February 1, 2008

4 Min Read
Exit Strategies

Since the late 90s, the investment community has viewed commercial real estate as a virtually infallible investment vehicle. Self-storage properties were always considered a relatively safe bet because of their limited management responsibilities and maintenance until the lending crisis and housing slowdown unfolded in the summer of 2007. Because of shifting capital markets, your exit strategy is more important than ever.

The Downswing

Last year, economic uncertainty caused investors to pull out of the commercial mortgage-backed securities market, and several funds announced problems with sub-prime mortgage holdings. Following this collapse, a number of Wall Street investment banking firms experienced similar downturns, battered earnings and losses. This downturn has changed some attitudes in the real estate investment community, and elevated the risk associated with acquiring self-storage assets.

To mitigate such risk, self-storage investors must conduct their due diligence and analyze a propertys financials more carefully before closing. They should ask a number of questions related to the facilitys operations, including:

  • How long am I going to hold this property?

  • How am I going to exit this deal?

  • What is my strategy?

Using the example of a private investor buying a $10 million asset, the new owner must first determine a hold period and then analyze net operating income. Lets say the investor establishes a hold period of five years and then determines the facility requires significant capital improvements and new management. While $10 million may be priced above comparable properties in the market, the acquisition will ultimately be profitable after the owner upgrades the facility and hires a new management company.

After capital improvements are implemented, the owner will be able to raise occupancy and achieve 10 percent rent increases over the life of that five-year term. At the end of five years, the overall property value should increase between $1 million and $2 million.

Ins and Outs

Sophisticated investors have always used an exit strategy, while many private investors historically purchased self-storage assets without much foresight and planning. When institutional investors buy a property, they determine a specific hold period, normally seven to 10 years. The strategy is different depending on the propertys condition: Some are rehab projects, some are in lease-up, and others are stabilized. The property could be worth less in five, seven or 10 years if market conditions change or the owner fails to make needed capital improvements.

A good broker or investment adviser must have thorough knowledge of the submarket in which the property is located. He must know whether demographics are solid. Will the area continue to expand or retract? Is employment growth strong? Is the single-family-housing market healthy? What new construction is being developed? What does the future hold? What makes this a good location? Location is still king in self-storage.

As the market has started to shift from a sellers market to a buyers, a number of investors in the Sun Belt and across the United States are acquiring self-storage assets at discounted prices, taking advantage of the market downturn. In many cities, occupancies have dropped as low as 70 percent, which opportunistic investors view as an excellent time to enter the market. These investors are betting market fundamentals will improve in five years, and occupancies should move closer to 90 percent, thus assuring strong profit.

In the more immediate future, asset focus will vary among investor types. Larger, cash-heavy buyers are expected to favor infill class-A space where construction costs make additions to supply of self-storage assets difficult. Specific attention will be paid to properties that offer amenities targeting frequent users, in areas that dont rely on relocation-generated demand. Smaller buyers and investors, on the other hand, will target value-added opportunities priced well below replacement costs.

Looking ahead to 2008, private investors should thoroughly analyze each aspect of a facilitys operations when making acquisition decisions and planning their exit. The best time to make money on a property is when one acquires it, not when one sells it.

This market is clearly shifting from a sellers market to a buyers carnival. The foolish money that entered the market eager to snap up all types of productwhether office, retail or self-storagehas left again. More sophisticated private investors and institutions, with strong balance sheets and the financial wherewithal to secure loans from non-conduit sources, have re-emerged to intelligently purchase real estate.

Where do you stand? More important, do you know your way out? Define your exit strategy and rest assured your financial future is in safekeeping. 

Michael Mele is a senior director in the Tampa, Fla., office of the Marcus & Millichap Real Estate Investment Services National Self-Storage Group. He can be reached at 813.387.4700 or [email protected]

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