New year’s resolutions are only as good as the “will” to accomplish them. Anyone can write a list of goals, but very few people will actually put the effort in to make them a reality. Coach Joe Paterno once said that the “will to win is important, but the will to prepare is vital”. So if you want to buy a self-storage facility in 2014, it’s critical that you hit the ground running in January. The first step is to decide what your criteria for the correct deal would be. How much do you have for a down payment? Are you credit-worthy enough for a bank, or do you need to stick with seller-financed deals? Where will you go geographically? Once you have put together your criteria to buy, then the next step is to put as many deals through your sorter as possible, to increase your odds of finding the perfect facility to buy. You’ll catch on pretty quick, but only if you start the process up. Remember the old quote “think like a man of action and act like a man of thought”? It’s time to take action in the New Year.
Memo From Frank & Dave
Why Construction Cost Is Only Good For Trivia When Buying An REO Self-Storage Facility
So you’re looking at a foreclosed self-storage facility to buy – one that has been repossessed by the bank. One of the worst traps you can make on this type of transaction is to let the bank’s loan amount – and the cost to build the facility – be your guide on valuation because, unfortunately for the bank, the original cost is only good for trivia.
The current income is what’s important
Self-storage facilities are income properties. Income is 100% of the equation. If the facility makes $10,000 per year in profit, it’s worth $100,000 at a 10% cap rate even if it cost $5 million to build it. That’s why so many brokers and sellers want to avoid the “what’s the net income?” question – because they know that it’s sheer death in getting their price. Don’t listen to excuses on why the net income is so low, or all the grand visions the seller has to improve on it. The current net income is all that you need to hear.
People make mistakes when building
Just because it cost X to build a facility, does not mean that it’s worth what it cost. Many developers way over-spent on their projects. I toured one in California that had a fountain out front and a tile roof – it looked like an expensive retail center. In fact, that’s what the rocket scientist developer thought he was doing, building a retail center that would be a self-storage in the early years, and then be converted to a shopping center by just moving the walls around. Instead, you’ve got a failed self-storage facility that cost twice what it should have. There are tons of projects like that out there.
Banks are seldom good decision makers
When was the last time you saw a banker who really was a real estate expert on self-storage? Let’s face it, the simple fact that you can get a loan on a self-storage facility does not mean that it was the correct decision to buy or build it. There were many poor loans made in the past, and there will be more in the future. Don’t let the fact that there was a loan made on a facility for $3 million make you, for one minute, believe that it’s a $3 million facility.
Appraisers are often corrupted
As equally poor at judging the true value of a self-storage facility is often the appraiser. We completely disregard appraisals, in favor of our own estimates of value based on income. Appraisals are based on a combination on the income approach, the cost to build, and comparable sales. Well, at least they got one of the those correct. If you required appraisers to buy back the properties at the prices they set, nobody would be an appraiser, as they know they really have no idea what the prices should be. Normally, the bank tells them the goal, and that’s the number that they come up with. When they instead go with a lower value than the bank needs, they normally fire them and just get a second opinion.
Our experiences in buying REO properties in 2013
We probably paid an average of 50% of note value on every deal we bought as an REO in 2013. We bought a $5 million property, with a $4 million loan, for $2 million. We also bought a $2 million property with a $1.4 million loan for $700,000. And we bought a $1 million property with about a $800,000 mortgage for around $400,000. Is that because we’re geniuses? No, some of these were auctions, so there were other bidders. We use these as examples to let you know that the only thing that matters is income, and many properties don’t have the income to support a price that’s even 50% of what everyone thought -- before it failed.
There are some great deals out there as REO. Banks have foreclosed on self-storage facilities, and the prices are attractive. But don’t be fooled into any deal that is not based solely on income. The money that was spent on building and buying these facilities is great trivia fun. It makes good cocktail party conversation. But remember that the facility failed based on that price. So clearly, if anything, those historic prices are a good guideline of what you shouldn’t pay. Use your common sense, and you can make big profits off the misfortune of others.
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