Self Storage Investing Newsletter

Independence Day is a good time to think about financial independence. That expression is massively overused in today’s media, with the suggestion that buying a few shares of this or that is the first step to being financially independent, which it certainly is not. Given the fact that the average retiree has less than $200,000 in total assets, and given that interest rates are currently about 2%, those “financial independence” ads that stock brokerages produce are ridiculous – how can you live comfortably on $4,000 per year of investment income?

Self-storage investments, on the other hand, can provide actually meaningful income in a magnitude sufficient to actually give you economic security. A self-storage facility worth $500,000 implied a net operating income of around $40,000 to support that purchase price. Assuming you never increased rents or occupancy even 1% over a 25-year hold, that income would give you ten times more than if you had invested in traditional stocks and bonds. “Financial freedom” needs to be more than just a cheap marketing gimmick, and self-storage can deliver on that premise.

Have a Happy and Safe 4th of July Holiday!

The Yardi Matrix self-storage report is out and there’s some interesting data that suggests some potential shifts and opportunities in the U.S. storage industry. One interesting item was the surge in rents in Columbus, Ohio – the fastest in the U.S. behind San Diego. So what’s up?

“Flyover” states may offer superior returns

For decades, storage investors have flocked to coastal states under the concept that these were the top-performers and everything else in the U.S. was somehow lesser. Storage construction went ballistic in markets such as Los Angeles, and things went so wild in markets like Sacramento that there’s a multi-year oversupply still to address. During this time the “flyover” states (basically anything between the two coasts) have been steadily growing in new industries and solid financial footing. Today, perhaps the best opportunity to boost returns for investors are these same states that were not highly discussed in the past. Columbus, Ohio clearly meets this criteria.

Millennial movement is creating new “boom” markets

Baby Boomers (those born between 1946 and 1964) were for a long time the largest segment of the U.S. population. But no more. They have now been replaced with Millennials (born 1981 to 1996). As a result, where the Millennials move is significantly shaping the future of real estate. And many of these Millennials are displaying traits that other demographic groups have not. For example, Millennials prefer better home values and historical venues. This has resulted in a migration back to these flyover states that have lower home prices and historical and varied cultural attractions. As a result, that’s where the fastest growing demand now is.

Things are always changing – even in self-storage

Those who thought they knew it all were clearly wrong. All industries change over time and all smart investors realize this and stay nimble enough to shift their strategies based on market conditions and trends. Only a fool thinks that they have mastered something as complex as real estate investing. The simple fact that so many “experts” put their eggs in one basket of coastal facilities would suggest that the “flyover” states are the place to be today.

Conclusion

The storage industry is always involving. Don’t count out the power of the “flyover” states going forward. Keep your options open.

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Many investors believe that they can’t compete with giant owner/operators. In 25 years of real estate investing, we have noted that the small investor actually has a significant advantage over the larger players. Why is that? Well, there are many solid reasons.

Moms & pops prefer smaller players they can identify with

Mom and pop sellers often select the buyer that they like the best. Not the one that offers the most money. Big groups try to buy love from moms and pops, while smaller players earn that affection by simply being likable. It’s hard for long-time owners – who typically built from scratch – to identify with a big company. It’s literally a culture shock when a conservative owner in jeans meets a New York employee in an Italian suit. Without question, the smaller player holds the advantage here.

Small players can move faster

The next attribute that puts the small player ahead is speed. Big companies move slowly – they have to as most decisions are made by committee. The person in the field, that represents the big company, has no actual power and it’s obvious to the seller. Since most moms and pops are not fans of B.S. and delays, they naturally prefer the buyer that can move fast and make decisions on the spot. Once again, the small player wins.

Small players put more effort in – it’s their money

There’s an old adage that the most motivated person is the one with the most at stake, and once again this ties back to the small player vs. the big company. At the big company, all of the acquisitions people are simply employees – they have no money at stake in anything that goes on. But the small player has all of his money at stake in making good decisions, and that translates to a much greater sense of urgency in getting the deal done, as well as fixing any hurdles that stop closing on the deal (which come up frequently in the areas of surveys, title, financing, and the like). So, once again, the smaller buyer wins.

Just look at the stats

Finally, let’s just look at the stats. The storage industry has been around for nearly a half-century. There are a ton of smaller buyers closing on significant assets. If large companies dominated this space, then why would Public Storage and the other major players not control everything? That’s how it works in many other industries (80% of all billboards, for example, are owned by only three companies) right? The fact of the matter is that small players are beating out larger ones every day on new acquisitions.

Conclusion

Smaller buyers have distinct strategic advantages over larger buyers. They win in head-to-head battles all the time. Never think you can’t compete because of size, because it’s simply not true.

Conduit debt (also known as CMBS debt) is a special product that offers 70% LTV on appraised value – regardless of what you paid for the storage facility. This means that if you have created value through greater net income, then you will be rewarded at refinancing with a higher valuation and, potentially, a “cash-out” situation. This means that you will effectively get all your down payment back from the original purchase, plus additional cash out based on the new effective value. And this “cash out” is tax free since it’s effectively a loan. In addition, these conduit loans are non-recourse and feature low, fixed interest rates and long loan terms. But how do you get one? If your deal is over $1 million, then the answer is using a loan broker, and the best in the business is M.J. Vukovich at Bellwether Capital. We’ve been using him for years and he essentially creates the loan request, meets with the lenders, helps you in the selection, negotiate the final terms and shepherds the deal to closing. In exchange he gets a small commission that is a bargain for the amount of time and expertise rendered. For more information call him at (612) 335-7740 or email him at [email protected]. You’ll be glad you did.

