Purchasing a self-storage facility can be more difficult than you’d think in this over-heated market, especially for first-time buyers. There are more investors than ever competing for fewer available properties. As a novice, you enter that competition with several disadvantages. To succeed, you should know what those shortcomings are and how to counteract them. Even under current conditions, opportunities can be found if you know how to identify them and you properly structure your offer.
The first step in finding the right self-storage facility to purchase is to define your search criteria. Answer the following:
- In what city, state or region will you look?
- What’s your price range? What can you buy for that price in the target market?
- Will you manage the site yourself or hire a management company?
- How often will you visit the facility?
After identifying where the perfect property will be, consider the best offer you’re willing to make, keeping your competition in mind. Be prepared to bid at a fair price. Offer the largest possible earnest-money deposit and the shortest possible due-diligence period. You can only do these things with confidence if you’ve researched and understand your chosen market.
After learning all about your target market, it’s time to consider which kind of investment suits your capabilities. Self-storage buyers usually consider stabilized properties or upside properties.
Prices and capitalization (cap) rates for stabilized properties in any given market should be fairly consistent. This means that when a property is evaluated by several well-informed buyers, its cap rate, sales price and value will fall within a narrow range. This isn’t the case with upside properties, where prices and cap rates vary widely and are much harder to establish. Upside is often subjective based on a buyer’s perceptions, beliefs and assumptions.
Stabilized properties generally offer higher current return with lower risk. They present the opportunity to slowly and modestly increase rents over time. Upside properties usually offer lower current return, sometimes much lower or even negative. However, they provide the chance to significantly increase return by improving the facility. These improvements can be physical, operational or a combination of both.
The following are common indicators of possible upside in a property (bear in mind they aren’t proof positive but a sign that further investigation is warranted):
- Higher vacancy than nearby competitors, especially if rents are equal to or lower than the competition
- Inexplicably high operating expenses
- Room to grow, i.e., excess land or many open parking spaces
Upside properties are in high demand by entrepreneurial buyers, but too often, stabilized properties are mistaken as having upside, causing buyers to substantially overpay. To avoid this mistake, it’s important to know the market, including the number of existing and planned self-storage facilities in the area, the major players, occupancy rates, rents, and expense ratios. You must know specific neighborhoods or sub-markets, their current population and growth projections, and other demographic information and trends.
There’s a lot of information to discover and absorb. It would be best to shortcut the process by working with a local real estate broker who specializes in self-storage. He’ll already have this information and should be willing to share it with you. He’ll know what’s for sale in the market or will be soon.
Remember, you’ll face competition from many other investors seeking properties in the best markets. Show your broker you understand local market values and are prepared to be competitive and act quickly when it comes to making an offer.
By this time, you should’ve contacted several lenders who understand self-storage and have a desire to loan on this asset class. Understand their loan programs in terms of:
- Minimum and maximum loan amounts
- Required loan-to-value ratios
- Rates and repayment terms
- How much time the lender will need before it can provide you with a “terms sheet” for your deal
Understanding available financing is critically important for a first-time buyer because you’ll likely compete against all-cash buyers whose offers don’t include a finance contingency. From the seller’s perspective, dealing with a financed buyer means additional time for the earnest deposit to become non-refundable. More important, it adds the unnecessary risk that the deal won’t close. If you understand the financing sources and options, you may be comfortable accepting the risk yourself rather than asking the seller to accept it.
Once you make an offer on a property, you and the seller will agree on a length of time for you to conduct due diligence, which is when you get to the inspect the property and its financials. The onsite inspection may involve soil tests, an environmental study and an engineering report for necessary improvements such as roof, utilities and HVAC equipment. You may also need to review existing site surveys or complete a new one. This can take up to three weeks, so an early start is essential.
Financial and other records to inspect include utility bills, tenant leases and correspondence, profit-and-loss (P&L) statements, bank statements, and cancelled checks. You want to confirm that the rental income shown on the P&Ls was deposited to the bank and there are no unreported expenses. Ask the seller to certify the accuracy and completeness of the material he provides. This is important because your lender will require the same certification from you.
Competition for the best properties among would-be self-storage buyers can be fierce, and first-time investors enter the field with many strikes against them. Follow this advice to mitigate those disadvantages on your path to ownership.
Bill Alter is a self-storage specialist with Rein & Grossoehme Commercial Real Estate in Arizona. He has specialized in storage since 1986, and has been involved in the sale of more than 160 storage facilities totaling more than 9 million square feet and a value of more than $400 million. He can be reached at 602.315.0771; [email protected]; visit www.rcre.com/author/billa.