The Big Financial Picture

November 1, 2000

13 Min Read
The Big Financial Picture

The Big Financial Picture

Self-storage retains its advantages, bright future

By Michael Parham

Truecommercial development of self-storage began in the late 1960s by severalindustry pioneers who recognized a growing demand for residential and commercialstorage. These were the real-estate developers who ventured out and set thestage for the industry that we know today--an industry that has doubled in sizeeach decade since its beginning, a new retail business where the investor'sreturn on investment (ROI) is often twice that of other forms of real-estatedevelopment.

The self-storage industry is no different than any other industry if onecompares supply-and-demand economics. As the demand for residential andcommercial storage has increased, so has the need for facilities that supply it.The tremendous industry growth experienced over the last 25 years can beattributed to greater public awareness of the economic and personal advantagesof the product. This continued increase in demand, teamed with excellentinvestment potential, has made self-storage one of the leading growth industriesin the country since 1978.

Once an industry's demand has been established, the driving forces behindthose goods or services necessary to meet it have always been capital and ROI.To understand self-storage's potential as an investment, one must firstunderstand its basic economics. Table 1 is a financial model of a typicalself-storage development, explaining the "bottom line" of such aninvestment. There are a variety of costs associated with self-storagedevelopment in different markets across the country. Therefore, this model usesnational industry averages to represent individual development cost, rents andproject size. It assumes an equity participation of 20 percent of the overallcost, with the remaining 80 percent being financed.

Cashflow Analysis

The "Statement of Cashflow" in Table 1 shows that a self-storagefacility with 40,000 net-leasable square feet, in a market with$9-per-square-foot annual rents, will generate $450,000 in gross annual rents at100 percent occupancy. Other income is derived from late fees, retail sales,administrative fees, truck-rental commissions, etc., and usually accounts foradditional income of 5 percent.

A 10 percent adjustment to the total projected income is common, because itrepresents normal projected vacancy and collection losses. Achieving andmaintaining an average occupancy of at least 90 percent should be the goal forevery development and should be used to evaluate the project's investmentpotential.

Normal operating expenses generally range from $2.75 to $3.25 per grosssquare foot of the development. This variance in expenses is due to the variablecost in different markets, such as property taxes, manager salaries and utilitycosts.

The net operating income (NOI) is the balance of the development's incomeafter operating expenses have been paid. Maintaining the highest possible NOI isextremely important because it is used to determination the facility's presentand future value. NOI should be from 60 percent to 67 percent of the effectivegross income of a development.

Debt service for this particular financial model is based on the loan amountof $1.59 million, an interest rate of 10 percent and an amortization rate of 25years. Debt service completely depends on the financial arrangement negotiatedwith the lender. The investor's financial health and lender's perception of riskinvolved will oftentimes determine the interest rate, loan amount andamortization period.

With the determination of a development's actual NOI and the debt service tobe paid over time, a projected cashflow is derived. In the financial modelprovided in Table 1, an investment of $397,615 has generated a positive cashflowof $117,761 or a 29.6 percent "cash-on-cash" return on investment.This is typical ROI for self-storage investors, which is one of the main reasonsfor the industry's tremendous growth over the last 25 years.

Development Cost

Also listed in Table 1 is a complete list of average development costs forthe startup of a self-storage business. Here again there are variables, but mostare confined to actual cost of the land and construction expenses.

One of the greatest variables and single most deciding factors fordetermining a development's feasibility is the actual cost of the land to thedevelopment. The financial analysis provided indicates the purchase price forthe land is $3.25 per square foot. However, due to having a site coverage ofapproximately 45.91 percent, the net cost of the land per net-leasable squarefoot is $6.82. A development's net-leasable square footage is totally dependentupon the allowable coverage of the site. Maximizing net-leasable coverage on thesite is dependent on factors such as zoning setbacks, easements, utilities,building-code compliance requirements, and the topography and actual physicallayout of the site. Normal site coverages range from 35 percent to 50 percent.

As to the cost of construction, site work and utilities are the greatestvariable costs. Normal site-development costs range from $4.25 to $8 and, again,depend totally on the actual topography and physical layout of the site.Clearing/grubbing, excavation, storm drainage, utilities, etc., are all sitespecific and their costs will vary from one site to another. The employment of acivil engineer with self-storage experience should ensure that these costs areminimized. Beware of land cost below market values. Most often, a low land pricemeans there is a problem that will require great site-development expenditures.

