There are two types of self-storage investors: 1) those that got into the industry early and rest on those laurels and 2) those that are making it happen in 2020. However, the storage industry loves to only embrace the narratives of the first group, and rarely talks about those entering the industry today and the issues that are important to them. And to succeed today you pretty much have to shun the first group and rely more on those who are real-time buying and operating under the new realities the industry faces. In this episode we’re going to talk about why there are two entirely different views of the industry, why one is more important than the other, and a call to action on the megatrends and issues of those who are trying to make money investing in storage facilities today.
Episode 9: Nobody Ever Made Money Hanging Out With Rich People Transcript
Back when I first got into business, someone said something to me I never forgot. They said, "Nobody ever got rich hanging out with rich people." Now, what did that mean? What I thought it meant was that when you hang out with people who've already made it, often they're out of touch with the modern reality. You ever noticed, you've got people hanging out, maybe at a country club who are seemingly doing really well with whatever they used to do, but now they're retired and the problem is their frame of reference, their moment in time that they were successful is long ago and today is not very applicable. Now I find in self storage, there's basically two types of people. You have the people from the prior era from let's say the 1970s and in the 1970s, it didn't take much to be successful because we all know the story.
Self storage began back in the sixties, seventies, people built those single story complexes. All they'd had to have was a metal building with roll up doors and a fence with some barbed wire on the top and they were in business. And then just minding their own business. Up came some of the large consolidators, most notably Public Storage and suddenly this thing they built for not a whole lot of money becomes hugely valuable as these large buyers are buying things at insanely low cap rates. On top of that, rents went up significantly during that period from the seventies on. Basically any idiot could succeed during the 1970s. All you had to do was buy a piece or build a piece of the storage industry, hold it for a brief while and then sell it to a consolidator. Kind of like people who bought stock in Microsoft back in the day for a dollar a share.
But the problem is that doesn't work today. Today, the playing field is a 1,000% harder. Today what you find in those same spots where those folks made money in the seventies, you find lower cap rates. In fact, you often find cap rate compression. That's when the cap rates because of supply and demand get so low, it's kind of hard to make sense of them. You also find too much supply because there's been so much overdevelopment in so many markets. You also can have financing issues particularly right now, post COVID, because a lot of your conduit lenders, which is one level above bank, they're not making loans like they were and of course because it's storage, you can't tap into Fannie Mae or Freddie Mac. They only do residential lending. Also, thanks to COVID-19, urban unrest, you also have declining occupancy and rents in urban markets.
The same spots that those folks back in the seventies were doing well, well, they just don't work anymore. Now they may have worked well in the seventies, maybe worked in the eighties, maybe in the nineties. I don't know. But clearly today, if you followed their same path, if you said, "Well, I want to be just like that guy at the country club driving that giant Rolls Royce. He was a storage guy. I want to do that." Well, you might be sadly disappointed. In fact, his advice really wouldn't be very timely. He'd probably say, "Well, just pick any old piece of land and build yourself a storage facility and sell to Public Storage." Well, it doesn't work that way anymore, that time has passed. Every industry has its own cycle and the cycle has changed, so then what does work today?
Well, certainly not the path of those 1970's folks. First thing you need to know is you probably are not going to want to be in those densely urban areas. It's very obvious why you don't. Zillow calls this the great reshuffling, basically people are sick and tired of COVID and urban rioting and urban unrest and they're all saying, "You know what? I'm not going to live in the city anymore. I now work from home because of self quarantine, I've learned I can do my job without ever leaving my house so I don't have to commute to downtown. And on top of that, all the things I liked about downtown, the restaurants, the shops, the museums, the arts, they're all closed down. Can't deal with COVID and what the heck? This is my favorite street to go eat on and look, someone's broken all the windows out. It's all boarded over."
Instead, what are they doing? People are leaving by the bushel basket and moving out to the suburbs and the exurbs. Number one, today, if you want to be in the sweet spot for investment in self storage, you're going to want to focus on suburbs and exurbs, not where all those old guys probably made their fortune in those deep downtown areas. That's not where things are going to be. Look at just some of the stats.
