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Buying Basics

February 1, 2005

4 Min Read
Buying Basics

Self-storage is a great business in todays volatile real estate market. The fact is, it carries the highest cap rate when compared to other real estate investments: single-family units, multifamily (apartments), retail, triple-net leases, industrial and office. While this business can be the best deal around, it takes careful planning and research to make it work to its potential. If youre interested in entering the market, where do you begin?

The Self-Storage Broker

The first thing to do is to contact a qualified self-storage broker in your market area. There are a number of agents who specialize in this field. A reputable professional can give you a tremendous amount of market knowledge, including local sold and rent comparables and, most important, information on new self-storage facilities in the planning stage, under construction or in lease-up. Finally, a good broker can help the first-time self-storage investor with the following questions:

  1. What type of return can you expect?

  2. How much should you spend?

  3. How do you make an offer?

  4. What do you do about management?

What Type of Return Can You Expect?

Self-storage has always maintained a higher cap rate than all other investments in the real estate market. A few years ago, storage facilities were selling in the 9 percent to 11 percent cap-rate range. Today, the cap rates range from 7 percent to 8 percent. For the sake of comparison, apartments are selling at a cap rate of 5 percent to 7 percent.

Take a look at this recent example: A buyer had $2 million in certificates of deposit earning approximately 1.5 percent. The facility he purchased sold at a 6.9 percent cap rate. He put the $2 million down on a new mortgage of $3 million, at a 5.9 percent fixed interest rate for 10 years, in a nonrecourse loan. The buyer was now looking at a return of approximately 8 percent with a property that had rental and operational upside. In addition, he now has an appreciating asset with a depreciation schedule. Which sounds better, a 2 percent return in CDs or an 8 percent cash-on-cash return from day one?

How Much Should You Spend?

The first thing to consider is how much down-payment money you have available and how much of a loan you want to put on a facility. The rule of thumb in todays market is a down payment of 30 percent, though it may be higher on a lower-priced property (one with a purchase price below $1.5 million). The trouble with these facilities, however, is most of the large self-storage mortgage companies are not interested in placing a loan below $2 million.

How Do You Make an Offer?

A potential buyer should start the purchase process with a letter of intent, which briefly addresses some of the larger issues: the purchase price, down payment and loan terms. It identifies the period of time in which the buyer will receive a loan commitment in writing from a lender for the new mortgage. It also outlines details of the inspection or due-diligence period, during which the buyer will conduct research of the facilitys books and records, market area and overall operation. Finally, it should include a target date on which the buyer and seller can expect to close the deal.

After the letter of intent is signed by both parties, the buyer and seller can agree on what type of purchase contract to use. In some cases, they will choose a boiler-plate real estate contract from a state authority or an in-depth self-storage purchase contract. In others, the buyer or seller may request to have his personal attorney draft the document.

What Do You Do About Management?

The due-diligence period is the best time for the buyer to determine if he plans to handle his own on- and offsite management or hire a third-party company. On-site management involves the daily operation of the facility, including answering phones, renting and cleaning units, dealing with delinquent tenants and, most important, getting the money to the bank. Off-site management includes staffing, paying bills, keeping track of receipts, balancing the books, marketing and overseeing any lien sales.

Most small individual investors hire an outside firm that specializes in the management of self-storage facilities. These companies can literately make the investment like a triple-net lease, while the owner/ investor just gets a balance sheet, profit-andloss statement and, most important, a check at the end of the month.

Self-storage is a great business. It enjoys ease of management and operations, and has the highest return of all real estate investments. The trick is to make sound decisions and buy right.

Carl E. Touhey is a self-storage specialist in the real estate firm Bancap Self-Storage Group Inc., which has brokered more than $600 million in self-storage transactions. In the past two years, Mr. Touhey has brokered more than $70 million in the Northern California market. He and his family own self-storage facilities in Florida, New York, Texas and Vermont. For more information, call 650.368.2216; e-mail [email protected].

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