Whats It Worth?
February 1, 2008
To view the charts that accompany this article, click HERE.
Have recent events in the financial markets affected your propertys value? If so, what is your facility actually worth?
Maybe you're considering selling or refinancing or want to know value for estate-planning purposes. Regardless of the reason, the methodology of determining your propertys value is the same. Ready to start figuring out where you stand?
Value
Value is not based on how much you paid for the property when you bought it, how long youve owned it ,or how much it cost to build. Its based on cash flow. Hopefully your property is worth more today than it was when you bought or built it, but time alone does not cause income property to appreciate.
In fact, only two factors affect property value: net operating income (NOI) and the capitalization rate (cap rate). NOI is calculated in exactly the same way now as it has always been. On the other hand, recent turmoil in financial markets will have a changing effect on cap rates.
NOI is the money left after all operating expenses are paid, excluding debt service and depreciation. Figure A depicts a typical self-storage facilitys unit mix and rents. As you can see, monthly potential rent flows into annual potential rent, to which other income is added and economic vacancy is subtracted. The resulting figure is effective gross income (EGI).
Operating expenses are subtracted from EGI, resulting in NOI. It's important that NOI be calculated for all storage facilities using industry standard parameters for other income and operating expenses. This hypothetical example uses those industry standards.Income is an easy figure for an owner to determine and for a lender or buyer to verify. There's seldom a difference of opinion regarding income. Its simply the amount of money deposited in the bank. One must assume an owner is doing all he can to maximize income. This means rents are as high as possible and in line with competition. It also means the facility is managed, advertised and marketed adequately, and occupancy is as high as it possible given market conditions.The Same, But DifferentNote that the incomes from same-size properties in the same market may not incur the same values. Income is limited by the average unit size of a particular facility. Two properties of the same square footage, occupancy and rents for the same unit sizes may have different unit mixes. These two properties would generate different incomes and have dissimilar values. Everything else being equal, a 90 percent occupied, 50,000-square-foot property with 600 units (an average unit size of 8.3 square feet) will be worth more than a 90 percent occupied, 50,000-square-foot property with 500 units (an average unit size of 10 square feet). This is because smaller units generate higher rent per foot and, correspondingly, a higher sales price per square foot at the same cap rate. Sales comparables report price per square foot but not average unit size. As a result, it could be incorrect to estimate property value by simply using the price per foot of recent sales.The Effect of ExpensesThe other component of NOI is operating expenses. Unlike income, expenses can cause a difference of opinion. You may or may not employ a professional management company or have a maintenance-reserve account. You may or may not pay salaries for full- and part-time employees in the proper manner or have adequate insurance coverage. Real estate taxes may increase substantially when a property sells. Buyers estimate the increase, but its irrelevant to you unless you're selling. In sum, the potential exists for different NOI calculations of the same property. This is why industry standards are used to confirm that expenses are in line. Regardless, after a propertys NOI is calculated, the appropriate cap rate must be applied. Several factors are considered in selecting the right cap rate. They can be adjusted lower or higher depending on the age and quality of the property and market characteristics. A larger, newer propertyconstructed of masonry, with a longer remaining economic life, state-of-the-art security systems and in a growing areawould command a better (lower) cap rate than an older, metal-constructed property in a stagnant market.As of press time, a great uncertainty exists in real estate lending. Many lenders are tightening their parameters or withdrawing from the market entirely, making financing difficult and more expensive to obtain. The cost of financing affects property value because, ultimately, the reason properties are bought is for their after-debt-service cash flow. Higher financing costs push cap rates up to maintain acceptable after-debt-service cash flow. Figure B uses the NOI from the property in Figure A to show how a 200-basis-point increase in cap rate can affect value by almost $2 million.When it comes to real estate for the self-storage industry, that was then and this is now. Dont let past market values or a previous purchase price lure you to settle on a selling price thats way off the mark. Study your NOI and visit present-day cap rates to target the right price for the best deal.Bill Alter is a real estate broker who has been a facility-sales specialist for 22 years with the firm of Rein & Grossoehme Commercial Real Estate in Phoenix. For more information, call 602.315.0771.
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