There are many ways to measure self-storage facility value, but first, we must understand the amount of income generated by a property as well as the nature and reliability of that income. The value figure must then be compared to those of other investment types to determine the appropriate return on investment to induce buyers.
Self-storage valuation is a professional art. While number manipulations are an important part of the process, a good deal of real estate experience is required to develop a precise value range. It would be difficult to elaborate on every point of judgment necessary to arrive at a precise figure. That said, let’s examine some basic number crunching to help get you get in the ballpark and some anomalies that can take you out of it. Since these exceptions can be difficult to understand and evaluate, you’ll want to seek advice if they exist at your property.
True market valuation is an in-depth process that incorporates three traditional approaches used by real estate appraisers:
- Cost basis: This approach compares the cost of replacing the facility within the market in which it’s located.
- Market-sales comparables: This method compares the value actually achieved in the marketplace by similar facilities that were recently sold.
- Income-approach basis: This method looks at the amount of income a property produces and applies a capitalization rate (cap rate). Dividing the net operating income (NOI) by the cap rate gives you the property value. For example, a property with NOI of $150,000, when valued at a 6 percent cap rate, would have a valuation of $2.5 million (150,000/0.06 = 2,500,000).
Without reconciling the values derived from all three methods, you can’t be sure you’ve identified the right number. Again, it’s a complicated process that requires the expertise of an industry professional. However, in large measure, the value of a self-storage property to potential buyers is largely determined by NOI and the income approach.
As you work through the calculations with your local self-storage professional, try changing some of the numbers to see the resulting effect on the value. For example, drop the rates by 10 percent or occupancy by 7 percent, or raise real estate taxes by 25 percent. This exercise will teach you why a good operation is often the most important factor in creating and maintaining value.
Because today’s buyers are heavily weighting the income approach, it’s extremely important to develop a clear picture of your property’s operating numbers. A good place to get these is from your most recent tax return or an operating statement from the previous 12 months. With this information in hand, you’re ready to begin your investigation and arrive at a market valuation. Following is a basic overview of the major areas on which to focus.
Rental income. Because self-storage is a seasonal business, you must consider a full 12 months of actual rental income. You should also evaluate rental income over the last few years to see if it’s declining or improving. If there’s a clear trend, it might justify a cap-rate adjustment.
A cap-rate modification may also be necessary if the property has significant vacancy, say more than 15 percent. When evaluating vacancy, it’s important to compare actual rent received to potential rent and not just physical occupancy. It’s very possible to have physical occupancy of 92 percent but an economic occupancy of only 80 percent due to discounts and concessions. Also keep in mind that very few buyers or appraisers will count revenue in excess of 90 percent of potential rent, except in very unusual circumstances.
Additionally, if there are any new facilities being built nearby that are about to open or already in lease-up, all bets are off until it’s clear that rates and occupancies will remain stable. This is a good place to test sensitivities by changing the revenue to reflect the potential impact of new competition.
Miscellaneous income. This is the catch-all category for funds collected from late fees, truck-rental commissions, and the sale of boxes, locks and tenant insurance. If the profit from these types of add-ons is greater than 10 percent of rental income, it’s possible a different valuation method may be required. As this figure grows, it may represent a separate business and not fall under “miscellaneous real estate income.” Also, such income is usually valued much lower than real estate income and often isn’t counted by appraisers for loan purposes.
Operating expenses. These generally run between 35 percent and 45 percent of income; however, this is just a rule of thumb. If your property falls outside this range, further analysis may be required.
Typical expenses include real estate taxes, salaries and benefits, business insurance, utilities, repairs and maintenance, management fees, marketing and advertising, office supplies, and capital reserves. Do not include expenditures such as loan payments, depreciation, and any personal expenses like convention costs, travel, business lunches, mileage expenses, etc. Keep in mind, this list by no means represents all the expenses you may encounter. Each property is unique.
The Right Position
Regularly evaluating the performance of your self-storage operation will best allow you to plan for refinancing, estate planning or sale. It may also uncover hidden value to help improve your bottom line. Positioning your property for maximum value is an important, complex activity that requires conviction and preparation, especially to achieve it in a reasonable timeframe.
Ben Vestal is president of the Argus Self Storage Sales Network, 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].