Real Estates Rodney Dangerfield

Self-storage was often thought of as the lowest common denominator of real estate. Real estate professionals used to think those little tin buildings couldnt really be worth much. Meanwhile, self-storage developers were doing the calculations and finding the numbers sure looked good. Slowly but surely, many real estate gurus began doing the math on the rent per square foot and estimated costs in their mind, realizing their first self-storage impressions were completely off the mark.

Perceptions have changed dramatically in our rather brief history. Wall Street has embraced self-storage REITs and conduit lenders are enamored with lending to self-storage at rates comparable to other trophy real estate. Finally, self-storage is getting the respect it deserves.

Having kicked around the real estate business with all types of properties for the last 35 years, I think self-storage may be the best investment you can make in the sector, and it hugely deserves its recently found respect. This isnt to say all self-storage is better than all other real estate. But income-producing, well-conceived self-storage projects are preferable on average.

My analysis reflects only certain attributes, such as product-demand growth, cash flow, return on equity, break-even risk, additional capital costs and other mundane things. Lets see how the relative merits of self-storage investments compare to other types of real estate.

Growth Industry

The self-storage market, unlike most real estate, is growing faster than the population, giving the industry tremendous leverage for two reasons. First, many Americans have never used self-storage, so in many areas theres still pent-up demand. Second, after about five years in operation, many facilities report most business, say 80 percent, is from repeat customers. Its clear customers are discovering self-storage, but more importantly, they are using it again and again. Growth isnt limited to population increases; it gets a great boost from moving up the learning curve of consumers.

A Remarkable Story

Self-storage doesnt require inhabitants to make it useful, unlike hotels, apartments, offices and homes, which all require human beings to occupy them to be useful and profitable. Rather, our industry relies on the fast-growing accumulation of stuff and peoples emotional attachment to it. Just think of all of things youre saving for your children compared to what your parents saved for you, not to mention the toys you cant part with but need to shelve until you get back in the game.

So, storage demand keeps growing faster than the population, at least for the time being. We know fast growth covers a lot of sins in real estate, but it also means greater returns on self-storage investments than other types of real estate. Just think back about rents over the last 25 years. Despite the fact the industry built nearly 45,000 facilities, rents keep going up, proving total demand has exceeded supply and population growth. Of course, rents in all real estate types have risen, but when you think of the relative amount of absorption of self-storage supply in such a short time, the story is truly remarkable.

Cash Flow

Self-storage cash flows are higher and probably more secure than other kinds of real estate investments, meaning higher returns, less risk and possibly higher prices sometime in the futureassuming the facility is in a good location, a rational market (i.e., not overbuilt) and well maintained. Once again, even though self-storage may be the best real estate investment, it doesnt mean it will bail out dumb deals.

Below are five reasons self-storage is so virtuous:

1. Zoning: Zoning is becoming harder in almost every community. Its not that self-storage is a bad civic citizen (actually its among the best), but it isnt glamorous, there are no sales taxes in most states, and real estate taxes are usually modest. What planning commission would ever approve a project that had no glamour and didnt produce a lot of tax dollars? This restricts additional development, increasing cash returns of existing facilities as demand builds. If you own a good facility, its more likely the local zoning board wont jump through hoops to help developers build competition.

2. Cap Rates: Cap rates on most self-storage sites average between 1 percent and 2 percent above retail, apartment and office properties. Therefore, if an office or apartment project yields a 6.5 percent return, a storage project might yield a 7.5 percent return. It may not sound like much, but the cash flow is 15.4 percent per dollar of purchase price and about twice that increase if the property is leveraged with a loan.

3. Capital Risks: Investors for other real estate types often overlook the requirement (and risk) for additional capital. Hotels always need new furnishing and redecorating, office buildings require massive amounts of tenant finish and commissions, and apartments need everything and often. However, as one industry wag puts it, self-storage has its own capital requirementsa new broom about every three months!

While this is facetious, the capital demands of a facility are small. A standard reserve in the industry is about 10 cents per square foot. For example, in an office building the amortization of a typical tenant finish allowance ($25) and commission ($5) over seven years would be $4.66 per square foot per year with interest at 10 percent. In storage, most costs are upfront and not amortized.

A typical self-storage rent might be $12 per square foot a year with $3.50 per square foot in operating expenses (including reserves) for a net of $8.50 per square foot. Office rent might be $24 a square foot per year with $8.50 per square foot in expenses, $4.66 of capital amortization, for a net of $10.84 a square foot annually.

Self-storage can cost less than $50 a square foot to build, but office space costs at least $125 square foot to build. The uncertain amount and timing of capital costs in an office building compound the risk of the large capital requirements. In other words, capital may not be available when you need it, like when a large tenant moves out. Knowing all this, you be the judge of what type of real estate is the best investment.

4. Operating Costs: Self-storage sites usually enjoy minimal exposure to current high energy costs and labor. Other real estate types have as much as 70 percent of operating costs in energy and labor.

5. For Love or Money: One of the main reasons self-storage is such a great investment is both a blessing and a curse: no glamour. All returns are from cash flow, not ego satisfaction. While you probably wont hold your daughters wedding reception in your facilitys parking lot, you might use your ballroom if you owned a hotel. On the other hand, with self-storage youll have the cash flow to rent any place she wants!

The curse hits when you sell your facility. Buyers are seldom so smitten with a facility they fall in love with it and forget the numbers, which sometimes is the case with homebuyers. Self-storage buyers are in it for the money. Most buyers own a facility, know the market cap rates and operating costs, and refuse to overpay, making it next to impossible to find a greater fool to shell out above-market cap rates or bid up the price.

Rodney Dangerfield would be proud: The former ugly duckling of the real estate industry now enjoys the respect of all investor types. The potential for growth, combined with impressive cash flows, has elevated self-storage to a whole new levelone to rival the most glamorous of property types for years to come.

Michael L. McCune has been actively involved in commercial real estate for more than 35 years. In 1994, he created the Argus Self- Storage Sales Network, now the nations largest network of independent commercial real estate brokers dedicated to buying and selling self-storage facilities. For more information, call 800.55.STORE; visit

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