Planning Your Self-Storage Exit Strategy: How to Ensure You Leave Your Investment Profitably
Self-storage investors often get so excited about the prospect of entering their new ventures that they overlook planning their eventual exit. The fact is the way you leave an investment is a critical component to financial success and should be considered from the very beginning, when you write the business plan. Here’s insight to help you exit profitably.
In his book “The 7 Habits of Highly Effective People,” author Stephen Covey recommends that we “begin with the end in mind, which means to begin each day, task or project with a clear vision of your desired direction and destination, and then continue by flexing your proactive muscles to make things happen.”
As you approach your next self-storage acquisition, conversion or ground-up development, apply this mindset to ensure you exit successfully. New investors tend to overlook this critical component of their overall strategy. They’re simply too excited to start to think about the stop. To be forward-thinking, you must consider several factors from the very beginning, including the timing and method of your exit along with tax implications, financials and others that’ll shape your decisions up front.
This is why it’s critical to create a business plan before you search for a self-storage asset to acquire or develop. You need a clear vision that defines the ownership structure, geographic concentration, marketing strategy, capital stack, asset management, key team players, third-party vendors … and your exit strategy! For this article, let’s focus on that last piece as it fits into your overall investing approach.
Personal Goals
It’s easy to let the excitement of a new self-storage opportunity override our ability to stick to the business plan. It’s easy to say, “I’m going to buy nothing but C-class, value-add facilities with 150-plus units that are within a two-hour drive of my home and cash-flow positive in six months or less. I’ll then reposition these as B-class properties, drive up the net operating income and sell the portfolio in five years.”
In practice, this should define your search efforts. In reality, you’ll likely find a 90-unit self-storage facility that’s five states away, won’t cash flow for a year and has $300,000 in deferred maintenance, but it has a tremendous upside! If your goal is to roll up several facilities within a single area to exit at the same time, this asset wouldn’t fit your strategy. You’d have to sell it separately, which isn’t terrible, but you’d miss out on the economies of scale while managing it as well as the compressed capitalization (cap) rate of selling it as part of a larger portfolio. When seeking opportunity, it’s important to know—and aim—for the goal.
Investor Returns
Another important exit consideration pertains to the overall return on a self-storage project, especially one with a longer-term play such as a new development or distressed portfolio you intend to turn around. If you plan to bring in private equity to produce the returns your partners seek, there needs to be a cash event such as refinancing or a sale at a predetermined date. You must project this cash event within three to five years to calculate the internal rate of return (IRR) your investors will receive—a formula that considers the length of time their money was tied up in the project.
In this scenario, you must consider the timing of the exit during initial project evaluation. The overall timeline includes acquiring or developing the self-storage project, leasing it to stabilization, and then selling it for your expected value. It might take three, four or five years, so the plan should be backed by your own experience, along with the help of a feasibility study and professional consultants.
Pay extra attention to the timing of your exit when syndicating, since these projections become part of the private-placement memorandum that’s shared with equity partners and governed by the Securities and Exchange Commission. As such, you need to make sure you’re hitting your marks.
Value Projections
In addition to defining your self-storage exit strategy and timeframe, you need to consider what plays into the projected value for your pro forma. In terms of predictions, what’ll the economic climate look like regarding interest and cap rates?
Our economy operates in seven- to 10-year cycles. We tend to experience a recession, followed by seven to 10 years of expansion, before heading into the next cycle. When interest rates rise, cap rates do, too. If you’re exiting at this point in the cycle, it puts downward pressure on values. Conversely, when interest rates fall, cap rates compress and values increase, which is the best time to sell.
Knowing this and planning for your exit on the front end will determine your overall profit for an individual project or portfolio. If you can’t exit in five years because you find yourself in a high rate point in the cycle, you may have to hold on until cap rates fall in line with your assumptions. Remember, IRR is key, not only for yourself, but for any equity partners tied to the project.
Wholesale Opportunities
All this isn’t to suggest you can't be opportunistic while operating within the constraints of your business plan. For example, let’s say you cranked up your marketing machine, have brokers looking for self-storage facilities that fit your acquisition goals, and have multiple options sitting on your desk. Some won't fit your overall plan, but that doesn't mean you can't monetize them with a separate exit strategy.
It can be as simple as getting a property under contract and assigning it to somebody else. Perhaps you engage in a joint venture in which you keep a small piece of the project. In this case, it wouldn’t require a lot of your resources. It would lie outside of your core business.
Another wholesale opportunity might be finding a piece of land you take through entitlement, with the exit defined as the sale of a shovel-ready parcel to another developer. There are many ways to exit gainfully when you uncover a profitable opportunity, without deviating completely from your original business plan and its defined exit strategies.
Sale/Leaseback
Another possible exit strategy is to sell your self-storage facility or portfolio but assume the bank role by financing the purchase. For example, you could offer your asset to the market and create your own loan, complete with a promissory note and mortgage for 60% to 95% loan-to-value on the new appraisal.
Under this scenario, the buyer brings the down payment or equity. The deed crosses the table, and you’re no longer the owner/operator. Should the buyer default, you’ve already received the upfront equity, and you have the ability to foreclose and take possession of the property.
Another benefit is this strategy defers your capital gains since you’re only receiving a portion of the sale proceeds at closing. This is an excellent tax strategy and a way to retain an income stream.
Legacy
For many self-storage investors, the primary strategy is to grow a portfolio of cash-flowing properties and sell them when the depreciation and tax benefits run out. Some owners choose to gift their properties to their heirs and place them in retirement or other vehicles for asset-planning purposes. Another way to exit is to perform a 1031 exchange into other projects of greater value.
At some point, you should set a cash-flow goal or dollar number with your financial adviser that you can work toward and add to your overall approach and exit strategy as you build your empire. In practice, it’s important to understand there are multiple exit strategies possible. This won’t only help you be well-prepared, it can allow you to be extremely opportunistic once you crank up your efforts and get in the game.
Scott Meyers, founder of Self Storage Profits Inc. and Kingdom Storage Holdings, has been involved in the self-storage industry as a developer, owner, syndicator and operator since 2005. He and his companies have bought, sold, developed and converted more than 2.4 million square feet of storage nationwide. His website, selfstorageinvesting.com, provides information, software and seminars to help people launch and grow a self-storage business. To reach him, email [email protected].
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