I recently helped a friend get into the self-storage business, walking him through the entire process of evaluating a market, selecting a site, developing the facility, implementing systems, obtaining financing and insurance, etc. He’s now in lease-up. The site is a nice size to start out, comprising about 180 units, with enough ground to add another 40. He’s at 20% occupancy after three months.
His situation is interesting. At 56, he can retire in 12 months, with significant pension payments and 401(k) funds. His kids are out of the house, and college for them is covered. He’s doing financially well even without self-storage; but after watching my wife, son and I build our eight locations over the last seven years, he finally got the itch.
We discussed how hot the investment market is, including the amount of cash chasing self-storage deals. He jokingly asked what a good price would be to sell if someone made an offer. Well, guess what? He’s received several calls, and one firm threw out a number that really got his attention.
In short order, his project cost him $X, and a national firm appraised the asset at $XX. Now a potential buyer is offering $XXX, and he’s pretty excited about a potential deal. Though his particular situation may not match yours, there’s so much investment interest in the industry, it’s smart for any independent owner to think through potential scenarios and whether it’s better to hold or sell. Following are some things to consider.
Considerations to Hold
- Don’t sell if you want to grow a portfolio. Financial relationships go smoother if you already have a track history and are in the business.
- The market will be crazy for the next two to three years, as inflation affects the value of the dollar and impacts building costs. There’s lots of “excess cash” trying to find a home before it gets devalued and interest rates rise further.
- Don’t sell if you don’t need the money. If you sell in the current market, you may be among those looking to find a place to invest in a race against cash devaluation.
- What are you going to do when you retire? The self-storage model can be handled while you’re golfing, fishing or traveling. Work today or don’t; it’s great for retirement.
- Don’t sell if you can easily put more meat on the bone, like increasing occupancy to 80% or higher over the next 12 months to increase value. There are many buyers out there; you can sell anytime.
- Don’t sell if the office is also your home. If my friend sells, he’ll need to find a place to live, which would take money off the table for collateral in his next deal. Side note: Don’t ever tell your banker you plan to live on site. They won’t finance you since bankruptcy laws allow you to keep your residence.
- Don’t sell to an individual who comes asking. It’s better to go through a broker. Yes, it’ll cost you 4% to 7% commission, but you’ll have more potential buyers and won’t have to worry about the legal transaction process.
- If you’re in a situation like my friend in lease-up, you’ll have to pay a higher personal income-tax rate vs. waiting for a year to lower your capital gains.
- Similarly, don’t sell if you don’t want to pay taxes on capital gains. Instead, wait until you die and transfer the property to your kids. Of course, this depends on whether the “step-up” rules in the tax code still apply.
Considerations to Sell
- Sell if the transaction will help fuel the next deal. If my friend’s sale goes through, he’ll have the collateral to do two or three more deals.
- Sell if it works as a business model to develop and then sell. My friend is already interested in four other properties. Typically, developing will bring a higher return than buying/holding due to the occupancy risk. A lot of the “Will they come?” or “Will this sell?” risk is out of the market right now.
- If your office is also your home, ask to stay rent-free for 18 months while you buy or build a new residence. Similarly, sell if they want you to stay on for X months to help with the transition, and have them pay you.
- Sell if you’re a cash taxpayer and not accrual. If you take the payment in two or three installments, with the first used to pay off bank debt and get back your initial collateral, you’ll be taxed at a high personal income-tax rate. Later payments received after the one-year anniversary would be at capital-gains rates. Have your tax accountant perform income averaging after year one to recoup taxes paid out at the higher bracket when you sell.
- Sell the property but not the business. If a national self-storage company is pursuing your asset, they don’t want your business name, website, etc. Keep those to make it easier to start your next project.
- Sell, but don’t sign a noncompete agreement. If you do, make sure there’s a time and location limit that makes sense for you. Make them pay for it on top of the property value.
- If a buyer doesn’t want to pay that much, but you need to do a deal, you could recommend multiple payments, with no interest. With inflation and the devaluation of the dollar, future payments won’t be worth as much. This may not work if they’re using a bank to finance, since the lender will want “first” lien position, and you won’t want to be in second. If you do sign this type of agreement, make sure you’re added as an “additional insured” on the property’s insurance.
- Who cares about the taxes? You didn’t have this valuation six months ago, so it’s like new money. Sell.
- Sell but don’t necessarily close. I recommended my friend go through due diligence, just so he understands the process and sees how buyer valuation works. Do this in good faith. If they offer your magic number, take it.
Think It Through
Keep in mind, these are just thoughts and considerations. Each of us is in a different situation, with our own levels of risk tolerance. When you consider that 70% of self-storage owners are mom-and-pops, it makes sense that most will go through just one sale in their life. It pays to think it through.
Henry Clark is owner of Clark Storage LLC, which operates seven self-storage facilities in Iowa and one in Nebraska. The family-run business also includes Clark’s wife, Sandy, and son, Ryan. To reach him, call 402.618.6595.