While there has been some pretty dramatic changes in self-storage operating performance, i.e., declines in occupancy and rental rates, greater use of concessions, etc., the method investors and appraisers use to estimate facility value has not changed—only the depth and sophistication of the analysis. The value of all real estate is still the present worth of future cash flow.
Thus, the appraiser’s job is to assess the local market conditions that will influence a property's future net operating income (NOI). An analysis of these conditions is the foundation on which an objective opinion of value can be reached.
The basis of direct capitalization starts with making an estimate of the facility's potential gross income, which involves a detailed analysis of asking and actual rental rates by unit type compared to competitors in the local market. Then an estimate of the stabilized vacancy is made, based on the current supply of competitive units in the market. Vacancy is comprised of three main components: stabilized physical vacancy, collection loss and concessions.
Next, the appraiser must estimate total operating expenses, which typically include:
- Real estate taxes
- Property insurance
- Repairs and maintenance
- Onsite management
- Offsite management
NOI is derived by subtracting vacancy and operating expenses from the estimate of potential gross income. It’s then capitalized into a value estimate by dividing it by the cap rate. The appraiser must select an overall cap rate that reflects facility quality and location and the risk of its future performance.
Investors consider the gap between class-A and -B self-storage facilities to be much smaller than the gap between class-B and -C properties. Cap rates for stabilized, class-A assets can fall below 7 percent, but tend to hover near the low to mid 7 percent range for class-B assets. The market generally indicates that overall cap rates for class-B assets are 25 to 50 basis points higher than class-A assets. For class-C assets, the spread increases to as much as 100 basis points. Thus, class-C cap rates can be 8.5 percent or higher, depending on quality and location.
Cap rates have been declining, and cap and yield rates continue to decline, according to the most recent self-storage investor surveys by PricewaterhouseCoopers (formerly Korpacz). With new capital (equity and debt), cap rates have decreased 45 basis points to an average of 7.3 percent (stabilized) from one year ago.
The accompanying direct-capitalization model assumes the self-storage facility is operating at its long-term level of economic occupancy. If the facility is not stabilized, the appraiser must estimate the value of the rent loss between today's level of performance and stabilization, and then deduct that amount from the stabilized value estimate.
Though good-quality, stabilized facilities are in the most demand, limited available product has caused some investors to consider the purchase of unstabilized, “lower quality" or “value-added” assets. This is bringing more focus on facility classification as it relates to investment risk.
Self-storage investment conditions have improved significantly over the past four years as a result of the industry's outstanding performance. Public and private real estate investment trusts as well as large national and regional companies are competitively bidding on the limited supply of available investment-grade sites. Investor demand for good-quality, stabilized facilities is pushing cap rates down and values up to near pre-recessionary levels in many markets.
Charles Ray Wilson is the founder of Self Storage Data Services Inc., an independent research firm that maintains the nation’s largest database of self-storage operating statistics. He’s an internationally recognized leader in providing independent research on the self-storage industry. For more information, visit www.ssdata.net.