Investment in the self-storage space has increased over the last 12 months, with a few new investors dipping their toes in the water. The majority of the investment activity has been from mid-size to large institutions looking to buy stabilized properties in major markets, with some reaching to second-tier markets for an increase in yield of 25 to 75 basis points. Smaller investors looking to purchase assets with a market value of less than $2.5 million are still struggling to find suitable financing and deals that make financial sense.
However, we’ve recently seen a few smaller, well-capitalized, experienced operators taking advantage of the tremendous opportunity presented by smaller properties that are not being actively chased by the larger institutions. This has allowed smaller, well-capitalized operators to acquire well-located and under-performing properties with considerable upside.
Many of the owners/operators who are considering selling to the institutional buyers are struggling with the bigger guy’s expense structure. Many of the companies that have the capability and desire to purchase large, single assets of $4 million-plus or portfolios of $10 million-plus have internal underwriting criteria that increase the operating expense structure, which in turn decreases the net operating income. Therefore, it also decreases the value the owner has calculated using his own operating expenses.
This has led several of these larger institutions to pitch their third-party management services with the assurance that they will increase revenue and value, all while they apply the additional operating cost to the property and the current owner. This also allows them to operate the property and identify the pros and cons before actually purchasing the asset, not to mention it changes the owner’s leverage when negotiating the sale.
This is apparent, as most of the larger operators in the business are reporting 25 percent to 60 percent of all new acquisitions are coming from their third-party management business. I do believe there are several well-run third-party management companies that also own properties and are looking to expand their portfolios. It has been my experience that many of these companies do add value through their revenue-management systems, online marketing and call centers, but I’ve also learned they’re typically not the highest bidder when the properties go to market for sale.
A word to the wise when considering selling your property: The only proven way to keep everyone honest and maximize your investment’s rate of return is to create market competition by listing the property for sale and let the market dictate the value. You owe this to yourself and your partners. Remember, you realize 90 percent of the value of your investment when you sell.
With the recent volatility in the market, self-storage financing has been clumped together with the rest of the commercial real estate financing market as banks, commercial mortgage-backed lenders and life-insurance companies struggle to pinpoint spreads, i.e., interest rates. This has made pricing self-storage loans very difficult. Much like the investment sales market, “the bigger the better” also holds true in the self-storage financing world. You will find more aggressive terms and interest rates as you see the loan amounts increase.
However, self-storage as an industry has performed very well. If your property has a defendable operating history, you should be able to obtain competitive financing with one of the sources mentioned above. We’ve also seen loan brokers adding value to their client’s negotiations. The value of having professional advice in a turbulent market can add a tremendous amount of value when negotiating the terms of your loan.
Yes, I said negotiate the terms of your loan. Some self-storage owners may not be aware their loan terms—interest rates, term, amortization, prepayment penalties—are negotiable.
The most important aspects to focus on when negotiating your loan are the term of the loan and the prepayment penalties. First, with interest rates near historical lows, you’ll want to get as much term on your loan as possible. We’re seeing loan terms in the 5- to 10-year range, and we’ve also seen some fully amortizing loans with interest rates in the 7 percent to 8 percent range. This will allow you to mitigate any unforeseen refinancing risk, as we’re most likely going to experience interest-rate expansion in the future.
Second, over the past 10 years, we’ve seen average cap rates range from 7.5 percent to 10-plus percent, so when you’re negotiating your loan, make sure you’ll have the ability to sell to capitalize on the current market conditions. You’ll make more money buying and selling at the right time than you will ever make by renting more units or improving your operating procedures.
Now’s a great time to be in the self-storage business, but owners and investors need to keep a close watch on the topics discussed above to make sure they’re maximizing their opportunity.
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 firstname.lastname@example.org.