Every self-storage facility you put under contract does not end in a successful purchase. Many times the deal will die quickly with cursory inspection, and others make it all the way to the finish line before they get cancelled. In this Self-Storage University podcast we’re going to discuss hidden deal killers, visible deal killers and suspenseful killers that sometimes pop up right at the end. It’s important that you understand these issues and embrace their meaning as opposed to buying a deal that will not work.
Episode 10: Hidden, Visible And Suspenseful Deal Killers Transcript
Deal killers. What negative words those sound. However, it's very, very important that you as a storage buyer understand the things that can ruin the performance of your self storage facility, guard against them and make sure you don't fall into that trap. This is Frank Rolfe, the Self Storage University Podcast. We're going to be talking about three different types of deal killers, ones that are quick to grasp, some that are hidden as some that are just filled with suspense because they don't pop up till the very end. Let's start off with the ones that you can typically tell right at the beginning.
Number one, a weak market. What is a weak market? A weak market means the market just will not support healthy self storage investing. Too much supply, too much vacancy, low rates, low demand, population declining, everything negative. Where do you see those right now the worst? Of course, urban markets. Lots of urban markets right now, heavily overbuilt. A lot of demand leaving the building, moving out to the suburbs and exurb. So if you're looking at a weak market, that's a deal killer. Often you don't know it day one, but you'll find out very, very early in your diligence it's not somewhere you want to invest.
Number two, the location. You can't always tell about the location from a flyer, from just a listing. Brokers are very good at taking photographs of any storage facility, making it look better than it actually is. However you may find when you see it yourself in person, the location is very, very bad. Has no visibility, very hard to get to, hidden behind everything, never going to work out. So those are two that you can grasp pretty rapidly on the front end, and then you just terminate your contract. Now what about hidden deal killers? These are things you can't see at the beginning, but are just kind of lurking around out there.
One is a phase one environmental failure. Now what is a phase one environmental report? This is something that you'd basically have to do. If you don't get a phase one environmental report, you could lose not only your investment, but many times that. Because if you buy a property that is tainted with pollution, you may be required by the government to clean it up no matter what the cost and no matter the fact that you didn't cause it. How do you get a phase one? You hire a phase one environmental engineer. They do a study of your property using aerial photos, photographs of the property today, looking at past uses, looking at radiuses of other environmental pollution to see if there might be something leaching onto your property.
Then they give you a report that says it's either clean or it's environmentally dirty. If it's clean, you're fine. But if it's dirty, you have to do a phase two and a phase three. Phase two to determine how bad it really is and phase three is your plan to fix it. Most people drop out if the phase one comes in bad. It's too expensive to clean up pollution. It can often be in the millions of dollars. The other one, title or survey problems. You can't possibly guess at the front end whether that property has a clear title and whether or not it has a clean survey, but we've had deals die because of both. This is something where you'll just have to rely on the fact that most properties are correct, but there are those few bad apples out there that people have actually been buying, selling, and sometimes financing despite the fact they're all screwed up on the title in the survey.
Some of these issues can be resolved, but others cannot. We once bought a property that had a piece of a road missing. We didn't know it, but the person who built the property had not gotten all the correct easements for the driveway into the property and they were missing a four by four section right in the middle of the road. We had to go out and buy that from the neighbor. So that was able to be solved. But if the neighbor hadn't sold it, you wouldn't even have a successful entrance and you'd have to drop it. Now let's move on to some of the things that are suspenseful. These are your Alfred Hitchcock endings to your self storage purchase.
First one we'll talk about is price too high. Yes, that would be obvious to anyone, but you don't often know the price and whether it's too high or not until you get near the end of the movie. What you've been doing is you've been getting all the information, all the feedback on how all the other facilities are doing, how full they are, what the rents are, and then and only then can you figure out what you can think your revenue can truly be. Same on the expenses. You start going through the historical costs. You get the actual power bills, tax bills, all these various items, and then suddenly you're going to find one of two things. Either things look better than you thought when you tied it up or things look worse than when you tied it up.
