Self Storage University Podcast: Episode 17

The Simple Way To Make The Final Decision On Buying A Storage Property

Buying a self-storage property can be a stressful undertaking – particularly when it comes to the final moment when you have to pull the trigger and close on it or throw it back. But we have developed a good way to get over this fear using a simple system we call Best/Worst/Real. In this episode we reveal this system and why it is so effective in giving you peace of mind that you’ve made the right decision.

Episode 17: The Simple Way To Make The Final Decision On Buying A Storage Property Transcript

Buying a self storage facility can be very, very stressful. The final decision whether to pull the trigger can fill you with anxiety. You want to make sure you're making a smart decision. You're wanting to make sure you're investing your money in the right way, that you've made the correct selection, that you're not going to later regret it and wish you'd done a different path. This is Frank Rolfe with the Self Storage University podcast. We're going to be talking about how to get over that anxiety, how to make the right decision before you pull the trigger and buy a self storage facility. Now, we've developed over the last decades our own theory that we believe to be very valuable in making those tough decisions. It boils down to isolating three factors: the best case scenario, the worst case scenario, and the realistic case scenario. Let's go over how this works exactly.

Let's start with the best case scenario. You're going to buy that self storage facility, but you need to figure out, in one case example, how much can it really make, the best it can possibly do? What is its maximum potential? Think of it like trying to craft some kind of race car engine. Think of the Ford versus Ferrari movie. You're trying to figure out what the maximum horsepower this engine can make, because you know how much horsepower it will need to win the race. What can it do?

What is the maximum amount of net income the storage facility can provide? If you tell yourself, "Well, okay, I think if I do all the right things," again, this is the best case scenario, "I achieve 100% occupancy. I push the rents. I cut all of the costs. The maximum it will make is X," and then apply a cap rate to that. Say, "All right, well, what would the best case cap rate be?" Let's see, in America today, gosh, I have it perfect. It's running beautifully. Maybe I could get, what, 7% cap rate on that, maybe. You apply your cap rate. You've now derived one figure. That is the maximum horsepower economically that that storage facility can provide.

Now, let's move on to the next. The next one is, what is the worst case scenario? Just as we did the best case, now we're looking at what's the worst thing that can happen. You're buying it at 80% occupancy. You're hoping to drive it to 100%. Well, that's your best case scenario. But, let's assume instead it goes backwards. How far backwards can you see it going? Could you see going down to 70%? You don't want to use zero. You can't and go that extreme. If we all used zero, it would be like every day when we'd pull our car out of the driveway, assuming that the car will have a horrific head-on collision and we will all be killed, then you'll be too afraid to ever drive your car anywhere. You can't do the true worst case. The true worst case would be that every single person cancels their lease day one.

Let's be a little more reasonable, yet let's be really negative. Let's put our most pessimistic hat on. Let's say you say, "Well, okay, 70% occupancy, I guess we could drop like that." You had planned on raising the rents, but let's assume you can't. Then you had some great ideas to cut the costs, let's assume none of those pan out. What you're doing is you're buying the property, and we're going to take the actual net income, rather than groom it higher, we're going to assume it to be lower. Now the question is going to be, can you survive that? If that was to occur, what would happen? Can you cover that mortgage payment, or will you flow negative every month? If you do flow negative every month, do you have the cash flow from other investments or your day job to cover that? Can you still make that happen? That's your worst case scenario. The worst case scenario is basically all about survivability.

Now we move on to the realistic case scenario. In the realistic case scenario, we're neither going to be the ultimate in bad, nor are we going with the ultimate in good. We're somewhere in between. The realistic case in this example might be you say, "Well, I don't think I'll go down and occupancy, but what if I don't get to it 100%? Well, let's see where I would be if I would be at, oh, 90% or 85%. Then, let's assume I don't get my rents to as high level as I had hoped, but I do get them up a little. Then, on the cost cutting side, well, I think I can get some of that cut, but I'll go ahead and leave a little in there for fluff. That's your realistic case scenario. The question now is, are you happy with that? Is that good work for you? Is that enough cash flow to make you feel good about what you did?

