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Bare Essentials: Critical Items to Cover When Performing Self-Storage Due Diligence

Conducting due diligence on a self-storage acquisition is critical to protecting your investment. Learn the most crucial areas of concern and what to include in your analysis at a minimum.

Conducting due diligence on a self-storage acquisition isn’t glamorous, but it’s critical in determining your success. As the discovery phase of investment, this is how you’ll determine—before you write a big check—if a property will meet your goals. Your purchase agreement will outline a full list of items needed to perform due diligence, but let’s examine some of the most crucial areas and what you should include at a minimum.

Financial Information

At a minimum, make sure you have:

  • Three years of profit-and-loss (P&L) statements
  • Monthly P&Ls for the past 12 months
  • Three years of Schedule E tax returns
  • Bank statements for the past 12 months
  • Security-deposit account statement

This information provides the valuation of the property’s income stream. It’s critical to assessing the investment. When you request it, you may receive a pro forma statement of income and expenses. “Pro forma” literally means “to form,” but translates to “as if.” This statement represents the property’s income, with certain assumptions that may or may not be true. Keep in mind that you need the reality.

In valuation, you must use the most recent, actual operating income performance. It’s a cardinal rule. Three years is a good length of time to gain a sufficient track record for the facility, including seasonality, but may not tell the whole story.

Operating Information

At a minimum, make sure you have:

  • Copies of all leases
  • Current rent roll as well as the past three years
  • Utility bills
  • Insurance-declaration page
  • Vendor agreements for management software, website, service contracts, etc.
  • Third-party management contract, if applicable
  • List of capital improvements

Income properties are sold subject to existing leases. Therefore, it’s critical to review every rental agreement, matching each with the physical unit during a walk-through. Leases should also be checked against the rent roll to verify the operating statement. In addition, the original lease documents must be delivered to you at closing.

The rent roll is a convenient report that consolidates the lease information. A basic report should show each unit number, tenant name, rental rate and lease expiration date. Some reports are more detailed and may contain payment history, outstanding balances and the lease start date.

Utility bills play a vital part in determining operating expenses; however, annual or monthly costs revealed on an operating statement aren’t enough to determine if expenses and use are in line. I recommend getting copies of monthly bills going back at least two years. If the owner doesn’t have previous bills, it’s fairly easy to obtain them from the utility company by submitting the account number.

Insurance coverage is another important piece. Once you have the current declarations page, use the information to gather competitive bids. Compare the amount of loss insured, policy type and standards of coverage (replacement cost, business interruption, etc.), any riders for additional property or casualty coverage (flood, disaster, etc.), and any coverage exceptions.

Review all vendor contracts and agreements to see if they can be canceled following the acquisition or if there are any automatic-renewal clauses. These might include contracts for third-party management, lawn care/landscaping, snow removal, pest control, trash pickup, janitorial supply, truck rentals, moving supplies, etc.

Also, make sure you see the property’s business or retail license. This should be displayed on a wall or kept in the owner’s files. If the jurisdiction doesn’t require a business license, this should be verified with the local government.  

Physical Information

At a minimum, make sure you have:

  • Property-tax assessment
  • Any site/building plans
  • Copy of previous title work

Property taxes are most likely the highest expense item and should be analyzed for rate increases over time. This information can be found on the source document or from the local taxing authority. In any estimate of future expenses, always plan for increases, especially after the sale. Some municipalities will reassess property taxes on a set period, such as annually or every two years, while others automatically reassess the property after a sale. If the latter is true for your acquisition, you may need to plan for a significant increase.

It’s always a good idea to have copies of any existing architectural, engineering or utility plans in the seller’s possession. This can be helpful and possibly save you money if you decide to develop additional buildings on the site.

Instances of personal property must be dealt with case by case. Though not essential to the initial analysis, a discussion and mutual agreement should be made whether it will transfer to you after the sale.

Third-Party Information

At a minimum, make sure you have:

  • Past appraisals
  • Past engineering/inspection reports
  • Phase I environmental report
  • Zoning information

Lenders will almost always want to order a new appraisal, but some cost may be saved if an existing appraisal is less than two years old and the property hasn’t undergone any major changes. Most lenders have a short list of appraisers approved by the bank to perform updates or obtain a new report.

Inspections are generally required by all lenders, but even if you’re paying cash, I highly recommend you have an inspection performed on any property you purchase. A building inspector will test the property’s systems, evaluate structural components and note any deferred maintenance or deficiencies. For multi-story facilities with a freight or passenger elevator, there are regulations that may require an elevator-inspection report.

A Phase I environmental report is conducted to determine the environmental status of a property. It includes a review of public records and databases maintained by state and federal governments for environmental “events” or known contaminations onsite or in the vicinity. Based on the findings, a conclusion will be offered as to whether any further action is recommended.

Zoning certification must be obtained from the municipal jurisdiction, usually at the local planning and zoning office, or from the economic-development office. Current zoning compliance can usually be verified with a phone call to the appropriate office.  

Market Information (3- to 5-Mile Radius)

At a minimum, make sure you have:

  • Competitor market survey
  • Existing market supply index
  • Feasibility study (optional)
  • Department of transportation traffic information
  • Demographic report

Most sellers will have some sort of survey available, but it may not be sufficient to satisfy your lender. Most lenders require a commercial real estate survey that meets the minimum standards set by the American Land Title Association (ALTA) in 1999. The ALTA survey requires that the surveyor and title company work together to determine whether the property’s physical presence and legal description match.

The surveyor will refer to the title commitment for the property’s legal description and any encumbrances (exceptions) on the title. He’ll then provide the title company with the information to ensure the title to the land and improvements match to the degree required.

Decisions, Decisions

The purchase agreement will state that at the end of the inspection period, you must accept the property and allow the earnest money deposit to go at risk, or reject the property and have the deposit returned in full. Your investigation will almost always reveal conditions that differ from the seller’s representations or render the property undesirable. These may warrant an adjustment in the price or terms of the sale. This is up to you, of course, and may cause further negotiation with the seller, depending on inspection findings and the amount of money required to rectify any unforeseen problems.

Due diligence is your chance to investigate a property and eliminate most of the risk that stems from a lack of knowledge. Remember, this is your only opportunity to obtain information when the seller is required to help. The benefit of being thorough is it gives you the confidence to act decisively, and with assurance that you have a clear picture of the current value of the facility and have mitigated the risk of future problems.

Scott Meyers is the president and owner of Indianapolis-based Kingdom Storage Holdings LLC. He’s been involved in the self-storage industry as a developer, owner, syndicator and operator since 2005, owning and operating 23 facilities across seven states. His education platform, www.selfstorageinvesting.com, offers information, software and seminars to help individuals launch and grow a self-storage business. To reach him, e-mail scottm@selfstorageinvesting.com.

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