Storage owners often ask me, “What do you think my property is worth?” My first response is usually, “What do you think it’s worth?” Taking their subjective viewpoint into consideration, I then ask the owner to provide me with a copy of the last 12 months of their profit-and-loss (P&L) statements. After underwriting the property, I can give them a pretty good idea of its value.
The underwriting method is not subjective and is typically the preferred method a potential buyer or lender would use when valuing any property. Numbers are black and white and can only be manipulated so much. In this article, we’ll examine how you can easily determine your property’s worth by figuring out your net operating income (NOI) and then applying a capitalization rate (cap rate) to that number.
Verifying P&L Expenses
In line with broader commercial real estate conditions, fewer storage properties have been sold on the open market in the past few years. The sales that have occurred act as evaluative “comps” for appraisers completing an appraisal. A typical comp would be another self-storage facility that has sold in the past six to nine months within the same geographic location. But during the last two years, some states have only seen the sale of one or two storage properties per year.
When no real comps exist, the facility’s operating numbers are the best source for determining property value. Since all lenders examine the last 12 months of numbers from an income property, let’s begin there.
In its simplest form, income, which is stated at the top of most P&L statements, is comprised of rent, fees and goods sold. Other income from truck rental, cell towers and billboards may or may not be considered income. Some owners love the foot traffic a truck-rental business brings in, while others think it’s more trouble than it’s worth. Telecommunications providers usually have a 30-day cancellation clause in their cell-tower contracts, so many lending institutions and potential buyers may not count their income. Only the true income from rent, fees and goods sold should be used in your NOI evaluation.
Sometimes more than 30 to 40 different expense items can be listed on P&L statements. These can be categorized into nine subsets: real estate taxes, insurance, third-party management, office, salaries, repairs and maintenance, advertising, utilities, and miscellaneous. If some expenses on your P&L statement do not fit in these nine categories, then they may need to be omitted from the NOI calculation.
Personal expenses, such as autos, cell phones and sometimes even alimony/child support are frequently run through a storage facility. While these items are perfectly acceptable for tax purposes, they would not figure into the property’s NOI calculation. A good rule of thumb is if an expense isn’t something every storage owner would typically have in his P&L statement, it’s probably a personal expense that can be omitted.
As you categorize the items on your P&L statement into the nine expense subsets, it should be noted that if you don’t pay to have a third party manage your property, you’ll be required to add in five percent of your gross income to account for this expense. Every lender or potential property buyer requires this to be included in the NOI calculation.
There are also industry standards for each expense category that require a minimum amount of that expense to be charged annually. An example would be a property at 80 percent occupancy that only shows $2,000 per year in advertising. This expense would need to be adjusted upward since not enough advertising money is being spent to get the property to 90 percent or 95 percent occupancy.
Another example would be a facility that has a one-year spike in the repairs and maintenance line item. Let’s say the property typically runs about $15,000 annually in repairs and maintenance, and then we see a jump to $28,000 in the last year. After discussing it with the owner, we learn the facility’s asphalt drive was repaved for $14,000. Since this is a one-time expense, we could decrease the repairs and maintenance line item.
Further, debt service, mortgage payments, depreciation and interest don’t count as expenses and should not be included in the NOI calculation.
Capping Off the Valuation
Once you verify the expenses, a simple subtraction from the income at the top of the P&L will determine your facility’s NOI. Lenders and potential buyers will look at this NOI figure because there’s no subjectivity involved; it’s based on actual income and expenses for the last 12 months. While a few years ago properties received additional value for future income that wasn’t yet in place, those days are gone!
To complete the property’s valuation calculation, you divide the NOI number by a cap rate. The cap rate is a percentage figure that can be somewhat subjective since an owner always thinks the cap rate is lower than it really is. Their logic is simple: A lower cap rate equates a higher value.
Let’s take two examples: A property with a $250,000 NOI in a 10-percent-cap market would be worth $2.5 million ($250,000 divided by .10 = $2,000,000). The same property with a $250,000 NOI in a 9 percent-cap-market would be worth $2.77 million ($250,000 divided by .09 = $2,770,000).
So who determines the cap rate? The best source for a market’s cap rate would be local real estate or mortgage brokers who specialize in self-storage. They have information on recent sales, listings and appraisals that would verify a market’s applicable cap rate. Every market has seen cap rates climb in the last few years, so don’t be shocked if your property’s value is not as high as expected. While there may be some factors that allow a facility to have a lower cap rate than competitors in the same market, the difference may only be one-quarter to one-half of a point.
Even if you aren’t planning to sell your property, this valuation exercise is a valuable process for any self-storage owner. Valuations are a critical calculation for loans coming due since property values have decreased as have the proceeds lenders are providing on loan to value.
This exercise provides a good indication whether you have enough value to refinance the loan without having to come up with more money to buy down the loan amount. Since the numbers don’t lie, you can realistically determine your property’s real value.
David Zorich is a senior vice president at The BSC Group, where he provides mortgage brokerage and financial consulting solutions to commercial real estate owners nationwide. He can be reached at 949.232.4997; e-mail [email protected]; visit www.thebscgroup.com.