October 1, 1997

10 Min Read


Facts, Fantasies and Trends

By Michael L. McCune

In the business of buying and sellingself-storage facilities around the country, the discussion withboth buyers and seller always ends with cap rates. Unfortunately,most people don't understand all of the ramifications of thissimple sounding number. Hopefully, this summary and discussionwill help clarify this mysterious, yet fundamental concept.

With us on this mission are Ray Wilson of Charles R. Wilson& Associates in Pasadena, Calif., and Steve Hopper, anArgus-affiliated broker with Whiteside Properties in Charlotte,N.C. Both have years of experience in self-storage appraisal andsales.

Additionally, I have asked some of our Argus Self StorageSales Network affiliated brokers to comment on the application ofcap rates in the marketplace and on trends they see developing inthis crucial area.

As with any good rule of thumb, there are certain assumptions that are implicit in the calculations of the NOI.

What are cap rates and why use them?

Real-estate valuation is a very complex business with manyvariables that affect price. Over the years, real-estate peopleneeded a way to compare property values in a market using ashorthand method, thus capitalization rates or cap rates cameinto general use. In a way, the cap rate tells you what investorsexpect to earn as a percentage of their investment. For example,a buyer who thinks a facility is worth a cap rate of 10.5 issaying that he wants a 10.5 percent return on his investment.

When the net operating income (which is subject to someassumptions to be discussed later) is divided by the cap rate, viola!you come up with a property value. This method is essentially away to develop a price based on a stream of income. The netresult is the lower the cap rate, the higher the price; likewise,the higher the cap rate, the lower the price.

This is only one of three methods used by appraisers to valuea property, but it is the one most focused on by investors. It isthe most frequently used because it does a very good jobcorrelating property values and helps facilitate comparisonbetween markets.

The underlying assumptions in calculating NOI

As with any good rule of thumb, there are certain assumptionsthat are implicit in the calculations of the NOI. Calculating NOIfor self-storage facilities is no different. As we see later,when all of these assumptions are in line, the cap-ratecalculation produces very consistent results. For cap rates to beuseful and comparable, the NOI must be calculated on a consistentbasis on all properties. The first assumption when calculatingthe NOI is that all revenues must result from reoccurringoperations and not from any asset sale or insurance recovery.Secondly, depreciation and debt service should not be deductedfrom revenues to arrive at the NOI. Depreciation and financing donot reflect value, but merely reflect tax issues and capitalstructure. These revenue assumptions are clearly defined and arealmost universally applied.

However, assumptions related to expenses are less uniformlyapplied and result in significant misunderstanding, particularlyamong sellers. The assumptions should include the following:

  • The property is properly insured;

  • The property is advertised in the Yellow Pages; and

  • Property taxes reflect current assessments.

Further, the expense numbers need to reflect that all laborcosts necessary to operate the property are included in the NOIdeductions, even if the owner is currently doing the work forfree. It is also assumed that the expenses include a managementfee over and above the on-site management expenses, rangingbetween four and six percent, depending on the size of theproperty. Another assumption is that of a replacement reserve,which is roughly 5 cents to 15 cents per square foot, dependingon the age of the facility. If any of these assumptions are notincluded in the expenses, an adjustment must be made to the NOI.

Many owners may believe that some of the assumptions don'tapply to them for various reasons, but there are almost noexceptions in the marketplace of real sales. In the end, ignoringthese assumptions is, at best, merely self-deception, and, atworst, could have serious impacts on the financing or sale of aproperty.

Why do some properties have higher or lowercap rates?

Since all properties are not alike, they can command differentcap rates. The variations from normal cap rates (between 10 and11) usually reflects the quality of the project and the risk tothe investors. For example, a metal-building project in a ruralarea that is 40 percent vacant would require a higher cap rate toreflect the increased risk and lesser quality. On the other hand,a large masonry project with full security, in a growingmetropolitan area, with consistently increasing rents wouldcommand a premium cap rate, perhaps in the range of 9.5 to 10.

Once again, while the cap rates may vary, the underlyingassumptions to the NOI do not. Property evaluations are somewhatsubjective, but our collective experience would indicate thatknowledgeable buyers and sellers agree on the quality of the NOIand with the risk variances that lie in a very narrow range ofcap rates.

This chart (Exhibit 1) lists some quality and risk adjustmentsthat will affect a property's value and the cap rate used toreflect that value. If you circle the applicable characteristicsof your property and find that they dominate one column, the caprate will likely be adjusted from the average in that direction.Obviously, the more the merrier, but don't cheat, because themarket won't. The chart is not intended to be scientific andshould be used only as a guide since many other variables canimpact the cap rate. If done accurately, this should give you agood perspective of where your project fits into the range of caprates. In summary, it takes a great facility to merit a 9.5 caprate and not too many flaws to find an 11 cap rate.