Of course, the cost of construction depends on the type of self-storageproduct one develops. However, the building costs vary only slightly compared tothe variable costs of the land and site development. The average cost forconstruction, including site work/utilities, ranges from $23 to $28 per grossbuilding square foot, or approximately 67 percent of the overall developmentbudget.

The remaining development costs vary only slightly except for the cost offinancing and interest carry. An investor's financial health and his abilitiesto negotiate will determine these costs. The typical self-storage developmentcost ranges from $34 to $42 per gross building square foot. Again, this varianceis dependent on land, construction and cost of financing. However, it isimportant to remember that there is a relationship between market rents anddevelopment cost. The higher the costs are in a market, the higher the rentswill be.

Financial Projections

The financial model provided indicates that an investment of $397,615realizes a 29.6 percent cash-on-cash ROI once the development has maintained a90 percent occupancy. Furthermore, it shows that the future market value of thebusiness, based on a capitalization rate of 10 percent and the existingfinancial conditions, would be $2.85 million. Therefore, an investor couldrealize a $864,425 profit upon the sale of the business at a future date.

Another important financial statistic to notice is the break-even occupancyfor the model in Table 1. This particular model projects that an occupancy of 65percent will cover all operating and debt-services expenses. Normal break-evenoccupancies on debt services in self-storage deals range from 60 percent to 72percent. This is well below normal break-even occupancies for other types ofreal estate. The lower than average break-even occupancies associated withself-storage developments minimize the investor's risk and give him moreflexibility to deal with market or economic fluctuations.

Understand that financial models are only projections. A variety of internaland external factors can affect the overall financial performance of adevelopment and the investor's ROI. However, the financial model in Table 1 istruly representative of the typical self-storage business and projects what theinvestor can normally expect from his investment. Self-storage has been and willcontinue to be one of the best investment vehicles available in this country.

In Comparison to Other Real-Estate Investments

One of the best ways to compare real-estate investments is to look at theperformance of self-storage and other real-estate investments during the pastdecade. Recently, my company completed an in-depth study of the performance ofmultifamily, office, retail and self-storage developments in Texas, Oklahoma,New Mexico, Colorado and Louisiana over the past 10 years. The study focused onthe failure rate of those developments that opened between 1980 and 1987 andwere operating during the economic recession that began in those states in themid-1980s. The results of the study are as follows:

1. Multifamily = failure rate of 58 percent
2. Office = failure rate of 63 percent
3. Retail = failure rate of 53 percent
4. Self-storage = failure rate of 8 percent

The number of self-storage properties that ended up for sale in the FDIC orRTC's real-estate portfolio were substantially less than other real-estateproperties during the same time period. Of this 8 percent in self-storagefailures, a considerable number of businesses were taken back by financialinstitutions because they were collateral for loans on other real estate.

Why is there a substantial difference in success between self-storage andother real estate? What are the key elements that give self-storage the extraedge for surviving tough economic times? The first thing an investor mustunderstand is what happens to the end user--residential and commercialcustomers--during the swings in a market's economy.

The End User

During times when a market is experiencing an economic recovery, businessbegins to thrive, employment opportunities increase and the sales of new andexisting single-family homes start to climb. One would expect self-storageproperties to do well; most often, they do. An evaluation of typicalself-storage property rent rolls during this time would usually show a highpercentage of mobile customers--people moving into the market for the first timeor customers "buying up" from starter homes.

On the commercial side, increased business activity means an increased volumeof self-storage commercial tenants. Conversely, when the economy starts tofalter, the same happens to business, employment and real estate in general.However, the reverse effect still causes the same mobility that most oftenbenefits self-storage. People begin moving out of the market or selling theirhomes and moving into smaller homes or apartments.

Commercial businesses downsize or look to self-storage for a more economicmeans for storing inventories. A staggering economy does have a negative impacton self-storage, but look at how self-storage properties compare to other realestate. During downswings in the economy, multifamily occupancies drop as muchas 25 percent, while office and retail occupancies drop as much as 30 percent.Who are the office and retail tenants? Businesses that have either failed,downsized operations and moved to a cheaper property, or completely moved toanother market. This is lost income to office and retail properties, and it isnot recovered until the market's economy improves.

Self-storage will also have an initial drop in occupancy, which differs fromone market to another, but usually averages between 15 percent and 20 percent.However, a typical leverage self-storage property has a break-even occupancyrate between 60 percent and 72 percent. Compare this to leveraged multifamily,office and retail properties with a break-even occupancy rate between 80 percentand 90 percent. Which real-estate investment has more room to absorb marketdeclines?