In Chicago, they estimate now that roughly 12% of everyone in downtown Chicago has left. They've left the building, moved off. Maybe they're out in the suburbs. Maybe they're in the exurbs. Maybe they moved away completely because maybe they realize with their job, it doesn't matter where they live. They can live anywhere they want. But clearly you can't make money, you cannot succeed when your demand is diminishing greatly. And on top of that, don't forget, there was huge over building before any of this began, even if we hadn't had COVID, many people so overbuilt these markets, it was going to slump anyway. COVID just basically spurred it on quicker than it would have with natural forces. You want to focus on suburbs and exurbs.
Number two, you want to buy direct from mom and pop because what's happened is in the brokerage community, they're always focusing on the deals that are the highest price points. They're going to want to try and sell you giant storage facilities and all the better. They're going to try and promote you into urban stuff. Why? Because those big urban things are going to be going on the market at a reduced costs because you're trying to get them out the door before they get foreclosed on. That's not what you want to be buying. You want to be buying stuff that's in fresh areas that really haven't been picked over that much.
How do you do that? Well, you do that by building a deal funnel made up of storage locations that interest you in the suburbs and the exurbs, getting their addresses, looking at the tax assessor's records, finding the owner and sending them a letter or a postcard or calling them and just asking if they would have an interest in selling. The old system that the old guys did, going to the brokers is all fine and dandy but at this moment in history, I'm not sure that'll work. Now there are some brokers who already have realized the new reality and are now aggressively working in suburbs and exurb storage facilities. But you know what the problem is, they're not nearly as expensive as those multistory downtown ones. If you're a broker, you don't really want to do that, you want to sell the most expensive thing you can get. Many will cling to that old stuff. The stuff that nobody really wants anymore, the stuff that is never going to make money again, probably ever. And you need a fresh path so try and buy direct from moms and pops.
Also, see if you can get seller financing. We're going to go into some period of lender reconsolidation. All these things that have closed because of COVID, it's going to have an impact. It has to have an impact. There's going to at some point be banks out there who take a big hit from all these various things closing. And then on top of that, whenever you have any kind of unrest in the financial markets, your CMBS lenders, who do the majority of loans in the storage category, they pull in their horns. They retreat into their shell, into their bunker. They decide not to make loans in a big way for a while. As a result, if you're trying to buy a self storage facility today in a suburb, in an exurb, directly from mom and pop, try and see if you can get seller financing.
Now, why would they give it to you? Well, they'll give it to you because you'll pay four or 5% interest and over at the bank in the CD, they only get 1%. They're making four or five times more money carrying the paper than they will with their alternative investments so push for that. Make two offers, make a cash offer if you can and also make a terms offer and make that terms offer higher. If they take the terms offer, which includes seller financing, they'll get more money twice, more on the price and also more on the interest.
Also, make sure that you demand to make money when you buy that storage facility. This is not a time in history when you should be trying to buy things at insanely skinny cap rates because we don't know what tomorrow holds and you need to make money. That needs to be part of your real estate investing plan is you need to ask to make a decent profit. That means you want to buy a healthy cap rate and you also want to have a smaller interest rate. You would never want to buy a property at a four cap with a 5% debt on it. That makes no sense, but you should want to buy a property with a 5% interest, maybe at an eight cap or even a seven cap because that spread above the debt gives you much higher cash on cash return. But it's up to you to demand. You have to stand up for your own rights. Don't buy things at ridiculous prices, buy them at sensible prices so that you can actually can make money.
And be sure to be a deal maker and not a deal killer. Anyone can be a deal killer, it's the easiest thing in the world. Every deal you look at say, "Nah, this one doesn't work. Nah, this one doesn't work." You're always perpetually trying to find the flaw that kills the deal. There's no money in that. Never has been. Now in a market like in the seventies where you could buy these things for dime a dozen, yeah, even if you were a deal killer, it was sometimes hard to find a way to turn it down. Sometimes you just had to buy it because you couldn't say no. Today, you want to be a deal maker. You want to look at all the pieces of the deal and say to yourself, "What would I have to do to make this work?" See if there's some kind of happy medium, something you can do either through the financing or through some other method, raising rents, increasing occupancy, whatever the case may be, to make the numbers tie.
Let the old guys hang out at the country clubs and they can talk all they want, but don't let them give you advice because the sad truth is what worked in the seventies doesn't work a half a century later. This is Frank Rolfe with the Self Storage University podcast. Hope you enjoyed this. Talk to you again soon.