Is Now the Time TO BUY?

By Michael L. McCune

Times are very good in the self-storage industry and,therefore, we in the real-estate industry are often asked,"Is it too late to buy or should we wait for a dip in themarket to get into self-storage?" Our answer sometimesperplexes the questioner in that we believe not only is it a goodtime to buy, but it is also a good time to sell. It sounds like alawyer's answer on first blush, but as you will see in thefollowing analysis, it is possible to have it both ways.

The Long Run

First, though, let's talk about self-storage as an investmentand examine the right approach to that investment. Self-storagefacilities are intermediate or long-term investments, not tradingcommodities. Any prudent investor will share this perspective. Itis a business that demands good management, either directly bythe owner or by a professional management firm.

As such, it is much more cumbersome to buy and sell aself-storage facility than it is to sell 100 shares of listedstock--which results in market values fluctuating over a longerperiod of time than those of the stock market. Thus, if you arelooking for something to make a "killing" on in theshort term, self-storage is not it. Yet, self storage is a greatlong-term investment.

From a long-term investment perspective, it is highly likelythat overall demand will continue to grow for self-storage.Studies have shown that once people use the product, they willcontinue to use it in the future and that there is currently avery small penetration into the market. Only about 3 percent ofthe households in the United States currently use self-storage,indicating a huge market yet to be tapped. While overall demandis quite positive, local conditions may be quite different, dueto overbuilding or regional economic conditions.

The Returns

Let's take a look at why self-storage is and has been such agood investment. The first concern that an investor should haveis the return on his investment. Typically, in the past, thereturns (unleveraged, i.e., no loan) on the selling price havebeen between 9.5 percent and 12.5 percent, with the vast majorityof returns falling between 10.5 percent and 11.5 percent. (See"Cap Rates and Sales Prices," October 1997.)Interestingly, these returns have not fallen significantly as themarket has dramatically improved. Thus, it appears that today'sinvestor is paying the same amount for almost the same investmentof several years ago.

Another reason why self-storage is still a good investment isbecause an owner can look to increase the rental rates over aperiod of time, which will increase the total return on theinvestment. Since the operating costs are relatively fixed, mostof the benefits of the increased rental rates fall directly tothe owner.

Interest Rates

The most important reason to be a buyer today may not berelated to our continuing positive view of the self-storagemarket, but rather to current interest rates. At the time of thiswriting, interest rates were at 15-year lows (about 8 percent ona 25-year amortization) and funds were widely available for thepurchase of self-storage facilities. Given these rates, it ispossible to achieve positive leverage on a self-storage project.

For example, let's say you bought a $1 million property withan unleveraged return of 11 percent (i.e., a net operating incomeof $110,000), using an 8 percent loan in the amount $750,000 withannual debt-service payments of $69,500. When you look at thereturn on your investment of $250,000 ($1 million purchase priceminus $750,000 loan = $250,000 investment), the return hasclimbed dramatically over a cash-on-cash basis ( $110,000 minus$69,500 = $40,500 divided by $250,000 equals a"cash-on-cash" return of more than 16 percent). Thisreturn does not include any build-up principle that occursthrough amortization of the loan, which would average another1.25 percent over the life of the loan. When you add up thecash-on-cash returns, the loan amortization and the potential forrental increases, acquiring self-storage facilities makes as muchsense today as ever.

Due Diligence

As with all investments, purchasing a self-storage facilitydeserves a careful and complete due-diligence process beforemaking a purchase commitment. A good feasibility study is alwaysworth the time and energy when considering an acquisition, andbecause there is so much optimism in the market today, it isdoubly important to ask all the really hard questions.

There are three significant qualifiers to watch for whenanalyzing a project: the vacancies and rates of nearbycompetition, absolute levels of vacancies and rates, and thetrend of the rates over the last six months.

Rising vacancies and falling rates are the first sign ofoverbuilt markets. After checking out the existing competition,go to the local governmental planning agencies and buildingdepartments to see what projects are on the drawing board thatmay have an impact on your purchase. Remember, you are not theonly one who is attracted to the great returns on self-storage.The downside is that overbuilt markets can cause sharp declinesin rents and increases in vacancies over a relatively shortperiod of time. Therefore, before buying a facility, it is highlyrecommended that a feasibility study be conducted by anindependent third party, if for no other reason than to providean unbiased perspective.

A Time to Sell

As stated in the introduction, this is also a great time tosell--if you are a seller. If you are a long-term owner, thereare very few options for a better real-estate investment.Nevertheless, sometimes you must sell, as in the case ofretirement, partnership issues, estate planning, death, cashneeds or a competitive situation that makes long-term ownershipunattractive.

If you fall into one of these categories, now is a great timeto sell for exactly the same reasons it is a great time to buy:interest rates are low and money is generally available-allowingbuyers the ability to pay a reasonable price and close quickly.The general optimism in the market also means that there will bemore buyers for your property, ensuring a better chance to getyour property sold on favorable terms.

Although the time is right for selling, a note of caution tosellers is appropriate. The buyers today are generally verysophisticated (many are already self-storage owners). So, don'tthink that a good market will allow you to achieve above-marketprices. The "Greater Fool" theory of pricing simplydoes not work. Instead, it always seems that in looking for thegreater fool, a seller almost always passes up a deal that shouldhave been made in retrospect.

Hopefully, our original paradox of a time to buy and a time tosell has been resolved. If you are going to buy, now is thetime--before interest rates move. It is also the time to sell--ifyou must. In sum, the comings and goings of the self-storagemarket couldn't be better.

Mike McCune is president of Argus Real Estate Inc., basedin Denver. Argus operates and manages the Argus Self StorageSales Network, the nation's only network of brokers dedicated tothe buying and selling of self-storage facilities. Mr. McCune haswritten numerous articles for Inside Self-Storage and is afrequent speaker at the Inside Self-Storage Expos and TradeFairs. For more information about Argus' services, Mr. McCune maybe reached at 821 17th St., Suite 300, Denver, CO 80202; (800)55-STORE.