Advice for New Self-Storage Developers: Critical Project Considerations in Today’s Market

There are risks and rewards to any investment. When it comes to self-storage development, a cautious and thorough approach can pay healthy dividends. The opposite can also be true if you don’t anticipate and account for potential pitfalls.

Between 2015 and 2019, our industry saw a large increase in new construction, both by existing facility operators and new developers clamoring to get into the business. While many projects were completed and ultimately successful, some first-time builders made mistakes that cost them their properties. They lost them to their lenders or investment partners.

There are two primary ways to become a self-storage owner. You can buy an existing facility or build a new one. When I got started in this business, I realized there was greater upside for me in the latter. Though some of my initial assumptions may have been wrong, I learned enough to recognize a good project as well as key challenges that must be surmounted to ensure financial success.

If you’re like me, you can’t afford to build a self-storage development with fatal flaws. The good news is many pitfalls are avoidable. Below are some factors and obstacles to consider in today’s market.

Site Factors

“Location, location, location” is a cliché, but it’s your first and most important key to self-storage development success. Besides appealing site characteristics and local demographics, you have to be concerned with whether a piece of property has the proper zoning to accommodate self-storage. Then there’s the cost of the land.

While you want the best location possible for self-storage, the property must be cost-effective and provide the square-foot yield you need to be profitable. Also, will it allow you to build big enough to meet market demand? Whatever you do, don’t fake the numbers to make the project pencil out!

Pay attention to site topography and utilities. What will it cost to make it construction-ready? For example, will you need to remove trees or soil? Are there lines for water, electricity, gas and telecommunications, or will you have to install them? Storm drainage is another consideration and must meet local building codes.

Facility design is critical, too. You must create one that meets your financial needs as well as customer expectations and the requirements of the governing municipality and community. Everything must be conceptualized, from the placement of the storage units and office to the location of the restrooms to the maintenance closet and mop sink. Here are some other questions to answer:

Pro Forma and Financing

Another critical factor in self-storage development is the accuracy of your financial projections. Your pro forma must be realistic and include relevant data. For example, make sure you’re accounting for seasonal fluctuations in self-storage rental rates.

A key consideration is whether your income will be enough to support expenses and debt service at less than full occupancy, say 70%. Another is property taxes. Include an adequate budget for these, factoring in the assessor’s valuation on competition/rent stabilization.

Construction financing is getting more difficult to acquire due to rising interest rates and development costs. Ideally, your loan-to-value should be less than 75%, preferably in the 50% to 60% range. Before shopping for financing and presenting your pro forma to lenders, do a stress test assuming your revenue will be 70% of projection. Based on that, determine if you’ll have enough to cover operating expenses and debt service, with additional cash flow for any investors.

Preliminary and Construction Costs

Many new self-storage developers believe their initial costs relate to the land purchase. Some know they need to invest in a feasibility study. The fact is, there are other out-of-pocket costs necessary before you even purchase a parcel. Don’t overlook the following:

When it comes to construction costs, the factor to keep in mind is gross maximum price, which gives you and your bank the final project cost. There will be unforeseen expenses, and your contractor will probably make some high estimates to ensure they won’t be underwater. Knowing that some assumptions might be higher than reality, ask for a percentage of any cost savings from the contract amount. With luck, you can negotiate 25% to 50%.

A cost-plus approach can be an alternative if there are budget restrictions, but these contracts are typically drawn up so that contractors are reimbursed for just about every expense incurred during construction. This puts you at the mercy of their ability to deliver the final product on time and on budget. In fact, the timeline can have a huge impact on project success. Remember that until you’re open for business, you aren’t creating any revenue. Your carrying costs and property taxes will continue to increase, and they can be more than $2,000 per day!

Consider All Your Variables

My goal isn’t to discourage you from building self-storage, but rather to consider all the variables that go into a successful project. It’s up to you to ensure viability.

When you pursue a development, you’re often using your time, equity and credit in addition to money from friends and family. You can’t afford to make unforced errors. Use the better side of caution if you’re building for the first time. Even after successfully building five self-storage facilities, I still feel uncertain when looking at a new project. Let prudence be your ally.

I look at the long game. It’s about future cash flow, not the value of the facility when it’s built and leased. Self-storage is a great investment. Though there will almost certainly be ups and downs, with lower leverage, you’ll be able to weather the storms.

Hank Saipe is the owner of 303 Self Storage. He began his commercial real estate career in 1981 as a broker who specialized in finding sites for Public Storage Inc. and other developers. Today, he owns multiple self-storage facilities comprising more than 4,000 units in the Denver metropolitan area. In his career, he’s been involved in site selection, financing and third-party managed properties. To reach him, call 303.888.1260; email [email protected].