If you’re looking to invest directly in ownership of a self-storage business, your choices are to build new or buy an existing facility. In today’s market, lending is readily available for either option, and each has pros and cons. Let’s take a closer look at both to help you determine which may be your best opportunity.
Perhaps the most attractive aspect of building a new facility is, well, everything is new. Ground-up construction means a facility will be relatively maintenance-free once built. It’ll include fresh driveways, buildings with brand-new rooftops, long-lasting pre-finished steel and, in many cases, all new fencing, gates and security equipment. While your primary motivation in owning self-storage may be to operate it as an investment, there’s a certain satisfaction that comes with having the colors, finishes and design just the way you want it.
On one hand, you’ll have the benefit of starting with your own operating procedures and running the facility as you see fit. You’ll get to choose the management software, for example. On the other, you’re starting at 0 percent occupancy and will have negative cash flow until you reach your breakeven point. Building new carries risk in the time it takes to rent up as well as potential project-cost overruns.
Overruns can come in many forms. Unexpected site conditions, changing building codes and unforeseen environmental hazards can greatly impact construction costs. For example, a developer in Iowa was adding to an existing facility when he learned the newer building code would require him to install sprinklers in the new building. The sprinklers alone would be a major expense, but to make matters worse, he had to excavate under several hundred feet of driveway to connect the sprinkler system to a water source.
Another potential drawback to building new is the overall timeline. Finding the right land and gathering the necessary approvals and permits is commonly a costly, multi-year process. The design work involved to obtain permits can easily run into tens of thousands of dollars before you know for sure the project can be built. But once the property is up and rented, it will grow in value with age.
In most cases, buying an existing site has the major benefit of immediate cash flow. You know what the current rent is, and you know what the expenses will be. A big challenge can simply be finding a willing seller.
The success of the self-storage industry has been well-publicized, and large real estate investment trusts (REITs) have been on a buying spree. REITs have low borrowing costs and, therefore, are willing to pay more for a site than the average investor. As a result, large sites for sale are hard to find. You’ll have better luck looking for a smaller property on which the big players are likely to pass.
Determining a fair price for a facility generally involves looking at the desired return on a cash investment. A capitalization rate (cap rate) is applied to the annual net income. The equation is:
Net Income / Cap Rate = Facility Value
For example, a site that generates $100,000 annually after deducting expenses (excluding mortgage and interest) would be worth $1 million at a 10 percent cap rate. More desirable properties will sell with a lower cap rate, while small locations or those in need of significant improvements will sell with a higher cap rate. Institutional buyers are typically looking for larger properties or groups of properties.
Accurately projecting expenses is a key component to buying an existing facility. When a property is sold, you can expect the city to re-evaluate its property taxes. Assume they’ll go up after you buy. Additionally, owner-operated facilities often underestimate the value of the owner’s labor. For example, an owner who plows and mows the facility himself might not be including that expense. For purposes of valuation, it should be incorporated.
You’ll also want to factor in any deferred maintenance items, such as roofs, driveways or doors that may be at the end of their useful lifecycle. Look for potential problems, such as poor layout, drainage, or locations where ice or snow may be problematic. In northern climates, there shouldn’t be water shedding to northern exposures with doors. Acquired sites may have issues that aren’t easily fixed.
Buying More Than Property
Keep in mind that buying an existing facility means more than acquiring land and buildings—you’ll also instantly have tenants. This is good, but you’ll inevitably inherit some problems. Did the previous owner or manager collect rent from a few tenants off the books? Why is there a locked unit with no contract? Are there delinquency issues? Depending on how tightly run the business was, you may have a project on your hands to clean up the rent roll.
You’ll want to evaluate the current operation to identify ways you can increase financial performance. How was the business being marketed? Does the facility have good online visibility and a well-designed website? Is the current rent below market rates? Can the site be improved with modern lighting and security features to justify a rent increase? Can you reduce operating expenses?
If buying an existing facility with room to expand, proceed with caution. While the extra land does make a site more valuable, you may find that codes have changed, making the extra land no longer buildable. New code could also require a catch basin for any new buildings as well as existing ones.
There’s no clear-cut answer to whether it’s better to buy an existing facility or build new. To figure out which may make the most sense, you’ll need to closely evaluate your available opportunities. Talk to consultants and brokers who specialize in self-storage and, if necessary, a local civil or city engineer to gain a better understanding of project costs and value. Good luck in your next endeavor!
Steve Hajewski is the marketing manager at Trachte Building Systems, which designs, manufactures and erects a full line of pre-engineered and customized steel self-storage systems, including single- and multi-story, portable storage, interior partition and corridor, and canopy boat/RV. He also owns a self-storage facility in Wisconsin and is a frequent contributor on Self-Storage Talk, the industry's largest online community. For more information, call 800.356.5824; visit www.trachte.com.