Self-storage owners and developers often choose to build their new projects in phases. There are several good reasons for this. You might lack enough funds to complete the entire facility at once. Maybe you have extra land at your existing site, but the demand in your market isn’t quite there yet. Perhaps you just want to save money! Whatever your motivation, it may be wise to consider this approach for your next build. Learn more and see specific examples below.
Building in phases allows you to save money on your mortgage and operations carrying costs while you fill up your first phase. For example, if you’re building a 70,000-square-foot building with 60,000 net rentable square feet in two phases of 35,000 square feet each, you could save around $290,000 in your first year. How?
Let’s assume building costs are $60 per square foot, and there are no additional construction costs due to the fact that you’re phasing (though that isn’t always the case). Your mortgage interest rate is 6.5 percent. Your operational costs are $4 per square foot.
- Mortgage savings: 35,000 square feet x $60 per square foot = $2,100,000 mortgage @ 6.5% = $150,000 saved in the first year
- Operations savings: 35,000 square feet x $4 per square foot = $140,000 saved in the first year
Phasing often makes more sense when there’s a longer time between builds, as the savings would be larger. Even when there’s storage demand in a certain location, feasibility reports are showing it takes 36 to 48 months to lease up due to multiple properties renting up simultaneously. This makes phasing an easy choice.
It’s important to note that some savings could be lost due to future construction-cost escalations, such as price increases on steel, duplicate bank fees, interest-rate increases, etc. The effort—and possible aggravation—of going through the building process twice should also be considered. Finally, there’s the risk that if the first phase is too small, the project won’t break even in phase one, which means you could have trouble getting financing for a second phase without providing significant additional capital to meet the lender’s owner-equity requirements. Reviewing project phasing with your banker and development team is a must to make a good decision.
A Profitable First Phase
Phasing isn’t the answer for everyone; but often, if you’re projecting a short rent-up period and an even shorter breakeven time, you may want to build enough square feet to have a profitable phase one.
For example, if your total proposed square footage is 80,000 but you only have $525,000 to invest, consider building a 60,000-square-foot first phase and a 20,000-square-foot second phase. You could build phase one with a 10 percent equity Small Business Administration (SBA) loan (or 15 percent equity at $829,000) that provides development funds including soft costs and caring costs. Then, once the facility is fully leased, you could refinance and build the second phase with the lender’s money if there’s enough equity. Here’s a sample calculation:
Loan-equity (down-payment) requirements have a huge impact on phasing. Many SBA loans are made closer to 15 percent than 10 percent equity. If you had $500,000 to invest and were required to put down 15 percent, you could borrow $3.33 million for the first phase, which would drastically reduce the 60,000 gross square feet of building noted above. Now, let’s look at the income potential for our example building:
Here’s the facility value at various capitalization (cap) rates:
If we assume a $5M loan for a highly qualified borrower at 6.5 percent (prime plus 1.5 percent), with a 25-year amortization, the principal and interest (debt service) is $32,300 per month. When you subtract that from our net operating income of $43,775 per month, that leaves $10,775 per month, or $129,000 per year.
Phase two, at 20,000 gross square feet, brings the project total to 80,000 gross, 68,000 net rentable. If you do the same calculations as above, you’ll see the profit and resale value skyrocket after the additional phase. Warning: I made a lot of assumptions in the above example, which is for illustration purposes only. You’ll need input from your builder, banker, architect, engineer and feasibility expert to do the calculations for a specific project.
The Second Phase
If you're going build in phases, it’s important to know how much square footage you’re building in each, so your project is designed correctly. Phasing should be shown on the plans so there’s no confusion and the municipal commission and others approve it when they review. This’ll ensure there’s no delay. A side benefit to phasing is the opportunity to update your unit mix based on rent-up rates and pricing from the first phase.
Don’t assume the obvious, and make sure the phasing details plus actual written description for phase-two items, which were required in phase one, are noted on the plans and in the construction-bid documents. Here are some of the phase-two items that are typically addressed during the initial build:
- Complete the detention basin.
- Bring water, sanitary-sewer, storm-drainage, electrical, lighting, security-door and camera services X feet into phase two as shown on the plans.
- Complete all offsite improvements.
- Provide temporary fencing between phases one and two as shown on the plan.
- Size all security cameras and other equipment for phases one and two.
- Stabilize all disturbed areas in phase one with four inches of topsoil and seed.
- Don’t remove topsoil off the site in phase one unless approved by the owner.
In the end, you need to determine how much cash equity you have for the development of your project—the real cash equity your lender is going to require and to realistically cover total project costs, including soft and carrying costs. Then you need to do the calculations for the project with and without phasing. Too often, owners underestimate final construction costs or fail to include enough soft and caring costs. It’s important to get help from your team to make a final decision on phasing.
Marc Goodin is president of Storage Authority LLC, a self-storage franchise, and the owner of three self-storage facilities that he personally designed, built and manages. He’s been helping others in the industry for more than 25 years. To reach him, call 860.830.6764, e-mail [email protected] or visit www.storageauthorityfranchise.com. You can also purchase his books on facility development and marketing in the Inside Self-Storage Store.