How I Analyze Self-Storage Investment Opportunities Today
I’ve talked a lot about the benefits of self-storage investing over other types of commercial investment real estate.
Usually the benefits circle around the fact that self-storage is a steel wall and a concrete floor generating rents comparable to apartments or office buildings. Operating expenses are lower, but most importantly, there are very few capital expenses that will ever interfere with your cash flow.
I saw early on in my career with self-storage that cash flows are more predictable with self-storage than any other type of real estate I have ever seen.
It is not perfect, but cash flow projections can be very accurate. Most of my misses have more to do with the amount of debt or the lease up assumptions than anything. Once the lease up occurs if it was slower than expected, usually, we are back on track.
Let’s take a quick look at how we can analyze a self-storage project. I could have chosen a lot of different types of self-storage opportunities, but I will take an expansion opportunity.
I will also use the Storage World Analyzer for the analysis. I could use excel, and do for some projects, but usually I start with this program. You don’t have to use it and can use excel, but I find it easier and faster as well as more accurate in most cases. Also note, I sell it, but I want to be very clear, you can be successful using excel, I just love this program and hope people who use it find it as user friendly as I intended it to be.
Our goal is to purchase capital items and generate ongoing cash flow and increased value. The capital items are the self-storage buildings. We can purchase existing, convert an existing building, build new, or like we are doing here, purchase existing buildings (along with the existing income) and build more.
The goal I strive for is for my income to go up at a faster rate than my operating expenses. In other words, each year of the ownership hold, we strive for an average of a 3% rental increase and try to keep our operating expense growth closer to 2.5%.
3% is not hard to average. Even in recessionary times, over time, 3% is fairly easy to maintain. From 2008 through 2012, we may not have had a 3% price increase each and every year, but by the end of the recession, we averaged the 3%.
2.5% has been the average inflation rate over the last decade, so that seems like a good number to use for operating expense increases.
If you do that year after year, the gap between rental increases and operating expense (in this case 0.5%) will compound and can create some real wealth.
So, analyzing is great, but remember, after you put a project in service, your job is to know where you are in terms of income year by year and expenses year by year. Usually my income and expenses will be somewhat different from what I may have projected, but it is amazing how close the NOI can be, and that is the number because the value of your self-storage project is determined by what a ready and willing buyer will pay for the NOI (net operating income i.e. income less operating expenses) cash flow.
Let’s look at a 22,000 square foot facility sitting on about 3 acres of land. It is listed for $2.2 million dollars and does have some expansion opportunities.
The first thing I do is make sure I have some since of the market area this property is located in. I use Yardi Matrix for a quick look into the market if they have the data. I know this is not exact, but it lets me know if I am wasting my time in an overbuilt market. Ultimately, I will get a self-storage feasibility report indicating the supply/demand, as well as barrier to entry information, unit mix, and another proforma, but here I just attempt to see if the market is overbuilt.
Yes, I know Yardi is expensive and most people can’t afford it (I’m not sure I can), but I have to use something. In the old days, I would Google and attempt to estimate the amount of self-storage and use the demographics in the marketing package, or what I could find online to try to see the amount of square feet of self-storage per person in a submarket.
Depending on where it is, I usually like to see 7 or 8 square feet or less per person. The more space I am bring on, the lower I like to see the number. In dense markets like Houston, TX, a higher number is OK. In smaller markets like Shelbyville, KY, I want a lower number.
For this project, I am thinking there is some unmet demand. My competition is all very full and there was no discounting going on. I had a hard time finding a 10 x 10 in this market.
The first analysis I do is an existing facility analysis. I want to know what is currently there and how it looks financially. I create an existing facility analysis based on how I would run the project.
Next, straight from the marketing package, I enter the existing unit mix and the current street rates. I want to know the Gross Potential Income (GPI). What is the maximum amount of money this project can earn? In other words, if every unit was rented, everyone was paying the street rate, and no one was late.
I can enter climate-controlled units, non-climate-controlled units, and parking. For this analysis, I entered the parking as additional income, because if I expand, most of the parking revenue will go away because I will be expanding where the current parking is.
Here is what it looks like as I enter it. If you are using excel, still create a unit mix. Do not just put a GPI number in because you can experiment altering unit prices top see the effect it can have on the project.
So now I have the current income potential in the program.
Now I enter the purchase price and loan assumptions. I am assuming I will pay $2 million for the deal as it sits, I will spend about $20,000 in due diligence expense, and will put a 75% Loan to Value (LTV) loan on the project using local bank financing. I have also used SBA and CMB loans as well.
Now I enter the project assumptions. This is what make a big difference in how we analysis deals over just doing a snapshot of a deal when it is stabilized. I am assuming that my income rises 3% per year, that my operating expenses go up 2.5%. Depending on the type of facility, I usually today use a 7% CAP rate for future values. In other words, every year I will determine the value of the project by applying a 7% CAP rate to the NOI (net operating income) for that year. The Storage World Analyzer does this each year in the ten-year cash flow statement.
I also assume my cost of sale is 2% or 3%. It can be higher if you list the property, but we have been selling direct to the REITS when we sale.
Then I put in stabilized occupancy. In other words, how will I run this project and what will my economic occupancy be. This program will apply whatever I put in here to the GPI (gross potential income).
I am interested what the current Seller is doing, but at the end of the day, I am not going to purchase this if I don’t think I can get at least 85% stabilized occupancy. Now I know many facilities are well over that now, but I always use 85% or maximum of 88%. This is the historic average, and most lenders are going to underwrite in the 80’s not the 90’s.