Now, let's tie them all together and see how we make the final decision. In the worst case scenario, it has to be survivable. You do not want to get involved in something that you cannot survive in the worst case. That's just not really a very good idea. If you say to yourself, "Well, the worst that I can possibly perform with this storage facility, I'll make it. I can cover that negative," or maybe there's no negative at all because you bought it really cheap. That's question one. Can you survive worst case?

Question two, is the best case worth the risk of the worst case? There's a real estate investor named Sam Zell. You may or may not have heard of him. He's famous, but most people don't know his name. If you imagine in sports, LeBron James in the basketball season, who then changes his uniform and puts on a football jersey and is number one in football, and then he puts on a baseball uniform, he's number one in baseball. He's number one in all three sports, that's Sam Zell. He's been number one in three sectors of real estate: apartments, mobile home parks, and office buildings. He really knows what he's doing, and he's done it for a long time. Sam Zell has been in real estate for about a half a century.

If you read his book, and his book is called Am I Being Too Subtle, it reviews his fundamental principles on real estate investing. One of the biggest being the concept of risk versus reward. Everything Zell does, he has to decide, he has to feel compelled to do it because the reward far outweighs the risk. In the same vein with that storage facility, when you run your worst case scenario and you compare it to the best case scenario, is it worth the potential pain and suffering of the worst case against the best case? If you say, "Well, no, the best case really doesn't excite me very much," well, that deal's not going to work. The best case has to be so exciting to you that it makes you want to take the risk of the worst case.

Again, worst case scenario must be survivable. Best case scenario must be hugely compelling, or you shouldn't take on the worst case scenario. Then comes the realistic case scenario. Under that scenario, are you feeling good about life? Because, that's probably where you'll end up. That's why it's called the realistic case scenario. Maybe you'll do better. Maybe you'll do a little worse. We don't know. All we know is, that's what we're going to count on from day to day. If you say, "Well, now, that realistic case scenario, that's not good enough for me. That doesn't really meet my financial goals," then, once again, don't do the deal. 

If, however, you say the realistic cases is good, it's a successful investment, you'd be happy to move forward into the realistic case, and if you say, "Well, my worst case scenario, I can survive that, and my best case scenario is very, very exciting and I would definitely risk the worst case to get to the best case," now the deal is meeting all those metrics. Now you can go forward with it, happy in the knowledge that you've made a good decision. Now, how many deals do we have to go all the way to the end of due diligence to make that final determination? Well, not always do you have to go all the way to the end to figure this out. As you do your due diligence on that storage facility, you're going to see things that align and don't align based on your initial expectations.

If your worst case suddenly turns really, really bad, you may say, "You know what? I'm out of this deal, because I was happy with that worst case I thought a moment ago. I'm not happy with it anymore. I don't find it to be survivable now." Same on the best case. As you do your studies of the market, if you find out there's a lot more vacancy than you expected, or rents are not as high as you thought, then once again, you may say, "Oh, well, based on this, I don't want to do it anymore because I no longer think my best case outweighs my worst case." Then on the realistic case, times may change. Just in the short time in which you're doing your diligence, you may find another deal which looks more exciting to you, or you may just decide that this deal no longer meets your investment needs. There's nothing wrong with that.

We've learned over the years, the best thing you can do the first time a sign of an issue comes up is to go ahead and get out of the deal or try and retrade it. The problem is, every moment that you continue on, you're racking up at least the loss of time, if not money in third party reports or fees. Again, when we look at any deal, and we urge anyone who looks at any storage deal, look at it through a best, worst, and realistic case scenario aspect. It will much more help clearly guide you as to what the correct decision will be. This is Frank Rolfe, the Self Storage University podcast. Hope you enjoyed this. Talk to you again soon.