February 1, 2008

5 Min Read
Second-Hand Self-Storage

Purchasing an existing self-storage facility can be a great introduction to the industry if you know what youre getting. The question is: What should you look for when you buy, and why?

Before you purchase a facility, evaluate your investment strategy. Are you looking for a steady rate of return, say 5 percent, 7 percent or 10 percent? Do you prefer minimal management responsibility and maintenance issues?

If this is the case, find a site that has reached stabilization, meaning the property has achieved market occupancy (typically 80 percent or more, annually) and rental rates. Stabilized properties may be your best fit if youre prepared to clip coupons to achieve a steady rate of return on a monthly and yearly basis.

If, however, you want a higher rate of return or dont intend to hold the property long, hunt for one that is a value-add play. This scenario is not for the faint of heart. These properties usually have issues related to management, advertising, competition, age of structure, etc. If your goal is to improve a sites performance and you have the resources to do so, look for your diamond in the rough.

The Right Fit

Regardless of your investment strategy, youll need a proper fit. Some pointers: Always purchase based on actual operating numbers not pro forma. Provided by the seller/broker, a pro forma projects how the property can perform, but you need hard numbers confirmed by the following:

  • Profit-and-loss statement for at least the past two years 

  • Profit-and-loss statement for the past 12 months, by month 

  • Annual occupancy report for the past two years 

  • Occupancy report for the past 12 months, by month 

  • Rent roll showing total number of units, sizes, climate control and rental rates 

  • Delinquency report for the past 12 months, by month 

This data will reveal what, if any, problems exist at the facility, and help you determine if the investment is suitable. For example, lets say a rent roll shows the property at 95 percent physical occupancy, but the monthly profit-and-loss statement reveals a 70 percent economic occupancy based on monthly receipts. It could be some rents are pre-paid, verified by higher revenue collected in preceding months. It could also mean a high number of delinquencies. If this is confirmed in the delinquency report, a red flag should be raised.

Other questions to ask the seller or broker include:

  • Why is the property for sale? If the seller is motivated, the purchase price may be negotiable.

  • Does the seller have other properties; if so, are they for sale? Find out why this particular property is being sold as opposed to other assets. You may be able to buy multiple properties at a discount.

  • What have other properties sold for recently? This gives clues regarding the sellers perception of property value.

  • What is the market rental rate, vacancy and cap rate? These numbers determine what you should pay for the property.

  • Who manages the property? If the seller is also the manager, he may be paying himself a salary above or below market, or nothing at all.

  • What are the capital expenditures for the past five years? Every property needs regular maintenance. If none has been done, chances are youll be doing lots of repairs if you buy.

Patience, Patience

Never buy on a whim; analyzing the data youve collected is essential. Each investor must decide for himself if a property suits financial goals. Let the numbers, not emotions, be the deciding factor. The following are some of the most common financial techniques used when analyzing a deal:

Cash-on-Cash ReturnThe annual before-tax cash flow received. This simple calculation should tell you right away whether to proceed with the project. It is derived through a two-step equation:

1. Net Operating Income - Debt Service = Net Cash Flow 
2. Net Cash Flow/Equity = Cash-on-Cash Return 

Capitalization Rate (Cap Rate)Rate of return used to derive the value of an income stream. This is the annual rate of return youd earn if you were paying all cash for the property. It varies by location, age, operating history and market. As an investor, target a benchmark cap rate for your deals. The equation: Value of Property = Net Operating Income/Cap Rate.

Internal Rate of ReturnThe true rate of return on equity over a period of time. This calculation more accurately determines the return received over the life of an investment with compound interest factored in. This is a must if youre looking at a value-add project with varying cash inflows and outflows.

Set a benchmark for each of the ratios outlined above and only invest in deals that meet or beat your goal. Patient investing is paramount.

Lets Make a Deal

What is a good deal? More important, what is a good deal for you? Just because the numbers work for someone else does not mean the property is an ideal investment.

For stabilized properties, you need to meet your projected rate of return. For a value-add property, things get more complicated. Here are some examples of investment strategies that can be implemented:

  • Property with a high occupancy that has not raised rents. Acquire the facility and raise rental rates across the board to equal market rates. You may lose some tenants, but overall revenue numbers should be substantially higher.

  • High-occupancy facility with room for expansion. Buy it and plan to expand. Consider adding units in phases to reduce out-of-pocket expenses associated with expansion.

  • Low-occupancy facility. Acquire the property and increase the advertising budget to amp up promotions. Ideally, you want to be the first facility people call for storage.

  • Older, somewhat rundown property. Many sites just need to be spruced up: Paint buildings, reseal parking lots and driveways, and put up new signage. A clean, fresh-looking site will attract tenants who place a premium on storing belongings in a nice, safe-looking facility. Often, theyre willing to pay more for it.

Look at your buying options cautiously and creatively. Sometimes it doesnt take much to improve a facilitys appearance and income stream. Regardless, dont buy a self-storage property unless the price is right and you can meet your own predetermined benchmarks through the purchase. A successful investment career is ahead of you if you can do both. 

Matt Lexow-Gray is a senior loan originator with S&W Capital and Realty, a boutique commercial mortgage and commercial brokerage firm that finds solutions for borrowers financing and property needs. For more information, call 888.525.9081; e-mail [email protected]; visit www.sandwcapital.com

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