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Moving to the Next Phase

April 1, 1998

10 Min Read
Moving to the Next Phase

It's no secret that a lot of thought needs to be given tobreaking ground on a new self-storage construction project. Andbefore one spade of dirt is turned, a wise developer will havecompleted a thorough feasibility study to determine just howrealistic the project looks. But even the most detailedfeasibility study will not guarantee success. Risk is part ofevery project, but fortunately, there are ways to ease the riskfactor of constructing a new self-storage property. One way isphasing, the preplanned strategy to build or expand a facilityone step at a time, where a developer builds a facility, watchesbusiness roll in and, if supply cannot fill demand, buildadditional units to keep up with that demand.

Taken at face value, phasing may seem more expensive, and itcan be, but the operator who phases will have the valuableknowledge of tested waters with phase one and will have a betteridea if more units are necessary to satisfy the market.

Moving to the Next Phase

The next step to determining if a facility would benefit fromphasing is to look at demand. If the facility is full, the phonecontinually rings with perspective renters and price increasesare being absorbed by the market, it may be time to expand. Allindicators show that the facility can handle more occupancy. Nowthat you've been down this road before, building the next phaseshould be easier than starting from scratch in an untestedmarket.

"Overall, it pays to build a project in phases if you'vegot any decent-sized project--by that I mean a project that's50,000 or 60,000 square feet or above," says Neil Gaunce, asales representative for Tacoma, Wash.-based Tech-Fast MetalSystems. "You can come in with a 30,000-square-foot firstphase, then balance it out with a second or even a thirdphase."

Unit mix may provide the most difficult area of the new phase,but the facility's own rental-unit pattern is probably the bestdetermining factor in this issue. Compare the average percentageof rented spaces in each size to the percentage of units built inthose sizes. It should be easy to see which unit sizes are mostin demand.

"Normally, I see variations in the second phase,"says Gaunce. "The original plan usually lays out the unitmix for the whole project. But when we go into the second phase,we will see a change where you'll have a big demand for largerunits or smaller units. And drawing on paper is easier to shiftthan in the field after the project's been built. It makes moresense to wait for the demand to tell you what you need, than itdoes to guess at what you're going to need. The client basedoesn't always do what we want it to do."

The next step should be to examine how fast the facility'sunits are renting. Let's take, for example, a 40,000-square-footfacility with an average unit size of 100 square feet. A unitoccupancy of 80 percent that has rented an average of 13 unitsper month over the past two years should be filled up in aboutsix months.

For construction time, a good gauge is to figure a month and ahalf for every 10,000 square feet, plus one month fordevelopment. If you're not sure about committing to anotherbuilding and are considering rearranging the current unit mix inthe existing building, keep in mind that it takes as much work todo the latter, and if it entails moving and replacing doors, itcan be expensive.

John Wilson, CEO for Houston-based American InternationalConstruction, says the time to put up the remaining phases hingeson work done in the initial construction phase.

"Sometimes people do all the dirt work and undergroundand not the building. Other times, people don't do anything. Whatyou're phasing will be determined by the lead time on what youhave to get done," says Wilson. "If all you have to dois finish the interior of a building, that takes about threeweeks, so you can wait until the last minute. If it's amulti-building job and you have buildings that aren't developedcompletely, then it might take eight weeks. It all depends onwhat you've left for the phase work."

Be sure to do your homework on the competition around you andcheck with the local zoning department on the status of vacantpieces of land surrounding your target area. That blank piece ofland on the corner could shape up to be your biggest competitor.

The Advantages and Disadvantages of Phasing

The concept of phasing is not new. In fact, it has been usedsuccessfully by all kinds of real-estate developments around thecountry. It is essentially "master planning" a projectby determining the number, size and locations of add-on projectslong before they will be built.

When separating one phase from another, it's basically wherethe developer chooses to draw the line. Knowing the advantagesand disadvantages of phasing is a huge plus.

The Advantages

There are several advantages to phasing. At the forefront,phasing allows the developer the flexibility of already knowinghis market and what the needs of the facility are. The earlierphase can serve as market research for the operator to understandwhat kind of unit mix is required for the next phase. If theoperator gets more calls for a specific unit size not availablein the first phase, he can add that or other sizes in theexpansion.

"Most people start out with a fairly standard unit mixand as the demand and customer base grow, it will tell them whatto build for the second phase," says Gaunce. "That waythey're coming into the second phase with a more assured clientbase instead of guessing what it might be. It is formulating abusiness plan that has depth to it and some assurance that thereis going to be some return on the investment."

Wilson says another option is to phase in climate control."If you make 20 percent of the units climate controlledspaces in the initial phase, but don't know whether it should be40 percent in the remaining phases, as you fill up the firstphase, you can make a decision as to how much climate control youneed in the second phase," says Wilson.

