“Buy low, sell high.” It’s a maxim we all know but many fail to follow.
The real estate market typically follows a predictable cycle every seven to 10 years. Property values reach an all-time high and hold steady for a short time; and then the market levels off and eventually crashes. Understanding this cycle is paramount when deciding whether to hold, refinance or sell your self-storage facility.
As far back as 1836, there’s been a consistent trend of four recurring economic phases: recession, recovery, expansion and hyper-supply. During an expansion period (such as now), it can be easier to attract self-storage tenants as they increase their personal spending. Not surprisingly, it can also be easier to attract property buyers. In large part, this is because banks loosen their lending standards. Loans with lower interest rates and less stringent requirements increase the price a buyer could pay for a facility.
During expansion, buyers are also much more optimistic and willing to buy at lower capitalization rates, which translates into higher purchase prices. Conversely, as interest rates rise, a buyer must pay less for a property to attain the desired return on investment (ROI).
As a facility owner, you also want to maximize your ROI. To do this, you need an exit strategy. Again, your options are to hold, refinance or sell. This strategy is all about timing the market.
Owning a property during a recession is like sailing a ship during a storm: The best course is to hold on and focus on getting to your destination. Because of pessimism in the market, buyers will be unlikely to pay high prices, and banks are unwilling to loan at low interest rates. If you attempt to refinance, you’ll pay a higher interest rate. If you want to sell, you’ll have to take less than you would during better times. When the “storm” passes, you’ll have more options. For the time being, focus on improving your management functions.
After weathering the storm and making it back to smooth seas, it might be a good time to pull money out of your property through refinancing. However, there’s an important factor to consider: prepayment penalties.
When a bank makes a loan, it projects an ROI to be made in interest. If you decide to sell the property before the end of the loan term, you’ll owe the bank a lump sum to compensate for that loss. In other words, the bank will charge you a hefty penalty to hit its projected ROI. If selling your property is a possibility in the near future, you’ll want to discuss the implications of refinancing with your accountant.
Right now, the economy is nearly into the hyper-supply phase. Markets where a significant number of self-storage developments are in the pipeline face the risk of significantly reduced occupancy levels. Rentals are cornerstone of your property’s value, and new construction takes a sledgehammer to them. If you lose 10 percent of your current occupancy, your property value potentially drops 20 percent! It’s probable that we’ll see the market peak, gently decline and plateau, and then finally head solidly into another recession.
“Buy low, sell high” has one caveat: When the market is in a recession, there aren’t very many buyers. High interest rates, restrictive lending requirements and buyer anxiety make it difficult to sell. If you miss your chance during the other three economic phases, you may be stuck holding your property until the market recovers.
How long do we have until the next recession? Nobody knows for sure, but we do know that we’re between the expansion and hyper-supply phases. It’s an ideal time for a property valuation. If your plans include selling your property, consider the timing. Now might be better for your investments.
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.