Self Storage University Podcast: Episode 43

Don’t Listen To “Experts” On Cap Rates And Potential Occupancy

There’s no shortage of articles and reports out there on the self-storage industry, but don’t let people give you guidance who are trying to sell you properties or have a vested interest in advancing false narratives. In this Self-Storage University podcast we’re going to discuss some of the “facts’ floating around the industry which are clearly wrong and designed to ensnare you into bad deals.

Episode 43: Don’t Listen To “Experts” On Cap Rates And Potential Occupancy Transcript

There's no shortage of experts in the self-storage industry, but yet a lot of the information they're gonna tell you has its own selfish motives. This is Frank Rolfe, for the Self-Storage University podcast. We're gonna be talking about the reports out there that circulate frequently, and those who make those reports and stick them out there for all the world to see. Now, if you Google self-storage news and self-storage reports, you'll see lots of articles and lots of reports out there, some that are free and some that you would have to buy. But they boil down to the two areas, that both disturb me. First, occupancy, and the other, cap rates. And let's first talk about who creates those reports. Now, a lot of those reports emanate from brokerages. These are real estate brokerage houses that sell self-storage facilities, and when you sell self-storage facilities, clearly you have a vested interest in making the buyer believe that things are better than they would seem, because when a buyer thinks they're getting a good deal they're more likely to close. If the seller wants a price that's more than what the market should bear, it helps make that possible.

So when I read a report that comes from a self-storage brokerage house, I immediately have to be somewhat suspect that what I'm reading is not really the truth, but it's something that has been perhaps embellished a bit trying to make other motives possible. The other group that you'll see all the time bringing out reports and things on the self-storage industry are people who are trying to sell these feel-good reports to larger players in the self-storage industry. Remember, the self-storage industry has a fair degree of consolidation, public storage and extra space, some of these larger owners, they control a huge percent of all self-storage in America. I'm not sure exact percent, but I would imagine it's probably over half of it. And as a result, they're willing to spend big bucks to make their investors feel good and make they themselves feel good. So what happens when you have a bunch of yes, men creating reports trying to make people feel good about themselves? Well, the quality of the accuracy starts to falter, because they're not gonna tell things as they really are. They instead are gonna tell things in a manner that makes you feel like you're doing a good job, or makes your investors say, "Oh, this person is doing good." And once again, that's not really factual information.

Let's talk about occupancy, that's the first key thing I see in these reports that's wrong a lot. Here's the problem, when they do these reports what they're doing is, they're talking mostly the larger players, so they're talking the larger players in the larger markets. And they go out there and they send them surveys and say, "How occupied are you?" And of course, number one, you're gonna say, "Better than I really am," because it makes you feel good. But also you're not really getting a nationwide sampling. What you're getting is a very, very narrow focus of just the larger operators, many of which have full-time managers or a whole manager hierarchy and are often in some of the top markets in the United States, like San Francisco, California. But that's not really telling you how things are. Well, if you read those reports, even given the fact that they have a very narrow focus on some of the top markets and the larger players, they're showing an average vacancy rate of 9%. Now, why is that important? Well, a lot of times when you talk to brokers and sellers they will tell you that, "Oh yeah, you can get to 100%."

You hear that all the time. And if not 100%, they'll say 99%. The factor of the matter is you typically cannot. Why is that? Well, there's constant turnover in self-storage. So you might hit a 100% and then two days later you wouldn't. But on average, given the fact that people are moving in and people are moving out, you're going to have, by their own admission statistics around a 9%. So if the industry is at 9% vacancy on their own nationwide average, so they claim then when you run your numbers on buying a self-storage facility, make sure you put in plenty of vacancy. Put in at least 10% vacancy, if not more. Do not let people try and convince you that in fact you can run it at 100% because you clearly cannot. There are no stats out there to support this theory. Now, I know people with self-storage facilities that are at 100%. How is that possible? Well, they're in a market that has so little supply and so much demand that they can achieve that, but they're never... Even those people are not going to bet the firm, they're not going to set their mortgage such that 100% is required to make that monthly payment.

So just don't let people convince you to push things too hard because it's not fair to you, that is not the norm. So when someone says, "Oh yes, 100% is totally a given here, if you just gave it a little better marketing and horse power." No, that is basically, clearly not true. The other is cap rates. Now, what is a cap rate? A cap rate is simply the net income for the property divided by the total cost of the property. Now, is cap rate a magical number? No, it's not a magical number, it's really just that fraction. That's all it is. It's just net income above price paid, you divide the net income by the price you pay, and that gives you the cap rate. Now, the problem is that cap rates are a very powerful force. If you buy a property on Monday at a five cap and sell it on Friday at a six cap, well, you just lost a whole lot of money.

So even though the cap rates sound all kinds of benign and friendly, they're really not, they can be absolutely vicious. They can ruin your investment. And the problem is that you hear brokers out there and people who do these reports suggesting lower cap rates than the norm. Some of them will say, "Ah, nationwide, the cap rate is 5%," while the real cap rate, if you read through those reports of many of the better reports, they're saying the real cap rate is 6.5%. Well, that's a huge swing in the reports from 5 to 6.5. But here's the problem, there is nobody buy-in storage facilities at 6.5 except in those big cities like San Francisco, et cetera.

Now, why is that? Because people who invest, they like to make money. To make money you have to have a spread between the cap rate and the interest rate on the loan, interest rates on the loan right now for self-storage facility, which cannot get Fannie Mae or Freddie Mac financing, because those only apply to residential. They're stuck in the world of bank and conduit, and you're not going to be getting enough spread on the bank and the conduit loan to cover the payment at a really low cap rate. Now, the interest rate on the loan will predicate the cap rate you can buy on, but again, do not listen to people trying to tell you that 5% is the norm. I wouldn't even believe 6%. If you're buying the kind of storage you should be buying in a suburban or exurban market, the old original Mom and Pop, or you're buying from Mom and Pop. You need to be demanding a higher cap rate and a lower price because you're in the money making business, and you cannot apply those kind of lower cap rates. Certainly, the things that are suburban and exurban.

Sure, you might find that one idiot out there that would buy a self-storage facility in San Francisco at a five cap or maybe even lower, maybe a four cap. Will they ever make any money with it? No. It's probably just some large company trying to make it using just the fees, but the issue is you making money investing in self-storage, and if that's the case, you've got to get a higher cap rate. Once again, what's happened is, is reports focused on the easiest information to obtain. They love sending surveys to large companies in big cities who happily put in numbers which are always erroneous, lower than what they pay to try to make themselves feel good about how good they're doing. And then of course, those groups try and publish numbers that are even lower, trying to convince buyers that the stupid price that the owner is asking is actually quite reasonable when everyone knows that it's not. The bottom line to it all is just use common sense. You can go online, you can read these reports, but take them with a grain of salt. Remember, there are motives to people who write such reports, so they're just not trying to just tell you the truth that isn't normally the goal. They're trying to get other actions on your behalf, and often those are not in the best interest of you as the buyer.

This is Frank Rolfe, for the Self-Storage University Podcast. I hope you enjoyed this. Talk to you again soon.