Another advantage of phasing is that it minimizes risk,initial capital and overall debt. By building in phases, anoperator can avoid tying-up capital and paying interest on alarge facility that at the time can only absorb 75 percent of itscapacity. As for unit mix, why build a facility that may needadjustments at a later date, at extra costs?

A financial advantage of phasing can be seen in financialinstitutions that provide interim financing for development ofself-storage facilities. They may view a phased project as a wayto minimize risk, which sometimes can be the deciding factor ingetting a loan.

In fact, some loan agreements can include provisions toprovide financing during all phases of the project. Often, loanswith phase financing include performance clauses, which give thedeveloper the OK to continue with expansion as soon as certaindetails are met on the original or previous phase, such as asteady occupancy rate, among others. This type offinancing--committing one or more phases of a project--willreduce risk and also makes financing and closing costs lessexpensive.

A big plus is that revenues created through a phasing projectcan be applied to future expansion. By way of example, thedeveloper of a 20,000-square-foot initial phase of a40,000-square-foot project--with later plans to add four,5,000-square-foot phases--can keep debts low and use the moneygenerated from the existing property directly on the next phase.

"If the developer builds the whole project (at one time),they're starting out with it 100 percent empty, and it's obviousthat it is going to take some time to fill up," says Gaunce."But they are also paying interest on that money the entiretime. What they are doing (by phasing) is being smart investorsby using their money and limiting the interest payments on thewhole project until they actually need that additional space.They're working the program like it should be worked, as afinancial investment, rather than dumping money in it and hopingit fills up."

The Disadvantages

As good as phasing a facility can be, like anything, there isa downside. Mainly, the disadvantage lies in the inescapablefixed costs that sit with the initial phase until the others arebuilt. The costs are broken down into categories such asoffice/apartment, security/access-control systems, businessstart-up and some site-development costs.

An example would be an office/apartment that costs $60,000 andadds $2 gross building square footage to a30,000-square-foot-project. Conversely, the same $60,000office/apartment adds only 80 cents to the gross buildingsquare-footage rate of a 75,000-square-foot project. It requires30,000 to 35,000 net-leasable-square feet to afford thedevelopment cost of the office/apartment in most markets.

Combined with the high overhead needed for the initialstart-up stage, the break-even occupancy requirement will behigh. Most likely, it won't be until the next phase is completedand leasing begins that the fixed costs will begin to spread overboth phases.

And there are times when construction costs will also be moreexpensive when phasing buildings later than during the initialconstruction time period.

"A disadvantage is sometimes you have to pay for apremium for the additional cost of the second phase and you runinto a situation where you're bringing in crews for a secondtime," says Gaunce. "A lot of times you're paying morefor labor and you may pay a little more in freight for oddballshipping quantities."

Conclusion

Self-storage development should be rooted in detailed marketresearch. Market demands for storage space and unit sizes shouldbe studied, along with the square-footage requirements needed tocarry the up-front fixed costs. Also, don't use the extra unitsin hopes of pulling the accounting ledgers into the black. Makesure the initial phase will be stable on its own before movingonto any other phases.

Sometimes developers hold off on building the office/apartmentor installing the security systems until a later phase. It's achoice that has to be made by the developer, but should neverjeopardize the first phase or give an advantage to anycompetition in the area.

Phasing in the self-storage industry has many advantages. Itcan lessen risk, up-front capital and debt requirements, and isaccepted by most financial institutions. Like anything though, ithas to be properly planned and executed before the advantages areearned.

Tips on Phasing

Whether you've been down the self-storage road before or are a first-time developer, any phasing or expansion project needs to be carefully researched. You can't eliminate the risk completely, but being prepared through solid research and knowing all of your options can only make life easier in the long run.

  • Conduct a thorough feasibility study.

  • Check out how the competitors are doing. Are they close to or fully occupied? What are their most popular unit sizes?

  • Does your initial phase make enough income to stand on its own? Jaime Lindau, sales manager for Tracte Building Systems, says the break-even point for the initial phase is generally 80 percent occupied. "Normally, a bank wants it 70 percent occupied before they're going to let go of some money to build the next phase," he says. "So in reality, when an operator pulls the trigger on the second phase, they haven't made money yet."

  • Is your financing secured to embark on another phase, expansion?

  • Have you considered RV and boat storage as a viable option if the market demands such a service?

  • If you've run out of contiguous property space, consider a satellite operation--one in which you build an additional phase on property down the road, but still manage it from the original office.

  • If you're trying to cut a few corners on an overextended budget, you might try to phase security systems or climate control in at a later time when finances become a little less tangled. Keep in mind, though, you'll save a bundle if you at least install the wiring and duct work during the construction process.

  • Build as much of the future phases as possible in the initial phase. "We recommend people do all the underground work for the whole project because then you don't have to bring in the big bulldozers anymore," says Lindau. "We've had a number of people who build one building to start, but put two slabs in. Then the next time, they build another building and put two more slabs in again. That way, they kind of hop-skip themselves."

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