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 going to tell you has its own selfish motives. This is Frank Rolfe, 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 say. 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 into two areas that both disturbed 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, it's more the market should bear it helps make that possible. So when I read a report that comes from a self storage brokerage house, I merely 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 exactly 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, the accuracy starts to falter. Because they're not going to tell things as they really are. They instead are going to tell things in a manner that makes you feel like you're doing a good job, it 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 is 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
going to 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 managee 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 in 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 fact of the matter is, you typically cannot why is that? Well, there's constant turnover and self storage. So you might hit 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 9%. So, if the if the industry is at 9% vacancy on their own nationwide average. So they claim that when you run your numbers on buying a self storage facility, make sure you put in plenty of vacancy, but then 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 will 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 farm, 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, Ah, yes, 100% is totally a given here, if you just gave it a little better marketing and horsepower. 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, just CAP rate, a magical number. No, it's not a magical number is really just that fraction. That's all it is, is 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 a 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 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 the of many of the better reports. They're saying the real CAP rate is six and a half percent. Well, that's a huge swing in the reports from five to six and a half. But here's the problem. There is nobody buying storage facilities at six and a half, except in those big cities like San Francisco, etc. 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 applied 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 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 kinds of stories 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 kinds 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 at 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 focus on the easiest information to obtain. They love setting surveys to large companies in big cities, who happily put in numbers which are always erroneous, lower than what they paid to try and 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 at 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 and is not trying to just tell you the truth that isn't normally the goal, to try 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, the Self Storage University Podcast. Hope you enjoyed this. Talk to you again soon.