Factors to Determining Self-Storage Investment Quality: Questions to Ask Your Seller and Broker

Comments
Print

By Bill Alter

In countless articles written by self-storage experts over the years, it has been drummed into our heads that property value is determined by capitalizing net operating income (NOI). The formula is NOI divided by capitalization (cap) rate equals value. The concept to remember is the lower the cap rate, the higher the value.

Cap rate is the yield on an investment, on an all-cash basis. Why is it some investments sell with lower yields and others must offer higher? There must be some logic to that phenomenon, but what is it?

The mystery is who determines the cap rate and how. Will buyers, sellers, appraisers and lenders all use the same cap rate for a particular property? Why do cap rates vary from property to property and market to market? The answers to these questions make you appreciate the subjective components that go into determining property value.

Property value is not simply NOI divided by cap rate, but rather a blend of the current snapshot and the prospect of future growth, which is subjective and varies with investor imagination and skill. It’s more of an art than a science. Here’s the question that needs to be answered: Is the net income from this property likely to increase over time and at what rate?

This article discusses factors that go into determining the “quality” of a particular investment as it compares to other (apparently) similar investments. The astute self-storage investor is aware of these subtle influences on value and understands how each one might justify a lower cap rate or require a higher one.

Ask Questions

To arrive at an accurate, fair value for a self-storage property, especially when it is in a city or state with which you are not familiar, it's often necessary to conduct an in-depth investigation of the property and its market. Ask questions of the brokers involved in the transaction and the seller himself. Ask about the city and the submarket.

When considering what the cap rate should be, you must know and understand how asking prices are being determined for similar for-sale properties in the market. Here are some things to consider:

  • What are the asking cap rates in this market?
  • How do the other properties compare to the your prospective property?
  • Are the rents and economic vacancy nearly the same?
  • Do the operating expenses of the other facilities for sale include approximately the same line items as your prospective property?
  • Are the expense amounts roughly the same?
  • Will those amounts go up or stay the same when you own the property?

You must also know and understand recent sales in the market. What has actually sold? What were their cap rates, and how were they underwritten?

You must also know if the city and your specific submarket is growing in population and at what rate. Can you expect that growth to enable occupancy and rent increases? Lower cap rates are justified if you can safely expect population growth to provide consistent increases. The reverse is also true: Higher cap rates are required if the market is oversupplied, creating a situation where it could be a long time before revenue increases.

« Previous123Next »
Comments
HELLO
comments powered by Disqus