When it comes to financing, an appraisal can be an aid or a death sentence. And with interest rates nearly double from their all-time lows, the modern storage facility appraised value can be a shocker. In this Self-Storage University podcast we're going to review how appraisals work, why they're often bad news, and what you can do to push back in a limited way.
Episode 156: Everything You Need To Know About Appraisals Transcript
By definition, an appraisal is an expert estimate of the value of something. And with a loan on a self-storage facility, that expert valuation can mean life or death based on you getting the loan. This is Frank Rolfe with the Self Storage University podcast. We're gonna talk about appraisals and the impact of appraisals right now in the self-storage industry, where things are going, what you gotta do to protect yourself. Now, on any typical appraisals, there's three methods of deriving value. Number one, replacement cost. In other words, what would it cost for you to buy that piece of land and build that self-storage facility again today? That's method number one. Method number two is comparable sales. What did that self-storage facility that's about the same size in the same town sell for just down the street? And then finally, the income approach. How much money is the self-storage facility making and applying what we perceive to be as the appraiser the appropriate cap rate that will tell us the value. And then we take all three of those together, put them in a blender, and then the appraiser magically tells you what he thinks the value is.
And in many cases right now in the self-storage industry, when they get it out of the blender and tell you what the average is of that valuation, it's a shockingly low number because so much of the self-storage industry was purchased during that long, long run we had of low rates all the way back to about 2010. We had, in fact, a horrendously long run of low rates. They didn't start raising interest rates until Q1 of 2022. But that means that any self-storage facility bought from about 2010 to 2022 is subject to having a big problem when that loan comes due. Because when you've already got the loan on the thing and you already paid that price based on low interest rates and low cap rates, and now suddenly it's coming due to get a new loan and they're gonna, for the first time ever, go out and figure out the new value, often that value can be terrifyingly low.
Cap rates of self-storage facilities used to be all the way down in the 4 or 5 percentage point range back in the day prior to Q1 of '22. But today a lot of those same self-storages are coming in at cap rates that are 8, 9, 10, double of where they were before, and that means the values have halved. On top of that, you have a lot of self-storage which has not performed, particularly in the world of climate control and a lot of those urban markets. People just don't really want that stuff, probably never really did. They like to be able to just back up their car to their storage facility, roll up the door, and throw it in. But the problem is that people got greedy and thought, well, we could build these multi-story storage facilities in some of these urban markets because gosh darn it, it's the only way we can make the numbers tie, without ever thinking about the customer. And now it's maybe payback time and the customers are saying, "You know what? I don't really need that self-storage. It's too hard to park, get the two-wheeler, carry my stuff all the way up, get in the elevator and do it. So I'm just gonna drop the stupid thing."
That's right, you're seeing a lot of reducing occupancy and reducing rents throughout America when it comes to self-storage. And all of those things are gonna come back when you get that appraisal. So what happens with appraisals and self-storage if the number doesn't come in at what you wanted? Well, if you've got a loan that's coming due and that appraisal comes in lower than what you paid and lower than the perception of what the last loan was based on, they're gonna have what's called a capital call. They're gonna say, "Oh well, I'm sorry. That storage facility is worth a lot less than it was last time we looked at this. So here's the deal. We require 30% down and right now to get to 30% down you gotta kick in another 100 grand or 200 grand or 500 grand." If you don't have the money, what happens? Well, you go into what's called term default because you've been making your payments but you can't get a replacement loan. It's pretty serious stuff and you're seeing it throughout the storage industry right now. People don't talk a lot about it, but it scares everyone to the core because. Because a lot of those deals out there which looked intelligent back in the day, maybe today people don't have any clue what they're gonna do about it.
Now, what if the bank gets the appraisal and you don't like it? What if the banker comes back and says, "Oh yeah, this property is worth X," and X isn't the number you were seeking? What can you do? Well, remember the bank gets to choose the appraiser, so you're active not in a big way as to what those valuations are. But you do have the ability to push back. If the value seems low, you can tell the bank, "Well, that value seems low because of this factor or that factor." Sometimes the bank will listen to you. Sometimes the bank will even agree to get a different appraiser. But many times the bank is gonna say, "I'm sorry, I'd do the same thing if I were you, but we'll just all have to accept this property isn't worth what you paid for it." And that means the bank can't make another loan like that. Then you're in real, real trouble.
