In life, we don’t always get a second chance to correct our mistakes. If we get it wrong the first time, we suffer the consequences. That may be true of flying a fighter jet, which allows for no mistakes at all, but it does not apply to building self-storage; that is, if the project is built using the phasing method.
If the wrong unit mix is selected during the first building phase, the second phase is a chance to install the type of unit mix needed. But that is only one advantage of using phasing in self-storage construction. Here are some other reasons to phase a self-storage project:
- Discourages new competition
- Minimizes initial investment
- Makes financing and payments easier
- First phase helps finance additional phases
- Land use is more efficient and can change
It is during the early stages of planning that phasing should be considered. Generally, phasing delays the final decisions of unit mix and construction. Decisions are delayed, allowing them to be based on actual events and not estimates, even if they are educated estimates.
A Case Study for Phasing
One conversion project in a small town in Louisiana featured in a 2003 case study had a gross size of nearly 100,000 square feet. The owner was afraid the area was overbuilt; however, two years later, the project was more than 90 percent occupied and several sizes had been depleted. The rent was raised, which might have discouraged some tenants, but even so, the occupancies stayed high or even higher. This project was part of a nearly vacant shopping center.
The owner was able to use an adjacent vacant grocery store, converting it to additional storage. This second phase added another 57,000 gross square feet to an already large property, which now has a total of 120,000 square feet of storage and is more than 90 percent occupied.
Originally, the owner, who also owned the shopping center, had tried to rent the grocery store. Luckily it failed to attract a renter, which made it available for additional self-storage. The storage brought in more revenue than the rent would have been had he found a renter.
Minimizing the Investment
Having enough land to expand is a must with most storage investments. The first phase can be left incomplete, saving money. This works particularly well for conversions, as a completion can be done very quickly and can correct errors made in unit mix. When doing conventional storage, land must be left available for additional buildings. Extra land should be a strong consideration from the initial search for the property. Many times larger tracts of land can be purchased for a more reasonable price.
One good idea is to pour the concrete slabs for additional phases during construction of the first phase. When occupancy reaches 60 percent, the construction process can begin again. It should only require about half the time to build the second phase as it did the first. It will also cost less than building the first phase because the building, doors and partitions are typically all that is required. Electricity will likely be needed for lighting, but most of the planning will involve first-phase costs. The second phase will take advantage of construction cost changes and building innovations.
When competition sees that you have or can have more units to rent shortly, they will think twice about moving into the area. The momentum of an existing property with more units to rent will make it harder for a new competitor to find renters.
One owner in northwest Florida has used this approach to keep significant competition from coming into his city. Yes, there is competition, but none of it has made a dent in his occupancy or profit.
Financing and Payments
Going to a bank with a loan request for a smaller amount in the first phase is better than asking for the whole project up front. Most banks will approve a loan with a statement that a second phase will be constructed when the occupancy reaches 65 percent.
At this level the project should have developed enough cash flow to pay the expenses and debt service. The lenders confidence in the project will be good, and the loan can be approved without the same amount of red tape required in the initial application.
Not only will phase two correct unit mix and construction problems, but it will also allow the owner to adjust to a new competitor in the area. If this new competitor has a different type of storage, which might be considered an improvement over what was built during phase one, it’s possible to make competitive adjustments.
Many times projects are completed without climate control, and if competition offers it, phase two may include it. Attempting to add climate control to an already completed project is difficult due to required insulation, doors, security and electrical systems
Climate-controlled space is similar to conventional space when phasing. Often, the complete building will be constructed with the heating and air conditioning systems already in place. The hallways, doors and some of the partitions can be omitted.
By leaving the doors, hallways and partitions out of the first phase, the unit mix can be adjusted to whatever is renting best. This adjustment ability for changing the unit mix will keep the project on track for having units to suit all needs.
Multi-story buildings will need to be built out with the exception of doors, hallways and partitions. One recent four-story building project left one floor for only conventional units (no HVAC). This was done to initially offer both non-climate-controlled and climate-controlled spaces. The eventual goal is to convert the entire project to climate control, thus increasing revenue. Multi-story buildings are usually 60,000 to 100,000 square feet or more. Most often, the first half of the project is built with phasing in mind.
Usually, it will require seven months or less to complete a project and 50 percent will be rented within one year. At that time, second-phase work can start and should be completed within four months. Of the total cost, about two-thirds will be in the first phase with the balance in the second.
Improve Financial Statements
The impact on the financial statement is shown in two or three different ways. Rent-up percentages are higher. This is a confidence builder for the lender. High mortgage payments are not made early on, but delayed until a time when the project has more operating income. In fact, some projects will have cash flowing by the time the second phase is completed.
The impact on reduced negative cash flow is very positive and lender confidence will be improved. Since phase two will have a unit mix based on actual units rented in the first phase, income will improve. If the market calls for better security, door alarms or other features, these needs can be accommodated in phase two.
Phasing is a familiar process for the large operators in the self-storage industry. It offers flexibility to market changes, minimizes capital exposure and reduces risk. Phasing should be considered on every project, even conversions. Flexibility is the goal for every owner of income property. Many owners and lenders are now realizing the benefits of phasing and use it as a valuable tool on every project.
Dan Curtis is president of Atlanta-based Storage Consulting & Marketing, which provides feasibility and marketing studies to potential self-storage owners. He is a frequent contributor to Inside Self-Storage as well as a speaker at numerous industry conferences. To reach him, call 770.432.2417; e-mail [email protected].