a low or no prepayment penalty on your existing loan. As you know, it’s not how you get into the deal, it’s how you get out of it that counts. Lastly, keeping your loan-to-value in line with the depth of your resources will enable the property to make money for you rather than its leverage. It’s also just a good business practice.
There are many things that affect self-storage value, and I can’t begin to address all of them or even do justice to the details as it relates to the relationship of cap rates and interest rates. Hopefully, this article has given you some insight as to the risks and opportunities present in the current market.
Ben Vestal is president of the Argus Self Storage Sales Network, a national network of real estate brokers who specialize in self-storage. Argus provides brokerage, consulting and marketing services to self storage buyers and sellers and operates SelfStorage.com, a marketing medium and information resource for facility owners. For more information, call 800.55.STORE; e-mail email@example.com.