The self-storage investment landscape has changed dramatically over the last several months, largely due to disruption caused by the coronavirus. The unconventional and unexpected have become a part of everyday business, making this is an unprecedented time in industry history.
As we look at self-storage performance data from the second quarter, it’s clear we’re doing better than most commercial real estate sectors and should be thankful we’re in this business. Nevertheless, valuation, transaction velocity and overall investment fluidity have been impacted. To better understand how transactions are being structured today, let’s look at several areas that have changed during the commotion and the associated strategies being employed.
Deal Terms and Timing
If you’re on the market to buy or sell a self-storage property, it’s important to understand that the deal terms and experience of all the parties involved can be as important as the purchase price. With the health crisis in full swing, advisors, consultants, lawyers, owners and investors who are accustomed to transacting are much better equipped to navigate the ever-changing process than industry newcomers. When considering a deal today, a strong emphasis should be placed on the likelihood of an efficient, smooth closing.
With very sophisticated capital continuing to enter the market and facility values continuing to remain relatively high, alternative structures and key deal points are becoming more important to execution. Too often, buyers and sellers focus only on price and glaze over the deal structure without considering the financial implications.
There are many fresh nuances due to COVID-19, such as extended due diligence and closing timing, force majeure language, finance contingencies, closing extensions and prorations, just to name a few. These allow buyers or sellers to achieve different goals and can be beneficial if you understand the full implications of each; but as always, the devil is in the details. It’s important to remember that every real estate transaction is unique, so seek tax and legal advice from an experienced real estate lawyer and accountant, and align yourself with an investment adviser who has meaningful experience in recent self-storage deals.
Typically, when investment advisers think about property price, they’re focused on a number on which a buyer and seller can agree. They’ll use a series of recent sales as data points and current market conditions to pinpoint the worth of an investment opportunity. Without these, there’s no transaction!
As a result of coronavirus disruption, the pricing of self-storage assets is very fluid, making it difficult for even the most sophisticated adviser (and nearly impossible for a local investor) to isolate the exact value of an investment in today’s market. There simply aren’t enough deal data points to identify an exact figure. Sellers often think about a price that would make them ecstatically “happy” and not one at which someone would actually buy.
In the world of real estate, the market usually has a relatively narrow band of value, but the volatility of the 2020 investment environment has led us to a much wider range. It isn’t uncommon for offers to be several million dollars apart—as much as 25 percent. This is largely due to the wide variety of opinions on how the pandemic will affect the debt markets, property performance, investor sentiment, etc.
It’s important to remember, however, that overpricing is not harmless! Today, you must diligently and carefully analyze the value of a self-storage project. Consider how COVID-19 will affect the long-term performance of the property, along with traditional valuation techniques such as market sales comps, price per square foot, impact of new development, embedded value and the income approach.
National and regional buyers are increasingly expanding to secondary and tertiary markets, largely because there’s been significantly less new development, and disruption from the pandemic appears to have had less of an impact on property performance. But don’t be misled to believe your secondary-market property is now a 5 percent capitalization (cap) rate deal. We’re seeing secondary-market deals in the cap-rate range of 6 percent to 8 percent and major markets at 5.5 percent to 7.5 percent. These rates assume market-rate operating expenses for underwriting, such as payroll, offsite management fees, advertising, repairs and maintenance, etc. Secondary markets may not get the same respect as major markets, but it’s clear that in the current cycle, this where the smart money is going.
When taking a property to market, it’s important to note that differences in quality and risk are often very subjective. For example, a self-storage facility with relatively low occupancy might indicate a poor performing property, an overbuilt market or, alternatively, a great opportunity to increase occupancy and revenue. For this reason, it’s critical to market each property broadly and find the buyer who has the most optimistic view of not only your asset but the investment market as a whole.
Always beware of the broker or colleague who says, “I have the right buyer for you. We don’t need to market the property.” To maximize your value, look for a buyer who’s qualified and sees the opportunity for improvement. The more qualified prospects who are exposed to your offering, the better chance you have of maximizing your sales price. After all, there are clearly two types of investors today: those who see the COVID-19 disruption as an acquisition opportunity and those who are cautious due to the possible long-term effects.
The next several quarters will be a bit bumpy, and it’ll be important to think a few steps ahead. It’s clear the groups that are active during these turbulent times will have the best chance for success as we navigate the ever-changing self-storage investment market.
COVID-19 will disrupt things for a while. There will be inconveniences, and the market will be challenging. But as we’ve seen in past cycles, self-storage will outperform most other real estate assets, and the industry will once again be a very coveted class. Now more than ever, when buying or selling a property, you’ll be well-served to align yourself with experienced industry professionals and focus more on the structure of the deal and less on price.
Ben Vestal is president of the Argus Self Storage Advisors, 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].