The self-storage market continues to be robust, and we’re seeing many new investors, large and small, enter the space for the first time. With so many buyers in the marketplace being new to the industry, here are some of the steps one must take to ensure a smooth transaction and successful closing.
Choosing a Market
When it comes to identifying opportunities, selecting the market in which you’d like to invest is the first step. You can start by looking at desirable demographics such as:
- Total population
- Population growth
- Percentage of home or apartment renters
- Income levels
- Proximity of the site to your home or office (flight time of 2.5 hours or less)
- Number of new self-storage developments in the area
- Size of local housing units
After you’ve identified several markets that meet your criteria, break each into several submarkets—typically four per small city and six to eight per each mid-size to large city. This will allow you to narrow your search. To correctly evaluate your submarkets, plan to spend a day or two touring each city so you have a good understanding of the area. Conducting this type of due diligence will help you better evaluate opportunities and give you the confidence to move quickly when they arise.
It’s important to remember that mid-size and large cities are often inundated with sophisticated self-storage investors, so if you’re new to the business, you might be well-served to look at smaller markets. Investors have uncovered some strong opportunities in secondary and tertiary markets where the competition from other buyers is less significant.
Making an Offer
When visiting a target market, meet with a knowledgeable, local broker and appraiser who have experience in self-storage to discuss the nuances of the area, see potential development sites, and understand what terms will be expected when you make an offer on a property. You’ll be surprised how much they can vary from area to area, and when submitting a letter of intent (LOI), you want your terms to be in line with the market. Price isn’t the only consideration. Other important items include:
- Amount of earnest money (2 percent to 5 percent)
- Due-diligence period (30 to 60 days)
- Closing time (15 to 30 days)
- Financial capability (broker references, bank references, etc.)
Be prepared to move quickly when you see an opportunity. I’ve seen several buyers miss out on deals that fit their investment criteria because they were too slow in submitting an LOI. It’s important to realize it’s still a seller’s market!
Structuring Your Acquisition
Whether buying a self-storage property, it’s vital to understand that the structure of the deal can be as important as the purchase price. It’s critical to identify your investment goals and horizon before making an offer so you can structure your LOI and purchase contract to maximize profitability. Parties too often focus on the purchase price and glaze over the structure of the deal without considering the implications of the non-financial aspects of the transaction.
There are two main structures that are typically used when selling or purchasing an entity or its assets: an asset purchase (real estate contract) or an entity purchase (limited-liability company or stock purchase). Let’s examine some of the pros and cons of both. (Note: I’m not an accountant or attorney, so please seek tax and legal advice from your counsel when structuring a deal.)
Asset purchase. There are two significant advantages to the buyer when structuring a deal as an asset purchase. First, he maintains a “step up” cost basis for tax treatment for all assets, which allows him to enjoy full depreciation. Second, he can choose the assets he wants to buy and avoid contingent and unknown liabilities, which are often costly and burdensome.
The main disadvantage to the buyer is an asset purchase may trigger a reassessment of real estate taxes after the sale is complete. With the very aggressive valuations self-storage properties have been receiving, this reassessment can be detrimental to the investment’s ongoing yield.
Entity purchase. The overriding benefits when structuring a deal as an entity or stock purchase are simplicity and convenience. However, this type of structure isn’t the norm in self-storage real estate. The buyer receives all the company’s assets and liabilities, eliminating the need for title transfer, reducing the number of third-party consents (except where there are change-of-control restrictions) and minimizing the vast transactional costs associated with an asset purchase.
The two main disadvantages are increased exposure to liability and the loss of tax benefits. Although a thorough corporate and contract review can help buyers mitigate the go-forward liabilities, they have to be OK with an increase in obligation. Additionally, they’ll need to talk with their accountants to see what tax strategies can offset and mitigate the loss of tax benefits.
There are many factors to consider when structuring a deal. Prior to drafting a purchase agreement, it’s crucial to consider all aspects of a potential transaction. Early planning and preparedness can prove to beneficial and can substantially cut transactional cost and attorney fees.
Note: The information provided above is generic and shouldn’t be construed as advice for any specific deal. If you’re a potential buyer or seller of a self-storage property, seek advice from a trusted real estate broker, attorney and tax professional.
Ben Vestal is president of the Argus Self Storage Sales Network, a national network of real estate brokers who specialize in self-storage. Argus provides brokerage, consulting and marketing services to buyers and sellers via an extensive marketing platform for self-storage properties. Property listings and informational resources can be found at www.argus-selfstorage.com. For more information, call 800.55.STORE; e-mail [email protected].