Phasing a new project is, in most cases, the right decision. Every market is unique in consumer demand, seasonal trends and economic incentives that influence rental velocity. When you understand market demand on these levels, you can make better decisions about when and how to launch your new product. While market demand isn’t the only consideration in construction phasing, it should be pretty high on the list. If you over build your first phase, you may never recoup the lost interest cost. If you under build, you risk losing competitive traction or leaseup speed.
For example, in one particular market, monthly move-ins average 25 per month, and the average tenant rents for six months. During the summer months, rentals may be as high as 40 or more per month. During off-peak months, the market leader uses an incentive, offering the second month for free and discounting street rates at about 10 percent. This information helps you understand what to expect from leaseup and can help you develop a reasonable phased approach to building.
In this example market, it’s prudent to expect net rentals in year one of operation to reach or slightly exceed 180 units. This type of information can help guide your design process and investment strategy. If you know your market will only net 150 units in the first year, 200 to 250 units might be a reasonable phase one, even if the overall, long-term expectation is the market will absorb 500 units.
I’m not trying to oversimplify the decision-making process. Developers create and attract many incentives to build more units in their first phase: price of steel, economies of scale in construction, and finishing a project. But if you know your market will only absorb 150 units the first year, you have to weigh the economic cost of over building—and there is a cost.
When you sit down to pencil out the costs and benefits of phasing a project, don’t lose sight of the development as a whole. Are there site-work items you can more easily absorb in phase one? How can you keep the future construction of additional phases from hurting your ongoing business? What are the key triggers and considerations for moving ahead with the next phase?
For all you investment nerds, don’t get paralyzed in all the details and never move. Just know that when you understand how demand moves and how it will drive our business, and then plan to respond to that demand, you create sound strategy for maximizing your investment, not just your site.
Lipstick on the Pig
Self-storage buyers often ask questions like, “What are some of the better markets for self-storage?” and “What is the best way to invest in self-storage businesses?” Well, here’s the big secret: There is no secret. It’s hard work, and it takes a lot of time.
Finding good sites or acquisition opportunities can be grueling and overwhelming, especially without the right focus, team and tools. Maximizing investment in an existing self-storage business is asset- and market-specific. For the small operator to make a good investment in an older self-storage operation requires taking a comprehensive look at the physical site, specific micro-market dynamics, and the prevailing business model and financials. With these details, you can determine the overall investment picture and identify the risks and possible upside of acquiring and managing the asset.
As I go from market to market, I see a lot of older sites, often in good locations, with a poor operations and management profile and obsolete physical features. It was easier 20 years ago to find a quality location for self-storage. Some of these operators, while innovative in bringing their product to the market, have been surpassed by current customer demands. This can create an opportunity for buyers who can develop and implement the right vision.
Often it doesn’t take a whole lot to improve a self-storage acquisition. In almost every U.S. market, I see stores lagging behind their true potential. When facility managers are complacent and the necessary site maintenance is overlooked, the asset begins to die. But some of these dying assets could be opportunities for buyers interested in doing the work and breathing life back into the business.
Every asset is different and every market unique. But it’s not uncommon to see weaker stores in healthy markets charging lower rates. These stores often lag behind the market leaders in achievable rental rates and occupancy, and yet customer demand trends toward the leaders. A $10 rental rate difference between the market leaders and weaker stores isn’t unusual. For a potential buyer, though, this might represent a huge upside.