By John E. Barry
Whether mild or extreme, real estate cycles have historically been five-year periods of relative highs and lows. Unless your self-storage business plan has always been to maximize long-term cash flow, pay down debt and leave the property to your heirs (with a stepped-up cost basis to avoid capital-gains taxes), you should consider some important issues to determine how youll exit the business at the most opportune time and in what manner. Without an exit strategy, you are a ship without a sail.
Understand Real Estate Cycles
Real estate values are cyclical, and this article could be written at any point in a cycle. This time, its easywere at the very top of a strong cycle of real estate values and self-storage property valuations.
Property values based on existing cash flow have increased by more than 20 percent in the last three years, and were experiencing all-time highs in our industry. But most economists forecast higher interest rates in the next several years, and the increased cost of money will negatively affect property values. Higher tax rates are now in place, and with continued budget pressure at all government levels, its unlikely theyll decrease any time soon. The bottom line is right now is an opportune time to sell income-producing real estate.
Plan for the Long Term
Away from the current up cycle, put a long-term plan in place and start right away. Its important to seek advice from your circle of professional advisors for financial, tax, retirement and estate planning. It's also important to seek industry advice on how to optimize facility operation and maximize future sales proceeds.
Also, install or update buy/sell agreements with investment partners, and create a capital expenditure budget so your facility maintains a competitive edge physically and technologically. Running the business in a passive manner with the status quo will ensure an unhappy exit when the time comes.
Know Where You Stand
For most self-storage owners, facility value is significant in terms of their overall balance sheet. Its easy to read your brokerage statement and know exactly what your stocks, bonds and cash are worth. The same holds true for the value of your home; most people know of comparable sales in their neighborhood. Similarly, it's wise to place a value on your self-storage property each and every year. Self-storage brokers can be a fine resource for this task.
In most cases, you have some debt on the property that needs to be repaid. Will the value of the property cover it? When is the debt due? When will the interest rate need to be refinanced? You should know the answers to all of these questions.
Evaluate the Longer-Term Holding Period
If you plan to hold the facility for a longer time, then ignore the noise and optimize the operation for maximum cash flow and value. You should focus on increasing revenue and minimizing expenses.
Lets assume you own a 40,000-square-foot facility with $400,000 realized annual rents and $150,000 in operating expenses. A 5 percent increase in rents coupled with a 1 percent decrease in operating expenses would increase your profit by $21,500 per year. In addition to enjoying the income, at a modest 10 percent capitalization rate, youve increased the facility value by $215,000!
On the flip side, if you didnt raise rents, but expenses increased by 3 percent or $4,500, your facility has decreased in value by $45,000. Imagine the potential if you could manage any part of these operational improvements over many years.
Maximize all possible revenue sources including retail sales, tenant insurance and truck rentals. Its important to have a track record of revenue from these sources, so start now. Analyze every expense to find other areas of incremental savings, such as keeping a watchful eye on delinquencies, appealing real estate taxes, reducing Yellow Pages advertising and shopping energy providers. These are just a few ways to increase revenue and reduce your operating expenses.
Prepare for Sale
An outright sale is the cleanest exit strategy, so when the time is right for you, consult with a self-storage broker. In addition to a free valuation, a broker can provide you with ideas to enhance facility value. This includes books and records, capital improvements, due-diligence checklists, and a marketing plan to generate offers.
In the one to three years prior to a sale, ensure your financial statements are in order and all income is reflected on your tax returns. Buyers will pay for what youve produced, not what could potentially be generated from the property.
Keep More Sales Proceeds
A popular tax-saving technique is called a 1031 Exchange, named after that section in the IRS Code. This allows you to sell your facility and reinvest the proceeds into a like-kind exchange or other real estate investment within a designated time frame. Ask you accountant about this technique.
Another option is to sell your facility to a real estate investment trust for shares in its company stock. This delays capital-gains taxes until such time that you liquidate the stock. This can be done over time or combined with your estate plan as gifts to your heirs. In many cases, your heirs will receive a higher or stepped-up cost basis, which is the stock value on the date of your death.
Make a plan and manage it. From daily operation to one day exiting the business, a keen focus on your investment, goals and timing will allow you to enjoy the fruits of your efforts.
For more information information, check out the webinar " Planning Your Self-Storage Exit Strategy: Options for Facility Owners ," available on demand through the Inside Self-Storage Store.
John E. Barry is vice president of brokerage for Investment Real Estate LLC, which provides brokerage, management, and construction services as well as feasibility studies for self-storage owners in the mid-Atlantic and northeast states. For more information, call 717.779.0804; visit www.irellc.com.