Are You Getting Your Money's Worth?

Establishing a value for your facility, for either finance or sale, can tell you a lot about your investment expertise

By RK Kliebenstein

If you are considering either a refinance or a sale, your first question will probably be, "How much can I get?" That question is most easily answered by asking the more important question, "How much is it worth?" This exercise is offered to help you determine a value for your facility before you spend a lot money for an independent MAI (or similar designation) appraisal. While this informal valuation method may not carry the weight of a traditional appraisal, you may be able to reduce the costs of a professional appraisal and even more important, know what the value is likely to be ahead of time.

Go for Fact, Not Fiction

The self-appraisal method requires some strong discipline...taming the ego. We all want to believe that our facility is worth more than the other guy's...or at least, the same. There are a number of factors that indicate value and are based solely on data, not emotion or subjective criteria. The most important contribution to the self-appraisal process is your ability to be objective. When making comparisons with other properties, seek the truth and work to compare apples to apples. Do not settle for oranges or bananas; keep your analysis based on facts.

Keep extensive notes and audit trails for your findings. Make certain you record dates, times, names and phone numbers or addresses. They will build credibility into what you are doing.

• Why Am I Doing This?
  Establish the reason for this exercise.
• Are you looking for a check and balance to a professional appraisal?
  Appraisers seldom make mistakes, but it is possible.
• Are you preparing for a professional appraisal and want to provide comparable sale data?
  Appraisers, particularly out-of-towners or those who are not local, may not have access to public channels of information that could benefit you. This self valuation may enable you to provide additional information to the appraiser.
• Are you selling your facility?
  Acquisition professionals may not have all the data necessary to make an informed offer. When the offer is low, perhaps you can provide deal-changing information.
• Are you seeking financing?
  Financial institutions may not have self-storage expertise, particularly local institutions that rarely make self-storage loans. Conduits and national lenders may use out-of-town professionals who aren't as familiar with the local market as you are.

If you are using the appraisal to make a life-changing decision--to buy or sell, for example--do not hesitate to get a second opinion...a professional opinion. Some industry leaders are Steve Hopper of Storage Valuation Specialists in Charlotte, N.C., or Ray Wilson of Charles R. Wilson & Associates in Pasadena, Calif.

The First Step: Research, Research, Research

Research is to the appraisal process as location is to real estate; it gives it credibility. Do not be satisfied with assumptions. Attempt to get verification in everything you do. All verifications should be in the form of written documentation with names, dates and times (who, what, where, when). Do not settle for hearsay. The grapevine may not be as reliable as you think. There are three approaches to value: income, market and cost. The latter two are of equal importance, but both together do not carry as much weight as the income approach.

Cha-chiiing!

Making the cash register ring is what creates value for you. Remember, as a rule of thumb, every dollar of income equals $10 of value. While that in itself does not seem like much, when you apply the dynamics of multiplication, every $1,000 of income equaling $10,000 of value, by the time you get to tens of thousands of dollars in income, the whole approach makes much more sense.

Let's start with income. Calculate the gross potential income of your property by writing down your unit mix and the prices, along with availability (see Figure 1). The bottom right corner indicates how much gross rental revenue you could expect if you were 100 percent occupied (every day of the year) and you collected every dollar owed. So, when you brag about 99 percent occupancy, that means in Figure 1 you would have had to deposit $438,000 in the bank in rental revenues. Have we hit the ego yet? Keep on reading.

Vacancy and credit loss: The bottom line when it comes to vacancy is how much money you deposited during the year vs. how much you could have deposited. That is actual deposits compared to gross potential income. Simply divide the difference between rents deposited and gross potential rents for your true vacancy. This is known as economic occupancy.

