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.
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.
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!
In the world of real estate appraisal, they consider this the income approach. It considers the earning capacity of the facility less the vacancy and owner’s expenses. It’s axiomatic that if the NOI increases, the facility value will be dramatically increased. By reducing the annual expenses, you not only increase the value by a multiple of the market cap rate, you increase the dollar amount you may borrow when refinancing (not to mention that you have an additional layer of protection from rising cap and interest rates).
Real Estate Taxes
The uncontrollable expense of real estate taxes may be the elephant in the room today. With so many historically high sales of self-storage properties over the last few years, local taxing authorities may have the sales comps to meaningfully reassess your property at a much higher value. The lower you can keep your taxes, the more realistic a buyer or lender will be in evaluating the tax increase a buyer might face.
To learn how to challenge and minimize your real estate taxes, contact your local tax authority. Most municipalities will have a process that’s relatively easy to follow. There are also many experienced property-tax consultants willing to provide you with guidance and help you protest your taxes for a contingency fee of typically 20 percent to 30 percent of the realized savings.
As the next wave of self-storage properties opens, it’s critical to keep tabs on new and existing competitors in your markets. Regularly conducting a rental-rate survey will keep you abreast of what competitors are charging as well as their specials and rental concessions.
Consumers have many resources to help them find the best deal. Not all storage properties are created equal, but most customers are price-sensitive when shopping for a unit. Ensuring that your property remains visible and competitive will help protect against occupancy declines that can occur when new supply enters the market.
Regularly review each tenant’s rental rate. The real estate investment trusts and other large self-storage operators have proven that revenue management is effective and adds facility value. Ensuring your tenants are at or above the market rate will help maximize your revenue, even as the market gets more competitive. Don’t be afraid to push rents on customers in unit sizes that have high occupancy and rental velocity.
Self-storage is still a high-quality investment, but property values are softening, so be diligent about reviewing facility performance. You need to keep a close watch on operating expenses and continue to be active with local governments on issues such as real estate taxes, sales tax and overbuilding. The fact that doing this will most likely create more cash flow and value is just a bonus.
Ben Vestal is president of the Argus Self Storage Sales Network, a national network of real estate brokers who specialize in self-storage. Argus provides brokerage, consulting and marketing services to self-storage buyers and sellers and operates SelfStorage.com, a marketing medium and information resource for facility owners. It also offers panel discussions in which brokers from around the country share their insights on self-storage market fundamentals and economic trends in their regions. To access recordings, visit www.argus-selfstorage.com/presentations.html. For more information, call 800.55.STORE; e-mail [email protected].