It’s not uncommon for a self-storage facility owner to manipulate their numbers in hope of deceiving you into paying a higher price that is not justified by the current net income. In this Self-Storage University podcast we’re going to explore the different methods sellers use to alter and hide their actual performance.
Episode 154: Unravelling Numbers Manipulation Transcript
All the problem with number manipulation probably begins with cap rates. Because if the seller can convince you that there's a dollar of EBITDA more than there truly is, that adds on at least $10 of value to the deal. You, therefore, as a buyer, being cognizant of the fact that the seller is probably gonna be lying to you to some degree, you have to be on your guard to unravel those manipulations. This is Frank Rolfe with the Self Storage University podcast. We're gonna talk all about how sellers lie on their numbers, how you can spot it, and why you must never lose focus on making sure the numbers are accurate.
So let's go over some of the categories where most self-storage facility complex owners lie. The first one often is on the repair and maintenance. Because even though storage facilities don't have a lot of moving parts, typically metal buildings where the only thing that actually moves are the hinges on the roll-up door, nevertheless things do happen. There's road repair, there's roof repair, there's roll-up door repair. Some sellers, in their goal of lying about their true EBITDA, they will conveniently leave those things off. The way they do that is by capitalizing these repair issues. Now, that's not to say it's wrong to capitalize repairs if they are in fact capital repairs. Capital repairs means it goes to the balance sheet. You will not find it on the profit and loss statement. When you put it on the balance sheet, of course, you can then depreciate it if that's what the IRS says you can do. But it's not really accurate inasmuch as there are some things you're not supposed to capitalize. There are certain repairs that are not truly capital repairs but instead are to be expensed.
If someone tells you, "Oh, I have no repair maintenance in my facility," you know that's wrong. You know, looking at the paving, there's been pothole repairs, there's been striping, things like that. So you've gotta push to look not only at the P&L, but the balance sheet and see what's really going on. If they can't give you any numbers, if they don't even give you a reliable balance sheet, you're gonna have to go ahead and make some guesstimate of what you think annual repair and maintenance is. But there's no way there's any self-storage facility on earth which does not have repair and maintenance numbers.
Also look at the revenue side. If they're showing a sudden revenue boost, if just out of nowhere they typically rent a few units a month and then in one month they do fivefold, what's going on there? A sudden surge in demand? No. What they're doing is they're letting people into these units, possibly even falsely, that are not legitimate customers. There's nothing in the storage industry that would hold you back, for example, from having your Aunt Betty suddenly out of nowhere go in and rent a bunch of units real quick just conveniently before you put the thing on the market. These are customers who are not vetted. You don't know who they are really. You don't know what's going on, but yet they came out of nowhere close to the exact moment when this thing went on the market. And suddenly they're there, but they probably won't be paying after closing. As soon as the deal is closed, they'll probably run off, pull out. Aunt Betty will pull out her Christmas decorations. So watch for any sudden gain in occupancy or revenue boost 'cause you can't really trust that.
Also look for missing expense categories. A lot of self-storage facility owners are gonna conveniently leave off some items which you know should be on there. Things like mowing, if there's any area to be mowed. These little things which they're hoping you'll forget about, that when you mention it to them, they'll say, "Oh yeah, I forgot about that 'cause it's such a such a small number." But yet those small numbers add up pretty quickly. Another big one is property taxes. Because the property taxes that you are going to pay, that you need to budget for, have to tie to an assessed value of what you're paying for the property. Now, if mom and pop are only paying on an assessed value of that storage facility of $400,000 and you're buying it for a million dollars, you can't use in your budget the property tax of 400,000, right? Because it could very easily move to a million dollars when the tax assessor next makes his impression of what the value would be when he sees the thing has changed hands.
Now, if you're in a state that's full disclosure, this is a non-issue. You'll have to tell them what you paid, and immediately the value will go to a million dollars. If this is a non-disclosure state, however, then it'll go probably somewhere between 400,000 and a million dollars, but we don't know where it will land. The only way you can safely buy that is to assume the value will go to what you paid. This is not a big issue in some states like Missouri, which has a 1% tax rate, but a big deal in states like Texas, which has a 3% tax rate. So in doing your budgeting, you gotta make sure you use the correct estimate for property tax. Now, this is one where mom and pop can say, "Well, okay, but we don't know that. We don't know it will go up to a million. And I just told you what I've been paying." But in the back of their mind, they're hoping that you don't think of that. They're hoping you gloss over the property tax and go, "Oh, okay, yeah, yeah, that's the number I'll use in my budget."
Another giant problem is when the storage facility owner does not have any current numbers. They give you their financials, but the financials stopped six months ago, even a year ago. That's a terrible sign. That means that the real numbers will not support what they're telling you. That P&L that they gave you, in fact, is not really accurate because it's of the past. Many things may have transpired since then. Taxes may have gone up, power may have gone up, occupancy may have gone down. It's very suspicious when they don't give you current numbers. That alone should set off an alarm bell with you that there's some serious manipulation going on. And then the worst is when they won't give you any numbers at all. They'll say, "Well, I kind of cheat on my tax. I don't really keep books. I take the rents in cash, don't really write any of it down. But here, I'll just kind of guesstimate where I think it's at."
Unless this is a property that is of huge importance to you, just run away. If someone can't give you any numbers at all, how are you gonna get a loan on it? If someone says to you, "I don't have any numbers," your first thing should be, "Well, you're gonna carry the paper then, right?" Because you can't expect me to go to any lender in the absence of numbers and possibly get a loan on it. But even more importantly, do you really want to buy something from someone who is so flaky, so irresponsible that they openly admit they're cheating on their tax and they don't keep any books? That could have a terrible ending for you as the buyer.
The bottom line to all of this is manipulation in the storage industry is rampant. It's very common. It's true of all real estate sectors, but storage may be worse than many because of the unusual nature of people moving in and out of the units. When you have a retail strip center, you can go over and look at the tenants. They typically don't number more than four or five, and you've either heard of Domino's Pizza or not. But when you're looking at all those little storage renters, you don't really know how many of those are real and how many of those are fraudulent or might be fraudulent and all that type of thing. All you can do is make a leap of faith judgment in what you think works correctly based on your knowledge of the industry but never forget that the seller will at all times in any transaction very commonly be looking to manipulate those numbers to get you to overpay. This is Frank Rolfe with the Self Storage University podcast. Hope you enjoyed this. Talk to you again soon.