If they look better, that's great. If they look worse, you have a problem. Now you're paying too much. So what do you do? You go back to the person you're buying the storage facility from and say, "Hey, here are the actual numbers. This does not support the income that you told me. And now I've got a real problem here. We'll have to drop the price by X or I'll have to cancel the deal." Sometimes they do it. Sometimes they don't. And if they don't, then obviously you're out. Another reflection, a corollary of this, can also be if their financial statements they give you as you're doing your diligence do not support what they've told you. If they tell you there's a net income on the facility of 80,000 a year, but then you get their tax returns and their statement is showing only 50,000 a year, that's right, there's a problem.
It may also cause you to not be able to get financing. And that of course is the next of the suspenseful endings. Often we think we can get a loan in almost anything but some property they just can't. It can be an issue with timing and the financial markets, but it can also be the property just is not bankable. And let's discuss for a minute why a storage facility would be bankable or not. Now bankers have an unusual position in life. They take huge amounts of risk loaning you money, but they don't share in the upside. Many great real estate investors have always talked about the whole idea of risk versus reward. If you have high risks, you have to have high reward. But the poor old bank doesn't get high reward, but it does take high risk.
When you put your money down on that property and they do a 70 or 80% loan to value loan, what they're betting on is if you default on the loan, they can then sell it and get their money back by taking a 20 or 30% discount. But if they feel there's greater risk than that, then they're not going to do the deal. Remember that banks only get that tiny fractional amount of interest 3, 4, 5%. But if you go belly up, you're going to wipe out all the profits not only from that deal, but from a bunch of others. Remember the old saying before you can have return on principle, you have to have return of principle. That's what the bank is most concerned about. There are some deals out there, because of the market, because of the general construction of the deal, they just don't want to do it. It doesn't happen all the time, but I have seen deals die because they just couldn't get a loan.
Now there is a fallback on that. If you still think everything is looking good, you can still get around that by sometimes having seller financing. However, don't get into the seller financing trap. If you're doing seller financing because you can't get bank financing because banks don't want to do it, that's a problem. Good seller financing is predicated on the fact that you could get bank financing, but the seller financing is much more attractive and less stressful because the seller themselves grant it. You don't have to go through any loan committee or any issues like that. But if you do it as a hail Mary pass in the end zone because no bank will give you a loan, the question should be, why will the bank not give you the loan? That is a very important issue to understand.
Now the final suspenseful lending is what we call bad gut feeling. Bad instinct. What happens is when you buy a property, you should always feel excited about it even at the end. The very moment of closing, you should be thinking, "What a great asset to add to my portfolio." And if you don't think that, if you feel queasy and uneasy about making that purchase, that's your brain sending you a message that says don't do it. We've all heard of the expression it's a fight or flight. Well, your brain is pretty good at processing danger, processing risk. And if your brain is saying, "Don't do this," you need to listen to your brain.
My partner Dave and I have always found in life that anytime we violated that basic rule of not following our basic gut feeling, we've always been very unhappy about it. It's never worked out well. And that's because your brain is built up with millions and millions of bits of information, and it's trying to keep you out of trouble at all times. Your brain is very loyal to you. Your brain wants you to succeed. It has no ulterior motives whatsoever. And as you built that deal, through all of that diligence and other issues you did. If it does not register in your brain as being a good transaction, then you need to listen to it.
Doesn't mean you have to drop the deal, but you need to hit the brakes. You need to find out what is it that's bothering me so much. It might've just been a headline that happened a few days before closing of a major employer shutting down. It might be that you notice survey stakes at the property across the street and your concern is a new storage facility going in across the street. But whatever it is that's spooking you, don't move forward until you've cleared that obstacle. You should never buy a property with bad gut feeling. This is Frank Rolfe from the Self Storage University Podcast talking about deal killers. Talk to you again soon.