So what happens? Well, you've gotta cough up the capital, maybe see if you could get the bank to hold it in abeyance while you maybe try and go out and sell it, possibly, but you'll still maybe have a loss over what you paid. But the big thing you need to do right now is try and buy time. Many people in the industry thought the rates would start coming down. I thought so too. What do we see on the Fed side? Well, we saw Jerome Powell leaving the building in May. Trump picked Kevin Warsh, the new head of the Fed, solely because he thought he had the desire to lower rates. It looks like he was wrong. Warsh has already raised the rates up a quarter and is pondering, supposedly behind closed doors, to raise them again by a quarter point before the end of the year. More importantly, the 10-year Treasury has gone completely the wrong direction. The 10-year Treasury not that long ago had declined down to about 4.5 and now it's back to being over 5.
So the storage industry just is getting absolutely no break right now in interest rates, and it probably won't get any break until we have our big recession. In America, we've had a recession every decade since the beginning of time, but it all stopped after the Great Recession in 2008. Should've had a recession in 2018, didn't get one. It's eight years beyond that, we still haven't had one yet. My personal opinion is we'll have one next year after the midterm elections. But even then, when you have the recession, it takes a while for the interest rates to decline. It takes a while to acknowledge a recession. You have to have two consecutive quarters of negative GDP for them to say it is a recession, even think about lowering the rates. And what that tells you is you're not talking best case. If you actually had a recession starting in January, it won't be reported until sometime in July. Then the rates would start coming down, but it still takes a long time. But you've gotta buy more time.
Now, that's where extend and pretend comes in. That's a banking rule where they let you take your loan and extend it for a longer period and then pretend it will all work out okay. A lot of lenders have stopped doing extend and pretend because they're afraid that there's no hope, that the rates will never come down, the values will never go back up. But you have to give it a shot. That's, in fact, the big shot. That's your Hail Mary pass, is to don't get an appraisal, don't get a valuation right now. See if you can't convince the bank to give you more time before you figure it out. If you can buy yourself more time and the rates go down and the values go back up, you may just pull it off. I saw it happen myself back during the savings and loan crisis way back in the day. Back in the late 1980s in Texas, you saw a complete crash of real estate. Every office building in downtown Dallas, downtown San Antonio, downtown Houston, they all went bankrupt simultaneously. They all were listed for foreclosure. And the only people who survived were the ones who convinced the bank, "Let's not sell right now at the all-time low. Let's extend and pretend the loan long enough to give me time for those values to come back up." Those who could pull it off, well, they were the winners. Those who had to go into the new appraisals, well, they were the losers. But if you can get that thing extended, that is the key.
And if you're looking to buy a self-storage facility today, it's absolutely essential that you break the chains of what people used to buy in the past. Forget whatever you saw in some book by some schmuck on how to make money in self-storage, 'cause I guarantee you that guy's probably in default on his own stuff by now. Storage today that I have seen that actually works are in suburban and exurban markets out of town. Forget the urban core. Urban core is shot at this point. You gotta go out where people are moving, where people actually have disposable income, where people have things to store. Most Americans who can afford it have left the big city and pushed out into the suburbs and the exurbs. The exurbs are the string of basically suburban towns that are a little farther out than the suburbs. But that's where you wanna be, where you can do the old-fashioned non-climate-controlled roll up the door and throw the stuff out of your car in it kind of storage. Places where you can buy things from the old original moms-and-pops at reasonable prices, or build them where you can buy the land inexpensively and the contractors too. But you gotta watch out 'cause there's a major reset going on right now in the self-storage arena. A brutal reset, a scary reset. People don't like talking about it because from a self-storage perspective, that marketing is dangerous, right? If you tell everyone, "Oh, storage is all messed up," it's gonna hurt the stocks of the REITs, it's gonna panic people. But it's the truth, and you've gotta prepare for that. This is Frank Rolfe with the Self-Storage University podcast. Hope you enjoyed this. Talk to you again soon.