Rents are another key to the success of self-storage properties. The averageannual rent ranges for the real-estate surveyed in our study are as follows:

1. Multifamily--$7.5 to $12 per square foot
2. Office--$14 to $24 per square foot
3. Retail--$16 to $20 per square foot
4. Self-storage--$6.5 to $12 per square foot

Self-storage rents fall within the range of other real estate. It is notuncommon for customers to pay the same or more per square foot for storage asthey do for living in an apartment. This rent comparison is even moreenlightening when comparing rents to average development cost per type of realestate. The average development cost per real-estate property surveyed is asfollows:

1. Multifamily--$60 to $70 per square foot
2. Office--$50 to $100 per square foot
3. Retail--$50 to $80 per square foot
4. Self-storage--$34 to $42 per square foot

When comparing both rents and total development costs, self-storage mostoften has rents that are slightly less. But self-storage has a total developmentcost that is a third to one-half that of multifamily, office or retailproperties. To the investor, this means a considerable less investment or loanamount to be serviced while having comparable rents to other real-estateinvestments.

The cost of operating and the actual management requirements is another keyelement that is appealing to investors. As stated earlier, self-storageoperating costs range from $2.75 to $3.25 per net-leasable square foot. Comparethis to operating costs for the other real-estate properties surveyed, whichrange from $3.50 to $5 per square foot. Apartments, office and retail propertieshave to continually maintain the grounds, appliances, plumbing, electricalfixtures and a variety of other maintenance concerns, which usually require amaintenance staff.

There are apartment "make-readies" and interior remodeling for newoffice and retail tenants. In comparison, self-storage usually has one or twomanagers and very few of the maintenance "headaches" associated with"live-in" tenants. In general, a self- storage investor has very fewof the problems associated with other real estate.

The "bottom line" in comparing self- storage to other real-estateinvestments is that the investor can realize much higher ROI for the typicalself-storage property than for other real-estate investments. Secondly, theinvestor's initial investment is a third or one-half that required by otherreal-estate investments. Due to the lower break-even occupancies, the investorshould anticipate investment cashflow sooner and a much lower element of risk inrelation to economic declines and their effect on lower occupancies and rents.The investor does not have to worry about additional capital requirementsrelating to tenant improvements or continual maintenance.

The advantages for investing in self- storage mentioned above have been andwill continue to be the key elements for its success. The self-storageindustry's future is very bright. The industry will continue to mature alongwith demand for its use. Those investors who venture into self- storage willdiscover what the industry pioneers did 25 years ago: Self-storage is one of thebest investment vehicles available in this country, now and in the future.

Mike Parham is the owner and president of National Development ServicesInc. (NDS) of Bulverde, Texas, which has designed and built more than 150self-storage properties since 1980. The company's accomplishments includereceipt of the "Facility of the Year" award in 1990, 1991, 1994 and1996, and the "Design Excellence" award from Mini-Storage Institute in1992. For more information, visit

Table 1: Financial Model

A. Statement of Cashflow


Annual $/SF


Monthly $/SF

Gross Annual Rents





Other Income





Total Gross Annual Income





Vacancy/Collect Loss

($47,250 )

($0.95 )

($3,938 )

($.08 )

Effective Gross Income





Operating Expenses

($140,000 )

($2.80 )

($11,667 )

($.23 )

Net Operating Income





Debt Service

($167,489 )

($3.35 )

($13,957 )

($.28 )

Before-Tax Cashflow





B. Statement of Development Cost Annual





Construction Cost & Security












Legal Expense



Builder's Risk Insurance






Office Equipment & Furnishing



Closing Cost



Interest/Lease Carry






C. Project Specifications


Gross Buiding SF


Net Leasable SF


Office/Apartment SF


Land Coverage/Gross

SF 45.91%

Land Area in Acres


Land Area in SF


Land Cost per Acre


Land Cost per SF


D. Development Financial Variables


Annual $/SF

Other Income %


Vacancy/Collection Loss %


Gross Rents/Net SF/Month


Interest Rate


Loan Amount


Equity Required


Amortization Period (25 years)


Payments per Year


Operating Expenses/Net SF


E. Development Financials

Capitalized Gross Rents


Capitalization Rate


Current Market Value/Gross SF


Break-Even Ratio


Loan-to-Value Ratio


Post Lease-Up Return on Equity


Debt Service/Period (With Principle)


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