It happens thousands of times a year: A buyer finds a self-storage facility for sale and makes an offer. Some negotiation ensues and a purchase agreement is signed. What should come next is a comprehensive due-diligence period so the buyer can ensure he’s making a good investment, but not everyone knows what that means or what the process should entail. Here’s an overview so you can be well-informed when you’re ready to make a purchase.
In commercial real estate, the due-diligence period is when the buyer can review additional details and inspect the property to decide whether to proceed with the investment. It's an opportunity to uncover possible issues, reveal hidden profit potential and verify that all information is accurate. During this period, the buyer can typically terminate the purchase agreement without penalty. Once it’s over, deposits become nonrefundable and the parties proceed to closing.
Often, it's the buyer who personally inspects the property and reviews materials. However, certain third-party inspections and reports must be provided by trained professionals, such as environmental, land surveys, appraisals, etc. The time permitted for due diligence varies with market conditions, but the process can usually be completed within 30 to 90 days. A prudent knows that those third-party reports take several weeks and will plan so they can be received and reviewed within the allotted time.
In the self-storage purchase agreement, you may receive broad discretion in the items you can inspect and review during due diligence. Begin with financial records. Ask the seller for two to three years of property-level income and expense statements broken down by month, if possible, which will help you spot trends and provide insight to where you can make improvements. Also review the sources of ancillary income, including truck rentals, tenant-insurance programs, retail sales, late fees, administrative fees, etc. Compare bank deposits and software reports to the income statements and look for inconsistencies.
Examine expenses by reviewing actual invoices and bills, questioning any large costs, and understanding the accounting used with capital expenditures. Here are a few tips:
- Get new quotes for property insurance and compare them to the existing. This is a common area for savings. Just be aware that if you stick with the current provider, the seller may have a preferential rate that might be lost after closing.
- Makes sure expenses for site staff (payroll) and the management company, if applicable, are clear.
- Examine the real estate tax history including how and when taxes are paid. Estimate any changes that’ll occur following the sale.
- Ask for copies of the last 12 months of utility bills. These will be helpful in verifying expenses but also in transitioning services at close.
- Understand the facility’s repair and maintenance expenses, noting that underspend in this category can be an indicator to look closely at deferred maintenance.
- Review third-party agreements for products and services such as software, credit card processing, landscaping, etc. Do you need to assume any of these? Seek opportunities to re-bid services and trim expenses. Also be on the lookout for possible increases.
- Red flags in the area of expenses include inconsistencies in the expense reports or items that are unaccounted for or undercounted, such as snow removal or property-tax reassessments.
Next, verify facility occupancy by reviewing the previous 12 months of management-summary and occupancy reports. Look at rental promotions and discounts, and consider trends. See that the facility’s rent roll matches these reports, including current rental charges and delinquent balances for all tenants. It isn’t customary for self-storage owners to obtain estoppel certificates, so perform lock checks. The information from each source should tie together.
In addition to analyzing the financials and rent roll, review a copy of the active rental agreement to ensure it complies with applicable laws and provides the typical provisions and protections. Examine non-storage leases pertaining to items like cell towers and commercial tenants. Think about how these leases can impact income and how these tenants’ rights might affect future use of the property.
Physical Site Review
Before you begin the physical inspection of the self-storage property, research any potential municipal issues. Review the title-insurance commitment as soon as it's available to see if there are any encumbrances or liens on the property. Find out if anyone else needs to approve the sale, and obtain all documents referenced in the title report, including deed restrictions. Review easements with the survey to visualize buildable areas and any encroachments.
Confirm the property is zoned and licensed appropriately for self-storage and any ancillary uses such as truck rentals. Ask for copies of the Certificate of Occupancy and all permits. If an expansion is planned, explore municipal requirements, including setbacks and parking-space minimums, and private restrictions found within deeds and other recorded documents.
A costly risk in commercial real estate is environmental contamination. Typically, when it’s discovered, the owner is responsible for any clean-up. A phase-one environmental site assessment should include a review of the public record and a site visit to give you reasonable certainty that the property doesn’t have any issues.
Finally, inspect the buildings, doors, gates, security system, lights, roofs, HVAC equipment, etc., to determine if any repairs are needed. Ask for copies of building plans and have a qualified professional review them for concerns related to construction. These are often overlooked but extremely helpful when the time comes for repairs and capital projects. Red flags in this area include the discovery of unpermitted buildings; building code, zoning and setback violations; deed restrictions; and title irregularities.
Lastly, examine all personal property that’ll transfer with the sale such as the golf cart, computers, furniture, etc. Is the condition as expected?
During the self-storage due-diligence process, take time understand the market. Here are a few items to explore:
- Visit competitors to gain knowledge of their rental rates, specials, occupancy and property condition.
- Review the demographics of the area, including the number of households, average income levels, growth rate, etc.
- Identify any underlying economic drivers and the area’s largest employers to see if the population is growing, stable or shrinking.
- Drive the area and speak to locals at neighboring businesses to get a sense of the community.
- Gauge the quantity of drive-by traffic, plus the level of visibility and access from the major thoroughfares.
There are also a number of operational factors to consider during due diligence. For example, most self-storage properties have employees. Interview the staff and obtain copies of any employment agreements. You’ll need to determine whether staff should be retained or dismissed post-closing.
Review the advertising methods employed by the seller including promotional materials and the property website. Ensure he’ll transfer the Web domain and business phone numbers at sale. Check online reviews. Verify signage rights and opportunities. How might these items impact your marketing plan? Can changes be made to improve performance?
Consider whether other key products and services will transfer to you after the sale. There are many things that could fall into this category. A few popular ones are management software, self-serve kiosks and other technology, truck-rental agreements, tenant-insurance agreements, etc.
You also need to understand the facility’s auction frequency, policy and process to see if there’s future risk in this area. Plan accordingly for any changes that should be made.
While the above guidance isn’t all-encompassing, it helps you understand the types of things to review during the self-storage due-diligence phase. You may choose to do more or less. Reasonable buyers seek an acceptable but not overly burdensome level of exploration to proceed to closing.
Some final words of wisdom: Opportunity is often found in self-storage operations that are mismanaged, which means some of the information you seek may not be available. In these cases, take a “trust but verify” approach and do your best to find alternate sources of data. You can work with an experienced real estate broker to help fill in the gaps. In the end, remember that rewards rarely come without risk, and overanalyzing is one way to miss out on a great property.
Jeff Gorden is president of the Gorden Cos., a regional group specializing in self-storage investments. He’s been active in commercial real estate for more than two decades, and has experience in retail, office, industrial and self-storage. He’s also vice president of the Arizona Self Storage Association and a broker affiliate for Argus Self Storage Advisors in Arizona and Nevada. For more information, email [email protected].