Self-storage has become an increasingly popular investment, in great part because annual returns over the last 15 years have averaged 15.43 percent. Many people also think storage is easier to understand than other types of investments, with less moving parts. Also, with approximately 83 percent of the sector’s facilities owned by mom-and-pop operators, new inventory is constantly coming into the market.
At the same time, consolidation within the industry is also a continuing trend. The largest operators, such as Extra Space Storage Inc., Public Storage Inc. and U-Haul International Inc., own 8 percent of the market, while mid-sized operations hold 9 percent. Now’s the time to buy a facility and capitalize on low-interest-rate commercial loans, before more independently owned properties are absorbed by self-storage chains.
Whether you’re buying your first facility or your 10th, you need to assemble a team of professionals who’ll ensure you make a smart acquisition. When you make a purchase offer, time is of the essence, particularly with so many eager buyers in the market. Having your team in place before you buy enables you to quickly and professionally close on your chosen property.
Here’s a breakdown of the team you’ll need before you begin to look at properties.
Real Estate Broker
The right self-storage broker may be the most important part your team, as he’ll bring you deals on which to bid, give you recommendations for your offers, and negotiate with the seller on your behalf. An industry-experienced broker can offer valuable insight to maximizing your investment. Because self-storage can be a more complicated business than some types of commercial real estate (i.e., a triple net lease on an office building), it makes sense to align with a broker who understands the business and won’t steer you toward an investment without upside.
Depending on the amount of financing you’ll need, there are several loan markets you can investigate. For most initial acquisitions, the first stop will be your local bank. If you have a long-term relationship, your local lender may be willing to finance your investment. In most cases, though, you’ll want to line up several bankers in case a loan falls through.
Ask your real estate broker for recommendations. An experienced broker will have been involved in many transactions and know about specific institutions that are issuing loans for self-storage. It also never hurts to look through industry trade publications for lenders. The benefit of financing through an institution that focuses on the storage industry is you won’t have to explain your business model, unlike the conversation you’re likely to have with your local bank.
If you’re looking at a property with high vacancy rates, the elephant in the room is whether the low occupancy is the result of poor management, not enough lease-up time (with new developments) or a deficiency in demand. If there isn’t enough demand for self-storage in the market, raising occupancy is going to be an uphill battle, with marketing costs eating into your profit margin.
On the other hand, if the property owner has artificially inflated demand for the facility—for example, through an intensive and expensive marketing campaign that isn’t reflected in his net operating income—then conducting a feasibility study can help you dodge a bullet. Keep in mind that certain seasons of the year will yield higher occupancy than others. If the asset is near a college campus, for example, you can reasonably expect an influx of students during the summer. In a market that’s undersupplied and showing demand for more storage space, a feasibility study may also reveal opportunities to expand the target asset of which the current owner isn’t aware.
A significant amount of money is made or lost in the negotiating process. For example, prorations are the funds paid by the seller or buyer for a period in which the other party owns the property. If the seller pays the real estate tax bill for the first six months of the year and then sells the property at the end of the third month, it’s fair for the buyer to pay the remaining three months within the tax-free period. Though prorationing is typical in the sale of self-storage facilities, it’s something you can easily overlook unless you have an experienced attorney reading every single line in the purchase agreement.
CPA or Tax Attorney
If you have an intimate understanding of taxes, there are a lot of opportunities to minimize your tax bill. One great example would be the classic 1031 Exchange. Under this provision, if you’re buying Property B with the capital gains from the sale of Property A, you can defer capital-gains taxes from the sale of Property A until after the purchase of Property B. Many investors love this concept because the deferral translates to a larger down payment, which enables them to buy a property that’s 10 percent to 25 percent more valuable than what they could afford without the deferral.
Although this exchange seems simple, it can be complicated and increase risk if handled incorrectly. The Internal Revenue Service can later hit you with a tax bill for capital gains on Property A, if the 1031 Exchange isn’t carried out properly. If this isn’t your area of expertise, it’s important to find a qualified certified public accountant (CPA) or tax attorney to advise you through the buying process.
In many states, real estate taxes are assessed upon the sale of each individual property. If this is the case, your pro forma can be significantly impacted by an increase in your tax bill. One way to mitigate risk in this area is to have a tax adviser complete an estimate for an automatically triggered real estate tax increase.
Assembling a qualified team of professionals will help you find potential properties to buy and evaluate them quickly. Collecting the team before you begin your acquisition journey will make the buying process an efficient one and put you a step ahead of those unprepared to navigate a crowded investment market.
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.