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Bottom-Line Benefits: How to Know if a Self-Storage Preservation Project Adds Facility Value

How to Know if a Self-Storage Preservation Project Adds Facility Value
Every self-storage facility needs maintenance and repairs. Aesthetics are often a primary focus, but what about the impact on expenses, revenue and property value? Learn how upkeep and improvements affect facility worth, and how to determine when a project makes sense.

A door spring breaks. The gate controller malfunctions. Asphalt cracks. Paint fades. A roof begins to leak. These are all examples of maintenance and repair issues that eventually occur at every self-storage facility. As the operator, you must decide if, when and how much to spend on fixing them.

Before you proceed, consider how the expense of upkeep impacts your net operating income (NOI) and facility value. The answer isn’t always simple; in fact, it may vary between markets. To drill down and arrive at an appropriate conclusion, let’s take a closer look at the relationship of NOI and value, factors that affect maintenance decision-making, and the financial impact of various repairs. Ultimately, what you want to know is whether a project has bottom-line benefits.

NOI and Value

NOI reflects the profitability of income-generating real estate investments such as self-storage. It represents all revenue generated from the property, minus credit loss and operating expenses. It doesn’t include depreciation, amortization, debt service (if any), or income taxes, though it does include property taxes.

When a buyer/investor considers a self-storage acquisition, the process includes estimating value. This can be done by using NOI and a capitalization (cap) rate. Market cap rates reflect the then-current rate of return (in percentage terms) that buyers will accept from an investment. Thus, value equals NOI divided by the cap rate.

For example, let’s say Any Storage had an NOI of $300,000 in 2019. We’ll also say real estate investors and lending institutions are in general agreement that the cap rate for this type of property in this market is 7 percent. An NOI of $300,000 divided by a 7 percent cap rate (.07) gives us an estimated value of $4,285,714. If we up the NOI to $350,000 but use the same cap rate, value increases to $5 million.

Notice that a $50,000 increase in NOI boosted the value by $714,286. This is why it’s important to determine whether spending money on maintenance or a repair item potentially increases or maintains the NOI and its subsequent effect on property value.

Maintenance Influencers

Self-storage site maintenance can include everything from regular lawn care to resealing parking lots to painting faded buildings and doors. The correlation between facility NOI (and, therefore, value) and maintenance isn’t always clear because a lot of factors can influence decision-making on these types of projects.

First, you need to consider timeline. Is there a time factor that affects a particular maintenance investment? For example, is it a project that can only be accomplished during certain times of the year because of weather? Maybe you’re thinking about putting your facility on the market soon. You might be eager to complete certain tasks before you start marketing; or, on the contrary, you might feel tempted to forego additional effort before you sell. Just bear in mind that leaving things undone could negatively affect a buyer’s opinion of the property.

Your market position is another important factor when it comes to maintenance decision-making. Operational strategies within the same market can drive spending decisions with different outcomes.

For example, if an operator has made a strategic decision to be the low-price provider in the market, he’s likely to attract more price-sensitive customers. These renters are less apt to walk away from a facility because of cracked driveways and peeling paint—at least up to a point. Assuming there aren’t safety issues, low cost may outweigh facility appearance. For this operator, investing in maintenance or upgrades may not lead to additional revenue, at least not in the short-term.

On the other hand, if an operator chooses to offer a premium facility, with a greater emphasis on cleanliness, organization and security, he can generally charge higher rental rates. This positively impacts income; however, it comes with a burden of meeting certain customer expectations. When tenants pay more, they expect more. Curb appeal, attention to detail and upgraded features become necessary.

Let’s say our premium, 300-unit facility is starting to age. The paint is fading, and the asphalt needs resealing. There’s also a new, aggressive competitor in the area. Our occupancy has dropped from 98 percent to 90 percent in the last year. Based on our knowledge of the market, we determine the loss is related to the dated look of the property. We know we should act, but how will the investment affect facility value?

If new paint and sealcoat creates a more inviting environment that results in higher occupancy, NOI and property value should improve. Let’s say that after the upgrades, we manage to rent 24 additional units at $100 per month. Over 12 months, that’s $28,800 in additional revenue. Dividing that figure by our 7 percent cap rate would give us a $411,429 improvement in value. The key assumption here is that improving facility aesthetics will return occupancy to previous levels.

The Impact of Repairs

As a self-storage operator, there are lots of components you might need to repair over time, such as a malfunctioning gate, broken door springs or an air-conditioning unit. As you’ll see, the amount spent on these types of items and the effect on NOI and facility value can vary widely.

Example 1. Gate access is essential to facility operation. Failure to fix a broken gate would have an immediate, negative impact on tenants. Continued gate problems could quickly lead to lost occupancy and revenue.

Let’s use the same $300,000 base NOI for Any Storage. At the end of the current year, let’s assume rental revenue will decrease by $10,000 as tenants move out and new customers stay away due to gate problems. If NOI falls to $290,000 at the same 7 percent cap rate, value will dip to $4 million. That’s a decline of $285,714. Though this example is simplistic, it illustrates the impact some repairs can have on income and property value.

Example 2. Now, let’s consider the impact of a broken door. Let’s assume the property has several working units available and only one in need of a door repair. It might be a good idea to fix the door, but it’s unlikely there would be any immediate increase in NOI since other units can be rented without incurring any cost. An argument could be made to not spend the money on this project until more units are leased. However, if we assume the property has only one available unit available, but its door is broken, the answer is obvious: The repair should be done as quickly as possible to capture the rental revenue.

How much could this improve NOI and facility value? Let’s say the rental rate on that unit is $100 per month, or $1,200 per year. At our 7 percent cap rate, the improvement yields a value increase of $17,143. Though the repair is identical in both instances, different market conditions lead to vastly different spending decisions and outcomes.

Decisions, Decisions

Quantifying the impact of self-storage maintenance and repairs on facility NOI and value can be challenging. Some projects are clearly more advantageous. When the rewards aren’t immediate and obvious, the picture get murky.

As a facility operator, you have to ensure your actions and spending align with business goals. Consider your market composition and physical environment, as well as what customers need and are willing to pay. Using all this information together is an art. It takes practice to understand why a particular project should improve NOI and value while another may not.

Michael Morrison and Hal H. Tanner III are brokers with Midcoast Properties Inc., a commercial real estate brokerage focused on self-storage in Alabama, the Carolinas and Georgia. A South Carolina native, Michael also owns two self-storage facilities. Hal joined Midcoast this year after spending more than 30 years in the media business. He has experience in finance and revenue management. For more information, call 803.600.0602; email [email protected] or [email protected]; visit https://midcoastproperties.com.

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