There are two ways to buy a self-storage facility: as an asset purchase or an entity purchase. What’s the difference? That’s the topic of this Self-Storage University podcast in which we’ll explore which one is superior and which is not nearly as good.
Episode 58: Asset Vs. Entity Transcript
When you go to buy a self-storage facility, there's two paths you could go down, you can either buy the asset or you can buy the entity that owns that asset. This is Frank Rolfe at the Self-Storage University Podcast. We're gonna be talking all about just that, should you buy the asset or should you buy the entity? Let me start off by saying, I am certainly not an attorney, nor am I an accountant. I have absolutely no physical properties, education or any degrees to be able to talk intelligently about these two. I'm just giving you some ideas I've got. This is not legal advice. This is simply things that I have heard or learned over the last 25 years of being in the real estate business that I think would shine a little light on the debate between buying the asset versus the entity, but you certainly should talk to your own lawyer or accountant before making any kind of final decision. Alright, the first thing you've got is, when you buy the asset, what you're doing is, you are actually buying the property, and you close at the title company, and then the title company, they give you title to that property, and it is then forever yours and cambered by whatever mortgage you have on it. So that self-storage facility that is owned by you technically for all the world to see on the property tax records.
But when you buy the entity, it's a little bit different. What you're doing is you're buying basically control of the stock of whatever kind of entity owns that self-storage facility. It might be a limited partnership, it might be a sub S corporation, whatever the case may be, instead of buying the asset, you're buying the entity that owns the asset, and that's what makes a huge difference between doing the two. Now, why is one better than the other? Well, if you boil it down, from talking to attorneys and pondering it, when you buy the entity, the problem is you are inheriting the debts and liabilities of that entity, and that can be a little scary because, of course, you don't know the whole story behind that. Let's say, for example, you're buying a self-storage facility and you were buying the entity as opposed to the asset, and somebody in that self-storage facility, let's say the manager was being accused of sexual harassment of perhaps the assistant manager. What happens is when you buy that entity, whatever liability that entity has towards the sexual harassment claim, you inherit that too. The clock doesn't stop.
When you buy an asset, you don't inherit those types of items. So the big hold-up in buying the entity as opposed to the asset, it simply comes down to the fact, you are stepping into somebody else's shoes and you don't know where they've been in those shoes. Now, many self-storage facility owners are good people, but as we all know, even in today's world, being a good person doesn't shield you from lots of crazy litigation. So there's every possibility that lurking out there somewhere, that you will not know and cannot possibly detect, there is something that can come back and cause you problems when you buy the entity. No one can actually give you a 100% assurance of that. Even if the seller tries to tell you, "No, I've done nothing wrong," and, "No, if a problem ever comes up, I'll stand behind that," you don't know that nor can you actually make that happen. So that's the big issue, is inheriting those unknowns, those things that you can't find.
Now, the next problem you have, when you buy an entity over buying the asset, comes from the world of banking, because most banks know of these risks. So when you go to the bank and say, "Hey, I need to borrow money to buy the entity that owns a self-storage facility," they're not real happy with that idea, because there are concerns, if you buy that entity, are there things that you don't know, which now the banks certainly doesn't know, that could mess things up and that they therefore may not get the regular mortgage payment or even worse yet, the capital at the end of the movie. So another issue you're going to have is with your bank. Most banks will only do a loan when you're buying the asset. They will not do a loan when you are buying an entity, and some who will do a loan if you're buying the entity but not the asset, they're gonna do it at a far lower loan-to-value to protect themselves. So if they were gonna do 80% loan-to-value or LTV rate when you buy the asset, they might only do 50%, or maybe even worse Loan-to-Value or LTV rate if you're buying the entity 'cause they're frankly concerned. They have the same worries and problems that you should probably have in buying the entity.
