Due to the incredible recent interest in the self-storage industry, one of the most common questions asked by aspiring owners is, “Should I buy an existing facility or build a new one?” The truth is, it depends. Every opportunity is unique, and there’s no one-size-fits-all answer. That said, let’s explore both options so you’ll have a better understanding of what each entails.
Option 1: Buying
When thinking about buying an existing self-storage facility, there are important considerations to factor into the decision. First, ask yourself: How much capital do you have to invest, and what’s your tolerance for risk? Answering these questions will at once determine how large a facility you can afford and what kind of capitalization (cap) rate is acceptable.
There are myriad listings for self-storage facilities for sale. When researching these opportunities, you want to look at price, facility size and geography, and potential for operational and financial improvement.
While the list price isn’t necessarily the final negotiated price, it’s probably not too far off. Self-storage is currently in a seller’s market cycle. List prices have more than likely been determined with the aid of a broker or other matrices, so they should be fairly close to what the market will bear. When reviewing the price and the attendant financial information, it’s important to consider the following:
- What does the price include? Is it a based on current financial performance or an expected pro forma? If it’s based on pro forma, are you willing risk that the site can reach those numbers?
- Does the financial information include a management fee and payroll? It isn’t uncommon for small, modest-size facilities to be managed by the owner. In those instances, there may not be a management fee assessed or any payroll. If you’re planning to manage the same way, that may be OK for you. However, if you plan to hire a manager or management company, you’ll have to factor that into your analysis.
Facility Size and Geography
There are three ways a self-storage facility can be managed, and the property’s size and location will have a great deal to do with which option you choose. Your desired management style is an important consideration when starting your property search in earnest.
First, you can manage the property yourself. This may make sense for small to mid-size facilities, as they may not have the income to support a management company. There may be an onsite manager, or the owner may handle the day-to-day operation himself. Of course, if you’re going to self-manage, you need to live in proximity to the site.
Your next option is to hire in independent, “unbranded” management company. If the facility you’re buying is medium-size or larger, you’ll likely want a regional company to oversee operation. By choosing an unbranded company, your site will retain whatever name is on the sign. You maintain control of its identity. Of course, the advantage to hiring such a company is you don’t necessarily have to live close to the facility.
Finally, you can hire a large, national “branded” management company, like one of the real estate investment trusts. In this case, your facility would be branded under the company’s name and operated as if it were owned by that company.
The size of the facility will also determine your potential exit strategies. Just about any property is sellable, but the size is a great factor in determining the pool of potential buyers. The larger national companies that are paying what seem to be crazy cap rates will likely not be interested in a 100-unit facility, but a local investor who plans to self-manage might be.
Potential for Improvement
Many self-storage investors are looking for facilities they can purchase and then increase the value by instituting operational and financial improvements. If a buyer knows what to look for, a facility listed at an obscenely low cap rate might include the opportunity to substantially improve in a fairly quick timeframe. Here are some questions to ask:
- Has the current owner been regularly raising existing tenant rates, or have there never been any increases?
- Has the current owner kept the street rates current to the market, or is the facility below market?
- Does the facility have ample room to increase ancillary income from offerings such as truck rental, tenant insurance, moving and packing supplies, and other potential revenue streams?
- Is there any excess land to expand the facility?
- Is the facility using an up-to-date, state-of-the-art website and Internet marketing platform?
- Is the current onsite manager capable of implementing new plans or programs?
Other Factors to Buying
When it comes to buying an existing facility, there are any number of additional factors you must contemplate such as financing, deferred maintenance costs and technology upgrades. You also need to consider who will conduct due diligence on the property. Will you hire a professional or do it yourself? Should you perform a market study, or will you purchase in a vacuum without knowing what’s going on in the market?
If you’re thinking about buying an existing facility, do your homework. If a deal seems too good to be true, it most certainly is.
Option 2: Building
On the flip side of the buying question is building. Again, there are numerous discussion points that will help you determine the best course. Basic considerations include:
- Location: Self-storage is still a retail business. A good location with decent visibility and access and at least a moderate traffic count is still important. Customers tend to store close to home, so it’s vital to have good population density and the potential for prospects to drive by your site.
- Zoning: Self-storage isn’t allowed just anywhere. Before you make any substantial investments or spend a great deal of time on any particular development site, make sure it’s already zoned for self-storage or could become properly zoned.
- Land size: Your cash flow will depend on rentable square footage, which will depend on the size of your land parcel. If you need to build 50,000 square feet to be profitable, and you only have an acre of land, the project won’t work unless you plan to go vertical; and that’s not always an option in every market.
- Market: A great site won’t compensate for a poor market. If occupancy levels at competing sites are less than robust and the rental rates are low, you can’t overcome those obstacles. Not all markets are suitable for new development. It’s important to have an unbiased, experienced professional conduct a market study to give you the information you need to make an informed decision.
- Future competition: Is there still vacant land in the area? Consider how easily it would be for another company to develop on a site that’s better located than yours. If it builds a facility closer to the population density, for example, or on the main road while yours is on the secondary road, it could hurt your business.
Financing and Operation
There are also financial considerations for new development. It can be more difficult to borrow money for new construction than to purchase an existing facility. Whereas financing for a new build is largely based on the strength of the borrower, financing for an existing facility is mainly based on the business’ cash flow. There’s likely going to be higher equity threshold for new construction as well. The developer must budget for lease-up capital reserves, as there will be a period of time before the facility will have positive cash flow.
Other things to consider with a new build are how the facility is going to be managed. As with an acquisition, your style will be impacted by property size and location. The viability of the business will be dependent on the quality of the management, the effective and efficient operation of the site, and the quality of the marketing efforts implemented. Consideration of all these aspects should be part of the process.
Although there are many factors to consider, there’s a great deal of benefit for developing a new self-storage facility over buying an existing one. First, a good ground-up project tends to provide higher financial returns than an acquisition—although the existing site will (or should) have better cash flow, at least in the short term. Second, a facility that’s been taken from ground-up to stabilization can have incredible value and, thus, create a profitable exit strategy.
The question to buy or build has a different answer depending on your specific situation. Contemplate all the various factors before making any concrete decision.
Bob Copper is the owner of Self Storage 101, a consulting firm specializing in self-storage. Bob and his team have worked with hundreds of owners, operators and managers to maximize asset value, conducting countless due-diligence audits and helping owners position their facilities to sell. To reach him, call 866.269.1311; e-mail [email protected]; visit www.selfstorage101.com.