The value of your self-storage property is like your blood pressure; it’s not something you need to track daily, but you should check it every few months to ensure the numbers are moving in the right direction. Unlike your blood pressure, however, you want to see your property value increase over time.
If you haven’t reviewed your facility’s value in several years, there’s a good chance you’ll be very pleased. Low mortgage rates for commercial properties and high demand for self-storage investments have driven up the price buyers are willing to pay. If you’ve considered selling your facility in the last few years or plan to exit soon, now’s an ideal time to find out how much your property is worth.
Since a storage facility is an investment for most buyers, property value is determined using net operating income (NOI) and capitalization (cap) rates. NOI is the money you have left after paying operating expenses, but before loan payments, income taxes and/or depreciation. Let’s look at each component.
For the purposes of determining NOI, most investors and bankers will insist you treat expenses the way an absentee owner would. In other words, though you may handle some tasks on your own, such as management and landscaping, the typical investor/owner pays to outsource them. With that in mind, below is a list of standard operating expenses that need to be considered when calculating NOI:
- Property taxes
- Third-party management fee
- Office expenses
- Lawn maintenance
- Snow removal
- General building maintenance
- Bank charges
- Retail inventory
To calculate NOI, subtract these operating expenses from revenue, which comes from various sources, including but not limited to:
- Standard storage rent
- Late fees
- Administration fees
- Tenant-insurance sales
- Outdoor vehicle storage
- Retail sales
- Truck rentals
- Retail/office/apartment rent
- Cell-tower leases
Once you know your NOI, you can determine an appropriate cap rate for your property. An easy way to understand the cap rate is to think of it as the return on investment a buyer would receive in the first year if he paid all cash for the property. Assuming the NOI remains the same in each of the following scenarios, you can see that the lower the cap rate, the higher the price. Conversely, the higher the cap rate, the lower the price. For example:
- NOI of $250,000 / 9 percent cap rate = $2,777,777
- NOI of $250,000 / 7 percent cap rate = $3,571,428
The problem is determining the cap rate is as much an art as a science, since it depends on location, property condition and investment-market factors. Let’s examine each to understand their impact.
Location is the first maxim of real estate. If your facility is in a heavily populated area, it’s going to command a lower cap rate than a small-town location. Why? Because cities have many primary employers supporting the community. A small town, on the other hand, may have only two or three major employers bolstering its economy. If one closes, that town might dry up.
A key aspect of location is visibility from the road. Generally, 50 percent of customers will come from drive-by traffic. A property along a major highway is much more desirable to buyers than one on a back road, simply because it’s more visible to potential customers.
The condition of your property also plays heavily into value. For example, if the roof leaks, the next buyer will have to repair it. Naturally, he’ll discount the value of your facility by the cost of replacement. To pay for future capital expenditures, he’ll reduce the purchase offer, effectively raising the cap rate.
Market conditions play a significant role in determining the cap rate a buyer will be willing to pay. Right now, demand for self-storage investments is very high, and cap rates have been driven down by the influx of buyers. With Small Business Administration (SBA) loans available with as little as 10 percent down (in contrast to the typical 25 percent for commercial mortgages), buyers can afford more expensive properties.
In addition, interest rates have dropped in recent years. Since buyers are saving money on interest paid to the bank, they’re able to pay higher prices for properties and still hit their desired return on investment. Keep in mind, though, interest rates are beginning to climb, which is creating a reduction in values and an increase in cap rates.
Location, property condition and market factors work together to indicate an appropriate cap rate for a property. The cap rate is typically determined by finding comparable sales of self-storage properties, determining the cap rates used to purchase them, and weighing the combined rates to come to an average.
Establishing the right cap rate is crucial because it has significant impact on the final value of your property. It’s usually best to enlist the opinion of a professional self-storage real estate broker. To find the rate on your own, you’ll need to collect data on half a dozen similar properties that have sold within the last two years. You also need to consider several market trends. Understanding how all this works in concert will help you calculate a rough estimate for your property. To confirm the value, though, you’ll need to seek professional advice.
Isaac Rothermel is a broker advisor at Investment Real Estate LLC, which has provided brokerage, construction, management and development services to self-storage owners and investors since 1998. For more information, call 717.779.0804; e-mail [email protected]; visit www.irellc.com.