Here is what I entered for this project.
On some projects where I am fixing a problem, I could change the stabilization rate year by year. Here is an example:
To complete the existing project analysis, I fill in my anticipated operating expenses. The biggest mistake I see people do is copy what is in the marketing package.
Do not do that. Put in your own numbers based on how you will run the project.
“I don’t know what they are,” I often hear.
Well figure it out. How many people are you going to need to run it?
Now I do use the insurance number, the utility number, and I look and make sure the agent has moved the property tax up to reflect the listing price, but that is where is stop.
• I use $3,600 for the cost of a web site. I put in something for online marketing.
• I figure out how many people we are going to hire. Here is a rule of thumb I am using now. We get about $335,000 of gross income per full time employee. But that is just us. Sometimes I put in more personnel if we are going to have truck rental.
• I put in my own repair number. I know we will spend between 12 cents and 15 cents psf for normal repairs. I enter something for tools, grass cutting etc.
• I use their utility number (upped a little). I use their insurance and projected tax amount.
• Then I enter what we will pay in a management fee and I put in the other expenses we anticipate.
Here is what it looks like.
On the first tab, you will see it is already generated with what I put in on my first analysis. So, I start where the new information on the expansion is that was not on the existing analysis, “Addition Sq. Ft. To be Added by Expansion”.
Again, at some point, if we move forward with this project, I will have a unit mix, but for now, I choose the “Specify by Using Square Footage” option.
I actually have to do some math here. I am going to use the 24,000 square feet of self-storage (we mark up to the gross somewhere else in a minute) and I am discounting the of $9.45 per square foot per year (psf) for the non-climate-controlled units and the $13.41 psf.
For climate control units to $8.50 and $12.50 respectively. If we are doing half non climate controlled and half climate controlled, the blended rate would be $10.50 average rent for that 24,000 square feet.
When I put $10.50 in the yearly income tab, the monthly automatically populates and vice versa for this program.
Also given that some of the expansion land is currently used for parking, I cut the parking income in half.
Next, I add a construction budget. Again, this is a preliminary budget, so instead of filing out a complete budget (which I will do later if the deal looks good), I just use a per square foot number. This is existing single-story metal buildings, so in today’s numbers, I can build this at around $52 psf.
If you have no idea about construction, the Storage Almanac and other data from the SSA or Mini-Co or the ISS (Inside Self Storage) can help with average numbers.
I know it could be built for less, but for what we do, it would end up costing us this with a construction manager etc.
The only thing I change on the loan assumption page is I add a year or two of interest only on the loan. Since I did a loan to value loan instead of a fixed number, this program will calculate construction cost as well as acquisition cost and modify the loan.
I want to introduce an idea here we will use on the operating expense tab as well. Since in year one I am most likely building the new square feet, I will not use all of the loan or some of the operating expenses for this time period. In other words, in year one I will be drawing on the construction portion, so the entire interest amount will not be used. I just guess here and assume that in year one the average will be 70% of the full interest because I would not have all of the loan drawn until well into the year.
Here it is just a guess. So, it looks like this. I put in a 30% reduction year one of the loan.
You will notice a few more line items now on the Assumption Page. The first one we left blank in the “Existing”, the “Gross Sq. Feet Increase. Remember, we now have hallways in the construction portion, we are for the entire project it will be a 12%. You can do the math to get the exact number. So that is what we put here.
Next is “Construction Completion Time.” Let’s say it takes a year of plan approval and construction before you can start renting.
The last new line is “Absorption”. That is how many square feet will on average be rented per month. It can vary, and the feasibility report will ultimately inform you. For now, let’s use 1,200 square feet per month.
Again, we think through how we are going to run this expanded project. It is already populated with what we put in for the existing project.
• I am assuming we will up the personal to about 1.5 full time people. But not the first year, so I reduce the personnel 50% year. I add a bonus of about $3,500 to incentivize lease up.
• Next, I up my online marketing to about $4,000, but cut it in half year one since I am under construction.
• I up the maintenance and reduce it 25% year one.
• I up property insurance but reduce it year one. I also up the utilities and reduce it year one because the new building isn’t online yet.
• I also increase the property taxes and reduce it year one and two because most likely it will be year three before I get the increase.
In the other line item, I increase bank and card charges because I will be taking in more income. Again, reduce it year one.
Now I think I am complete. Let’s take a look.
Getting better. I try to have a 20% IRR or better on a ten-year cash flow analysis, this is 19%. I want to see the cash-on-cash return slightly higher than this but not bad.
I would tweak a few things here to see if I can improve it. I want to be careful not to reduce my construction cost or operating expenses too much, but let’s reduce the offering price $200,000 and see what happens.
This looks better.
You can see we would have $3,068,000 in the deal and in year five it looks like it would be worth $4.2 million. We would have made slightly over $1 million in value and gave a slightly over 13% cash-on-cash return by then.
For us this works. Your requirements may be higher or lower.
This does not mean we will buy the project, but it looks like it could work. Further research will determine if this will really work.
But this is how we can take something making 2% and turn it into something making 12% or more and create a million or more in value for our efforts.
Ultimately, we would most likely pass on this because there are others that offer better returns, but this could work for us. I wanted to share how we analyze a deal, and this was one I was just happening to analysis.
I hope this helps you with your self-storage investing decisions as you try to figure out how to get in this fantastic business.