Next, you have all kinds of issues when you buy the entity regarding depreciation. When you buy the asset, then typical depreciation rules apply. When you buy the entity, there may be limitations on how much depreciation you can use going forward, 'cause that entity is already eating up some or all of those depreciation benefits. So for that, you need to go to your accountant and say, "Hey, what do you think? What's gonna impact the depreciation and my financial ultimate profit from the self-storage facility if I buy the entity as opposed to the asset?" Which then begs the question, if buying the entity is always inferior to buying the asset, if buying the asset is the classic gold standard of buying a self-storage facility, then why would anyone ever do it? Why would you buy an entity? Well, the first reason might be if you are trying to bypass local permitting issues. Let's say that self-storage facility was built under some kind of special use permit, where when you sell the facility, then the permit ends or it starts some time clock to end that usage. But if you buy the entity, often you would not trigger that. Now, of course, you'd have to ask yourself if that was the reason to buy the entity, wait a minute now, what happens when I go to sell this down the road? Then how will that work?
Because if I refused buy the asset because it'll trigger some kind of terrible permitting issue, would that really, really hurt me in the future if I go to sell it? Won't the new buyer say, "Wait a minute, I'm not buying this self-storage facility because the permit is all screwed up." And, of course, that will also trickle down to their lender who will say, "Wait, I'm not putting a loan on the self-storage thing because of the screwed up permit." So if you're trying to buy it, just to that, for that one issue, well, you might wanna put the breaks there for a minute and think about why are you doing that? Another reason you might buy the entity, and the big reason you might buy the entity over the asset is just to get the deal done. Sometimes, the seller, for whatever reason, they won't sell you the asset despite the fact that's what you really wanna buy. They'll say, "Yeah, yeah, I don't wanna sell that. I would only sell if you bought the entity that owns the asset."
Now, if that's the case, you'll have to make a judgment call. Does this have everything else in good working order that you really, really, really wanna buy? Do you wanna buy it so badly that you'll buy the entity? Is the price maybe just spectacular? I once bought a property that... Well, I bought just the entity. It was a crazy deal. It was a zero-down deal, and there was a first lien, and a second lien, and a third lien, and the only reason I agreed to buy the entity was because the worst I had to lose in it was not much, because I had no money in it. There was no skin in the game on my part at all. It was a truly zero-down deal. It was a property that was failing, and there was really no way anyone would get involved unless it was no money out of pocket. They were literally just looking for someone they thought could actually bring the thing out of the dumpster. So, on that deal, yeah, okay, I bought the entity, but again, I didn't have to put out any money towards buying the entity. But it's up to you, it's your choice. If you see a thing and a self-storage facility that you say, "Oh my gosh, at this price, I can't go wrong. I understand the risks of the entity and buying the entity, but by heavens, I'm gonna go ahead and go forward anyway knowing full well what I'm doing," well, then that's just a general business decision.
It would be no difference if it were some other issue like floodplain or something that also concerned you. When we make decisions on buying a storage property, there's many things that go into that decision. It isn't just one item. It's not just asset versus entity purchase. There's a host of other things. And if everything else points to positive and you say, "Well, I understand the risk, I'm gonna do it anyway," well, that's fine. Also, if you're going to buy an entity, make sure that you do hire an attorney or someone to help you try and minimize what your exposure is. In some states, there may be tricks, things that you can write into the agreement that will protect you should something pop up. And there are additionally places you can search for looking for outstanding litigation that may have been filed or other issues. On a final note, it's a lot less scary to buy an entity when you're buying it from someone that your gut instinct tells you truly can be trusted and has been running a property in good condition. Everyone knows what it's like when you go to a mom-and-pop storage facility that is very, very poorly run. You know there's all kinds of things you don't know, because no one's really been minding the store, and that's where you would probably have the greatest risk.
If there was any risk to your entity, is simply because no one was ever taking advanced precaution or being proactive to stop those things from happening. But if you're buying from a mom-and-pop that appears to you to have a fairly well-run property, then definitely crossing all the T's and dotting their I's, and building a good paper trail in every occurrence, that would definitely give you a little greater comfort in that concept. But once again, anything you do when you're buying an entity, do seek proper legal counsel and accounting counsel, just to make sure you know fully where you're getting involved in. This is Frank Rolfe at the Self-Storage University Podcast. Hope you enjoy this. Talk to you again soon.