By Jeffrey Supnick
The self-storage investment market has returned to nearly all-time heights. In this article, I’ll explore ways facility owners can position themselves today for increased profit when they sell their property in the future.
The two main drivers of high investor interest in self-storage are the excellent current performance at the property level (occupancies and rents) and, perhaps of greater influence, today’s historically low interest rates. The 10-Year U.S. Treasury bond is a primary benchmark for commercial real estate loans. To illustrate just how significant the interest-rate environment is, consider that over the past 130 years, the 10-year Treasury bond traded at an average rate of about 4 percent. In July 2012, the rate hit an all-time low of 1.47 percent. At the time of this writing, it had drifted up to just about 2 percent.
Lender rates to self-storage owners are now ranging from the mid to upper 4 percent range. Most analysts agree we’ll see a slow but certain rise in these rates. As the 10-year bond rises, it’s highly likely that the interest rates will go up significantly.
Investors base their offering price for income-producing properties like self-storage on market capitalization (cap) rates. This is a calculation of the value of real estate based on the expected or desired annual rate of return, expressed as a percentage of expected income over purchase price. Market cap rates can be determined from comparable sales of recently sold properties.
Based on the character of a particular self-storage property, current cap rates are ranging from 6 percent to 8.5 percent. For example, if a property produces $400,000 in net operating income (NOI), which is income minus expenses before debt service or income taxes, and sells for $5 million, it generates an 8 percent return on investment ($400,000 divided by .08 equals $5 million).
Cap rates rise and fall as a direct result of the cost to borrow money. As interest rates rise, a buyer will, for the most part, not be willing to pay as much for your property as he would when borrowing money at much less expensive rates.
Take Advantage of Rock-Bottom Rates
So what does that mean to you as a self-storage owner? If you haven’t already done so, review your current financing and determine your options to refinance. In looking at new financing, a primary concern should be your exit strategy. Many loans have prepayment penalties that can make it extremely costly if you later want to sell your property.
If you’re in the market for a new loan, ask the lender if it would consider providing the loan with an assumption right. The loan-assumption provision will allow a future buyer the option to benefit from what, in all likelihood, will be your lower interest rate. There’s usually an assumption fee of typically 1 percent of the loan amount. In exchange, the assumed loan will involve lesser processing costs and details.
What makes an assumption so compelling is the overwhelming likelihood that, as rates rise, the lower-interest loan will make your property more attractive to potential buyers. It will also enable a buyer to pay you a much better price than if he needed to pay higher interest for some future market-rate loan.
Maintain Good Records
While financing is currently inexpensive, buyers and their banks are more in tune with the need to substantiate operating income and expenses, after the lack of underwriting controls that were in place prior to the recession. Potential self-storage buyers, whether institutional or single-facility owners, are unified in their need to purchase facilities whose operating procedures provide the confidence required to make a very important financial decision.