There is a definite relationship between successful storage facilities and population density. Although there are many successful storage facilities in rural markets, the bulk of the industry is located in larger city limits where the population is often massive. Why is population density so important to success?

High density means more demand

The first effect of density is obvious: higher population density = higher demand. This makes complete sense, as the more warm bodies you have the more that the phone will ring. Since this is incredibly easy to understand this relationship with density, it’s not even worth further discussion.

High density means higher cost per foot of their residence

OK, this one is more interesting. When you have higher population density you typically have higher housing prices, which equates to higher costs per square foot. When the price per square foot becomes extremely high, there is no desire to waste any part of your home on storing items. So once the price per square foot of storage is significantly lower than the price per square foot of housing, the demand goes up exponentially. In San Francisco, for example, the price of a home can exceed $1,000 per square, so renting a 10’ x 10’ storage space is a no-brainer.

High density means more business demand, as well

A growing part of self-storage demand are large and small businesses. They need this space because they need to store inventory or raw material. And, just like housing, when the cost of renting commercial space goes up, it makes that storage unit look much more attractive. With industrial and commercial space rents at their highest in history, the relationship between density and demand is extremely apparent.

High density means less supply in the future

Here’s another interesting fact. When you have greater population density, you have more expensive – and less available – land for new storage construction. Since the industry has a bad track record of over-construction when there is infinite raw land available, this supply restriction is favorable for investment. In some markets, the shortage of buildable land is so large that the only storage you can add is buying existing buildings and reconfiguring them (there’s a very successful self-storage facility built inside a bankrupt sporting goods store in San Francisco that illustrates this point well).

Conclusion

While there are many attributes that make a self-storage investment a success, one of the most important is the population density in the market as well as surrounding the property. Take note of this when evaluating deals to buy, as the relationship is significant.

America is a land of many options and tastes. There are roughly 300 million people in the U.S. and no two are exactly alike. And the same can be said of self-storage investors. So what are the types of buying decisions you have to make before looking for a storage facility to buy.

Geographic preference

What areas of America do you feel strongly about investing in? What region? Part of this may be based on where you live, but the better reason is where you feel the future of America is shifting. Remember that self-storage – like all real estate – is built upon the foundation of location, location, location. Some regions have been sleepers for decades (like Alabama and Georgia) and others have been perhaps too overheated for decades (California and Washington). But where do you think things will be in the future? That’s what’s important.

Size of deal

For most buyers, this is a function of down payment. So take your available capital and multiply by five and that’s probably around the size deal you are looking for. That’s not to say you can’t expand that range with a partner or a willing seller who will carry the financing.

Financing structure

Are you bankable? Are you OK with carrying debt and, if so, at what LTV ratio? Some people are only comfortable with 50% LTV (loan-to-value ratio) while others may be perfectly fine with 90% LTV. Obviously, the higher the ratio the higher the risk. Also, are you OK with signing recourse loan documents, or are you only agreeable to non-recourse debt (debt in which the most you can lose in a foreclosure is the amount of down payment)? This must all be decided.

Cap rate

What cap rate are you comfortable with (or, effectively, what level of return)? The “cap rate” is what you get when you divide the net income by the cost of the deal (the industry norm is around 5% to 8%). Obviously, the higher the cap rate, the more money you’ll make, but there’s also the issue that the lower the cap rate – typically – the lower the risk of the deal hitting its targets.

Ability to push cash flow

Most of the positive cash flow that comes from a storage facility after purchase (except for 25 years into the future when the property’s mortgage is paid off) comes from improving the occupancy and pushing the rents (also cutting the costs in some cases). But some storage properties are already at 98% occupancy and full market rents, so there’s not much you can do to create additional net income. How important is that to you?

Conclusion

There are roughly 45,000 self-storage facilities in the U.S. These come in a wide variety of sizes and prices and, of course, locations. It’s important to honestly assess what you’re wanting before you even begin to look at – and make offers on – deals.

This is a sign at a McDonalds drive-thru that thanks you for your business. Why did McDonalds install this? Why not say something like “please don’t litter”? The answer is that smart companies constantly reaffirm the consumer’s decision to trust your business – and the same is true of self-storage.

Competition

America is a very competitive place – and the options are only more apparent to the consumer today thanks to the internet. Self-storage is just as competitive as fast food, which is exacerbated by the fact that storage is also a commodity, just like a hamburger, and doesn’t really offer a lot of differentiation between facilities. That’s why you have to constantly remind the customer why they rent from you and not your competitor. People like that attention.

Buyer’s remorse

When the customer first signs the lease with you and gets their key, they are always subject to “buyer’s remorse” which is basically a nagging doubt that they made the right decision. To reinforce that you should send them a letter or email thanking them for their business and explaining why your facility is the right choice.

Marketing studies

Marketing studies on the storage industry have proven that continually affirming your customer’s decision is smart. They found that owners who send the perpetual message that the customer made the right selection of storage for their goods have greater retention – rent longer – and even give higher rankings on social media and word of mouth.

Conclusion

You need to constantly be reinforcing the message to your customer that you value their business and that they made right selection. It’s just smart business. That’s why McDonalds does it – and you should, too.