Is Now the Time TO BUY?

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 the market to get into self-storage?" Our answer sometimes perplexes the questioner in that we believe not only is it a good time to buy, but it is also a good time to sell. It sounds like a lawyer's answer on first blush, but as you will see in the following analysis, it is possible to have it both ways.

The Long Run

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

As such, it is much more cumbersome to buy and sell a self-storage facility than it is to sell 100 shares of listed stock--which results in market values fluctuating over a longer period of time than those of the stock market. Thus, if you are looking for something to make a "killing" on in the short term, self-storage is not it. Yet, self storage is a great long-term investment.

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

The Returns

Let's take a look at why self-storage is and has been such a good investment. The first concern that an investor should have is the return on his investment. Typically, in the past, the returns (unleveraged, i.e., no loan) on the selling price have been between 9.5 percent and 12.5 percent, with the vast majority of 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 the market has dramatically improved. Thus, it appears that today's investor is paying the same amount for almost the same investment of several years ago.

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

Interest Rates

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

For example, let's say you bought a $1 million property with an unleveraged return of 11 percent (i.e., a net operating income of $110,000), using an 8 percent loan in the amount $750,000 with annual debt-service payments of $69,500. When you look at the return on your investment of $250,000 ($1 million purchase price minus $750,000 loan = $250,000 investment), the return has climbed 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). This return does not include any build-up principle that occurs through amortization of the loan, which would average another 1.25 percent over the life of the loan. When you add up the cash-on-cash returns, the loan amortization and the potential for rental increases, acquiring self-storage facilities makes as much sense today as ever.

Due Diligence

As with all investments, purchasing a self-storage facility deserves a careful and complete due-diligence process before making a purchase commitment. A good feasibility study is always worth the time and energy when considering an acquisition, and because there is so much optimism in the market today, it is doubly important to ask all the really hard questions.

There are three significant qualifiers to watch for when analyzing a project: the vacancies and rates of nearby competition, absolute levels of vacancies and rates, and the trend of the rates over the last six months.

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

A Time to Sell

As stated in the introduction, this is also a great time to sell--if you are a seller. If you are a long-term owner, there are very few options for a better real-estate investment. Nevertheless, sometimes you must sell, as in the case of retirement, partnership issues, estate planning, death, cash needs or a competitive situation that makes long-term ownership unattractive.

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

Although the time is right for selling, a note of caution to sellers is appropriate. The buyers today are generally very sophisticated (many are already self-storage owners). So, don't think that a good market will allow you to achieve above-market prices. The "Greater Fool" theory of pricing simply does not work. Instead, it always seems that in looking for the greater fool, a seller almost always passes up a deal that should have been made in retrospect.

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

Mike McCune is president of Argus Real Estate Inc., based in Denver. Argus operates and manages the Argus Self Storage Sales Network, the nation's only network of brokers dedicated to the buying and selling of self-storage facilities. Mr. McCune has written numerous articles for Inside Self-Storage and is a frequent speaker at the Inside Self-Storage Expos and Trade Fairs. For more information about Argus' services, Mr. McCune may be reached at 821 17th St., Suite 300, Denver, CO 80202; (800) 55-STORE.

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