Do cap rates really reflect the market?

The answer is unequivocal: Yes. If cap rates did notreflect the marketplace accurately, we would not be using them inso many ways. Exhibit 2 will give you an idea of the consistencyof pricing in the market as well as how cap rates relate topricing. For the purpose of this article, Ray Wilson has sharedhis collection of data with us and help create a very powerfulvisual representation of this point. The chart shows recent salesbased on the sale price per square feet and the NOI per squarefoot. (Remember: To get the cap rate, we took the NOI per squarefoot and divided it by the sale price per square foot.) We havedrawn on the chart lines that represent the cap rates, 9.5, 10.5and 11.5.

As you can see, there is a real consistency of prices in thisrange with a convergence around 10.25. The few exceptions arealmost exclusively for properties with a price per square footmore than $40. This would generally indicate a more exclusive andnon-competitive market for the project. Often times additionalexpansion land distorts the calculation. This consistency inactual sale's cap rates tells us several things:

  1. Our shorthand cap-rate valuation method reflects the real selling price in the marketplace;

  2. There are no "greater fools" in our experience, otherwise, there would be quite a few variances or sales that are "way out of line;" and

  3. If a buyer or seller wants to participate in the market they must do so at market prices, i.e., market cap rates. It is clear from the chart that "greedy" sellers and "bottom feeding" buyers are not doing much business in the marketplace. Also, the consistency of the prices indicates that this is what economists would call, "an efficient market."

Comments from our experts

Let's ask our experts to give us some thoughts on caprates and trends.

Are cap rates declining?

"The market is very competitive for first rate projectsand the cap rates might be a little better for these projects,but run-of-the-mill good projects haven't gone down much."
Joan Lucus, Joan Lucus Real Estate Services, Denver.

"I think this is an excellent sellers market that haspushed the cap rates down about as far as they can go."
Stephen McKnight, Island Associates, West Islip, N.Y

What happens if interest rates take a jump?

"I don't think I want to find out!"
Harold Helm, Commercial, Louisville, Ky.

"Higher rates make financing more expensive and thissqueezes the equity in a project. That means lower prices andhigher cap rates. It also means it's harder to build a newfacility, which is good for existing properties."
Joan Lucus

Do you ever see facilities sell at prices that areinconsistent with the cap rates we have talked about?

"I have buyers and sellers that really believe there is agreater fool out there, but I've never seen one close adeal."
Harold Helm

"Almost never. While many sellers point to sales thatappear to have lower cap rates, typically the seller is missinginformation. A good example of this would be the availability ofexcess land to expand, which the buyer reflected in the offeringprice. The contributory value of the excess land must be factoredout in order to determine the true cap rate."
Patrick A. Lemp, Self-Storage Consultants, Hartford, Conn.

Do buyers really look at the NOI adjustments wediscussed earlier?

"We go to extensive length to verify sales, given that weare not only brokers, but MAI appraisers as well. In verifyingsales with buyers, we have learned that these adjustments aremade by most every buyer we encounter.
Patrick A. Lemp

"Almost all self-storage facilities are bought by otherself-storage owners. This group knows the business and doesn'toverlook the obvious."
Stephen McKnight.

Cap Rate Adjustments (Exhibit 1)


9.50 - 10.00

10.00 - 11.00

11.00 - 11.50

Vacancy (last two years)

95% - 100%

90% - 95%


Rates (last two years)

Continuous Rise





30,000 - 45,000


Competition (3-mile radius)



More than one

Competition's Vacancy

95% - 100%

90% - 95%


Surrounding Area

Growing Metro

Large City


Density (5-mile radius)


100,000 - 200,000


Traffic Counts


10,000 - 25,000


Median Household Income

Above Average


Below Average


Full-time Living on Site

Full-time Living on Site


Records (last 3 years)

Computerized and Professionally Audited



Computer System

Computers and SS Accounting Software




Concrete or Brick

Combination Brick and Metal




Little Deferred Maintenance

Modest Deferred Maintenance


Full Gate and Card Access

Full Gate



Very Direct

Clear, but not Direct



Can See Sign and Facility

Can See Sign and Entrance

Can See Sign Only





Michael L. McCune is president of Argus RealEstate Inc., based in Denver. Argus operates and manages theArgus Self Storage Sales Network, the nation's only network ofbrokers dedicated to the buying and selling of self-storagefacilities. For more information on cap rates, contact Mr. McCuneat 821 17th St., Suite 300, Denver, CO 80202 or at (800)55-STORE.

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