When you buy your second and successive self-storage facilities, you are faced with a tough choice of synergy vs. diversity – namely, to congregate all your holdings in one basic market or to spread that risk over more than one market. In this Self-Storage University podcast, we’re going to explore these two opposing forces and how to make the correct decision based on your goals.
Episode 55: Synergy Vs. Diversity In Portfolio Building Transcript
Synergy versus diversity. Any self storage owner faces this difficult decision when they go to buy their second property. This is Frank Rolfe, with The Self Storage University Podcast, we're gonna be talking about the role of synergy versus diversity in building your portfolio. And let's first start off with Synergy. Now, what does synergy mean when buying that second, third, fourth, fifth, however many storage facilities you buy? What is it? Well, synergy is when you buy them all near each other, the basic concept is, by having them clustered together, it makes lots of things better. And what does it make better? You might say, if you buy them all in the same general location, well, number one, easier management, it's not uncommon for a clustering of Self Storage facilities to be managed by just one manager, or if there's several of them, that all have individual managers still, having one person who then oversees those managers. So that's the first key advantage of to synergy is management, and the ease of management. The second is it makes it easier to analyze the market, right? And so if you only have to do a deep analysis of the market one time, that's a whole lot easier than doing a separate analysis on a whole bunch of different markets. So many people feel they can become, over time, have a mastery of that market, and therefore they save themselves the difficulty in analyzing several different locations.
Also, you have cost savings, potentially, because if you share that manager over several properties, that will give you a lower cost per property, and it may not just be the manager, it might be a maintenance person. Heck, you might even have joint agreements to mow. All kinds of things can be done when you have several properties close to each other, so cost savings would be another synergy decision, and then you can also possibly get a better quality manager because if you share a manager between several facilities, you can obviously... Probably pay more, because each facility can kick in a little money and you can probably pay one manager who manages several properties more, obviously, than you could if they were just managing one property. It's also sometimes easier for lending, because you can often just use one bank and if we're gonna go ahead and have several storage facilities near each other, in one general market, well, that same bank probably will make a loan in each of those same areas. Why would they not? Why would they make one loan, but not more than one.
And also when you go to sell at the end, you may get a higher price because instead of selling X number of units, you're gonna sell, 2X, or 3X, or 4X. And there are buyers out there who will pay more to have that kind of synergy. So there's all kinds of reasons that synergy sounds good, but there's one huge bad item, and that is, synergy leads to a lack of portfolio diversity. Now, what does diversity mean? Diversity means basically spreading risk. A mutual fund, for example, the reason that people buy a mutual fund as opposed to one stock of the stock market, is you get a whole bag of stocks, some stocks go up, some stocks go down, some don't move at all, but in general, it gives you a little better risk adjustment, because if that one stock were to plummet and you owned only the one stock, you'd be in much greater damage than if you had a bag of 100 stocks or 200 stocks and one stock went down, that might only impact your investment by half a percent or a percent, even if the stock was completely wiped out. Now there's some other good things about diversity, obviously, because not only are you reducing your risk due to market forces, because none of us really know in today's crazy America, what's gonna happen in many of these cities, and states, regarding employment, so you may have entire industries taken down, we've seen industries taken down in recent times, strictly during COVID.
So there's every reason to believe that, over time, even markets we think are very, very strong, because of one certain employer might still over time go down the drain, and the other is, weather events, as we all know, the weather keeps getting more severe in America, constantly, more hurricanes, bigger hurricanes, more flooding, bigger floods, more fires, bigger fires, so what can happen is, if you have everything in one defined market and you had some kind of horrible, horrible weather event, it could potentially take out all of your holdings. Whereas if you were diversified, it wouldn't. If you had a giant hurricane, and it took out one of your storage facilities or did damage to it, if you had nothing else in that general vicinity, then more than likely, you would not have any additional problems because you would only have weather in that one spot. So when we talk about synergy versus diversity, what are we really talking about? We're really talking about risk. So the key question is how risk-averse are you? If you're extremely risk-averse, if you say I hate risk in all forms and fashions, I want nothing to do with risk. Well, then clearly you wouldn't want a diverse portfolio, because by having self storage facilities spread over a number of markets, and areas, you are going to protect yourself from all kinds of occurrences.
However, if you say, "No, no, I am very risk-tolerant," then perhaps it will work for you, having a more synergistic portfolio, because you're gonna have to accept on the front end that there are problems, but there are additionally good things about having everything clustered together. Now there's one other item that you have to talk about when you talk about synergy versus diversity, that's just simply, how sold are you on that market? Because you're banking a lot on that one specific spot. Now, not all of America is built the same economically, there are some cities, some markets that are much more attuned with the modern America than the old, there's some industries right now that are seemingly dying while other ones are being born. You saw that happen in a big way during the whole rise of the internet and technology, areas of America, before, were thought to be very rock solid, suddenly lost a lot of their employment and other areas that had never even seen the industry before, such as the rise of the internet in Northern California, for example, suddenly became hugely powerful as that industry rose. So if you're gonna be a synergistic buyer, one key question to may would be, how sold are you on that spot? And if it's a market you don't feel that secure with, you're not that excited about, then why would you wanna synergistically build a portfolio around a market that is not that strong to you.
However, if you feel this market has a great future, and a great current, both near-term and long-term, if you feel that this is actually an opportunity for you, to get in on the ground floor of a market that you feel very confident with will grow and even be better over time? Well, then that may mean that synergism would work for you because you believe that strong. Remember that when you're in the Self Storage industry, you're still in the real estate industry, and that means location, location, location, you cannot get away from that, so as long as your location is terrific, you should do well, because a storage facility's demand and its rents will be a function of how strong that area is, but if you're in a market that grows weaker over time, even though you may be the best storage manager or operator in the history of the world, you'll probably still not do well because you'll be battling the simple fact that your market is declining on a regular paces, and that's gonna cause you a lot of problems, it really isn't fair because you want your future in storage to be judged based on your performance and not that of your market. So again, synergy and diversity, they're both very important items, they have very big considerations, there's good things and there's bad things, but the key is you've gotta pick out what is right for you, no one can make that decision other than you.
If you think about it, really, with your future at stake, as an investor, it's absolutely important that when you do make that decision, that you make it with full forethought on what you were achieving by picking one over the other, and have a plan and strategy as to why you accepted or did not accept that risk and acknowledging to yourself that you're making this path forward because that's what's best for you. This is Frank Rolfe, The Self Storage University Podcast. Hope you enjoyed this. Talk to you again soon.