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As the Tide Turns: Softening Self-Storage Values Requires Owners to Tighten Performance

By Ben Vestal Comments

Over the last several years, self-storage assets have enjoyed high values and low capitalization (cap) rates, thanks to the dramatic increase in capital flow of equity and debt as well as the self-storage industry’s garnered respect from Wall Street, private-equity firms and other major investors. Compared to other real estate classes, storage facilities have higher returns and lower perceived risk. The lower operating costs and breakeven occupancy rates have led investors to think this is a less risky investment.

However, the tide is beginning to turn, and as self-storage valuations soften, the operation of a property becomes critically important. As interest and cap rates begin to increase, it’s vital that owners review the performance of their investments. It’s time to sharpen your ax and focus on what makes these facilities so valuable.

You need to regularly assess your operating expenses and market competition to ensure the value of your property—and its cash flow—aren’t being undermined by subtle, yet devastating increases in costs, new competition or rental-rate decline. Below is a short list items to examine.

Operating Expenses

Benjamin Franklin once said, “A penny saved is a penny earned.” The same holds true in the real estate business, except that we can expect an even greater return when we strive to save on operating expenses.

We know that 90 percent or more of a property’s value is created by the net operating income (NOI). However, as the market starts to turn and values begin to soften, it’s important to understand the magnitude of what each dollar of NOI means to facility value.

Let’s take a storage facility with annual revenue of $600,000 and annual expenses of $250,000. This facility has an NOI of $350,000, which will then be capitalized at a rate of return acceptable to an investor to arrive at the value. With cap rates in the 7 percent to 9 percent range, this facility’s value would be between $3.8 million and $5 million. Reducing the operating expenses by 8 percent (roughly $20,000 a year) would increase the value by $220,000 to $285,000. This means that for every dollar you add to the NOI, you’d receive $11 to $14 in property value.

Self-Storage Facility Values***

With most self-storage expenses occurring in the categories of real estate taxes, payroll, insurance and advertising, it’s understandable how yearly escalations in these items can deteriorate facility value. Interestingly, you don’t have to sell your facility to get an immediate gain out of these saved expenses. The value will be reflected in the amount you can borrow on the property. Generally, you can borrow 75 percent of the increase in value when you refinance, so you can have your cake and eat it, too!

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