One of the appeals of investing in self-storage is the ability to enter the industry with a relatively small buy-in. If you can save enough toward your equity contribution and qualify for Small Business Administration financing or a mortgage approved by a lender active in the business, you can take down a deal. Once you own your first property, you’re in!
However, as you continue to scale and grow your portfolio, you may deplete your capital options. Unless your operation produces consistent cash flow to replenish the equity you’re using to fund investment opportunities, you’ll quickly run through your own dry powder. This lack of capital can bring your growth to a screeching halt.
Successful portfolio expansion requires a fundamental understanding of how to navigate the capital markets. Knowing when and how to access various sources of growth capital can mean the difference between success and stagnation. Accordingly, it’s incumbent upon you to bolster your capital-raising IQ.
Investors of all profiles apply two primary criteria when evaluating whether to invest in a self-storage deal. The first is whether the investment will deliver the returns they seek; the second is tied to the level of governance they have over the deal.
Other People’s Money
When you begin raising third-party capital to grow your storage portfolio, you’ll naturally approach your network of friends and family. These individuals know you and your track record. They’re generally less stringent on the specifics of the investment opportunity and will more broadly consider it based on your involvement. The more familiar these prospective investors are with your success, the higher the likelihood they’ll entrust you with their money.
If you have your sights set on raising this type of equity, it’s important to continually cultivate you network. This includes staying in front of past investment partners and finding ways to make inroads with other likeminded individuals who are receptive to attractive opportunities.
These investors consider two primary measures of return:
- Return of investment: When will they get their initial investment back?
- Return on investment: How much will they make above the initial investment?
The first measure addresses the investor’s risk, while the second is focused squarely on the reward for that risk. Naturally, you’ll want to define a reasonable split for yourself in light of having sourced the deal and, ideally, delivered on the business plan. Individual investors will generally look to you to present that structure, considering it against the two return measures.
The structure is typically a single-tier waterfall in which, after a certain return is achieved—return of investment, plus some percentage above—you receive a specific percent of the profit. Further, your investors will look to you to present the governance structure, leaving much of the decision-making to you. They’ll take a more passive role in day-to-day operation while staying more involved deal-making decisions.
Institutional investors, such as private-equity groups, insurance companies and investment managers, have shown a strong and growing interest in the self-storage sector during the last several years. This is reflected in the billions of dollars they’ve invested to acquire and develop properties via joint ventures with existing storage operators and developers.
Some institutions have dedicated funds and mandates with specifically defined investment parameters for self-storage, including total deal size, minimum investment size, target markets, hold periods and return minimums. These specifics make it easy for you to know if a project fits within their programs.
These investors also apply two primary measures of return for investments:
- Internal rate of return: Annualized return over the life of the deal
- Equity multiple: Return of their initial investment, plus a return above that investment
The driver for their measures is the same as yours. Institutions are managing money on behalf of others and must deliver returns to their investors so they can take their profit split. Those returns are measured the same way.
Unlike individuals, these investors generally dictate the structure of how the profits will be split. The structure is typically a multi-tier waterfall in which certain tiers of return are achieved. As you clear these tiers, you’ll begin to receive a larger percentage of the remaining profit.
Since institutions are managing capital for their own investor base, they generally require a governance structure that affords them a high level of control when it comes to decision-making. They’ll want a say in when to sell or refinance. Some even require the right to be involved in the day-to-day decisions, such as changing rates, management processes, staffing, management software, etc.
Evolution to Investment Management
When you begin building a self-storage business, part of the initial success comes from being your own boss. As you invite new investors to participate in your platform, you must consider those stakeholders and even provide a level of participation in decision-making. However, every business that experiences exponential growth does so because it has the capital available from external investors. When this occurs, the owner/operator becomes a fiduciary, serving his investors and shareholders regardless of the specific governance involved in that stewardship.
While you may initially identify yourself as a self-storage owner/operator, you need to think about your platform as an investment-management business. To be successful at accessing the necessary investment capital for growth, you need to get acquainted with investor profiles and risk-reward parameters and adjust accordingly.
David Blatt is CEO of CapStack Partners, an investment bank and adviser specializing in real estate. He leads all principal-investing and capital-raising efforts for the firm, and has negotiated and structured countless transactions since 2001. A motivational speaker, he’s also host of “Make the Deal: Real Estate Investing with David Blatt,” a YouTube-based information series. For more information, visit www.capstackpartners.com.