Move on to other income: You can cross the fine line between valuing self-storage as an on-going business or a real-estate asset. Other income associated with the operation of the real estate is generally allowable. The gray area is whether the sale of merchandise is allowable, and at the far end of the spectrum (and for many, off the charts) are the revenues from truck rentals. Income associated with the operations would include late fees and charges, auction proceeds, and administrative or set-up fees. Merchandise sales usually include storage-related sales, such as locks, tape and boxes. Figure 2 demonstrates typical revenues formatted for valuation. For a subjective value, exclude any income other than rents, late and collection fees, administration or set-up fees, and lock and box sales. Subtract the cost of goods as illustrated.

Newton's Theory of Relativity: What Goes in Usually Goes Out

For the purposes of simplifying and making your valuation report most useful, combine your expenses into the categories as depicted in Figure 3. Remember the K.I.S.S. theory: Keep income and spending succinct. Follow logical patterns, such as alphabetical order and group expenses in a uniform manner. If you are paying the Yellow Pages ad with the phone bill, then subtract the cost of Yellow Pages and add that amount to advertising. Insurance costs should only be physical damage (property) and liability insurance costs.

All personnel-related insurance should be included in on-site personnel costs. As with any expense, make certain that if your accounting is on a cash basis, that the insurance expense reflects an annual amount and does not over- or understate the expense because of the timing of payments. Adjust management fees to 6 percent of total revenues. Include in the on-site personnel costs all expenses associated with employees: wages, taxes, bonuses, training, health and life insurance and perks. If you are paying below minimum wage, adjust wages to meet minimum wage tests for the purpose of analysis. If you have a "bargain" manager who earns less than the prevailing wage for the area, make an adjustment upward. And, if your manager has a sweetheart deal, you can reduce the salary level to prevailing wages, unless there is a specific reason for the higher salary requirement.

Property taxes should include personal property as well as real-estate taxes. When placing a value on your facility, here is a chance for you to let your objective skills shine. If your property taxes are well below what they should be, adjust them to the market. Oh, how that is going to hurt. If, at the end of the valuation, you have determined the market value to be $2 million and the tax bill shows market value at $1 million, then double your property-tax expense.

Other expenses should include all expenses as not categorized above. This will include office expenses, bank charges and collection costs, postage, repairs and maintenance. Include pest control, snow removal, janitorial costs and incidental wage costs...remember when your neighbor's son swept the parking lot last summer (did you include it)?

All in all, the total expenses should range between 30 percent and 40 percent of total revenues. At the low end of the spectrum would be a large, multilevel facility and, at the high end, a small facility with large land area. Expenses should not include amortization, depreciation or interest expenses. Partnership-specific expenses, such as legal and partnership accounting, should be excluded. Extraordinary expenses, such as owner expensed automobiles, key-man life policies or other partnership expenses not incidental to the operation of the facility, should not be included.

The Bottom Line: Just What Is It Worth?

Once you have calculated a "good" net operating income, the challenge of applying a capitalization rate (Figure 4) is ahead of you. Supporting data is not easy to find. Most warranty deeds do not state a purchase price, so you must rely on other data sources, usually the seller or buyer. Corroborate the information if possible. If the seller states a cap rate, attempt to verify the number with the buyer.

Be objective about the comparison of your facility to the comparable sale you are analyzing. If the documented cap rate is 10 percent and you are comparing a 15-year-old facility with unpaved drives, no access-control gate, and you manage the facility yourself, adjust for the comparison to a new, fully leased, low-maintenance property. If you can discipline yourself to adjust for curb appeal and a fair evaluation of management, you can fairly establish a value for the facility. Attempt to obtain at least three comparable sales and adjust each cap rate to calculate a realistic value. If there is not something tremendously unique about your facility, the cap rate should fall between 10 percent and 11 percent.

Be aware that determining a cap rate is the most crucial area in which to be equitable in analysis; the results carry the most dynamics. All cap rate verifications should be well documented, particularly if you later have a professional appraisal completed and the cap rate established by the appraiser differs from your findings. Providing the appraiser with the ability to verify a cap rate may be an acceptable basis for having the value adjusted if you are in disagreement with the professional valuation.