A Self-Storage Investment Journey – Chapter 1
FIRST, A LITTLE BACKGROUND
I’m writing this series at the request of a couple of close friends. It is where I will document (the good, bad and ugly) my journey into acquiring, owning and managing self-storage facilities. I set a goal to acquire 3 properties in 2021, and this is where I’ll invite you to share my success and failures.
Commercial Real Estate (CRE) has quickly become a passion of mine. I’ve been a real estate investor for over 30 years, but have primarily stayed with single-family homes, duplexes, light commercial warehouses and vacation rentals. However, multi-family (apartment buildings) and self-storage investing has always been of interest. Now, it’s more than an interest – it’s nearing an obsession (just ask the lovely Mrs. Barnes). I’m not good at retirement, so I decided to take action on pursuing a new adventure. To be clear, I’m an investor – not an operator. I am pursuing additional passive income, not trying to buy a job.
I used the pandemic as an opportunity to focus on learning everything I could about commercial real estate, from an acquisition and ownership perspective. Over the past year, I’ve attended several hundred hours of virtual workshops, home study courses and one-on-one coaching from experts. In parallel, I have built an 80+ member network of commercial lenders that I now represent and decided to open a capital funding company that would focus on CRE and small business lending (Ultreia Capital Solutions). This combines a couple of passions into one endeavor and is definitely taking up a lot more of my calendar time than the TV is!
When I first began this journey, I was focused on Multi-Family properties. In fact, I made several offers on apartment buildings in Texas (Denton, Waco and San Marcos), but couldn’t reach agreement on any of them. During this same timeframe, I was introduced to a couple of people who were serious investors in the self-storage market, and I became extremely interested in what they were doing. I think the epiphany for me was when one of them told me the reason he moved from apartments to self-storage was that “storage units don’t have toilets in them”. Having been an investor in residential real estate for such a long time, I knew exactly what he was talking about! The light bulb when off, and I turned my focus to acquiring a self-storage facility.
A SIMPLE LIST OF WHY SELF-STORAGE
- Lower expense ratio than most other forms of commercial real estate
The costs to operate self-storage is traditionally lower than most other CRE asset types. For example, an apartment complex has very high management expenses, utility costs and repair/maintenance costs that just doesn’t exists in self-storage. It’s not uncommon for an apartment complex to have a 45% expense to income ratio, where a self-storage facility can easily operate at a 30% ratio.
- Spreads the risks
A self-storage facility can easily have 200+ tenants, which means that 90% occupancy is perfectly fine. However, if you own a commercial office building that has 2-5 tenants, losing just one of them can have a devastating impact on your cash flow.
If you’ve ever dealt with an eviction in residential real estate (either single family homes or apartments), you’ll know this can be a brutal and expensive process. In the self-storage world, it takes 45-60 days and costs are minimal. The rules of the game are simple, easy to follow and have a mechanism to recover lost rent through the lien process, which allows you to sell the contents of the unit to recover unpaid rents/fees. Compare that to COVID era multi-family. The government has blocked evictions on single family homes or apartments but have done nothing for the owners who have to continue to cover debt.
- Month-to-Month Leases
Unlike other forms of CRE, leases in the self-storage world are almost always on a monthly basis. My initial reaction was, “yeah, but that means people can move out on a moment’s notice”, and that’s true. The flip side is that it allows for an aggressive revenue management program where systematic increases in rent are easy to accomplish.
- Rent Regulation
Self-storage owners can adjust their rates at any time, without legislation/regulation. All that is required is that you follow the rules of due notice, outlined in your rental agreement which is approved by the state you operate in. This is unlike multi-family where, in some states, they are subject to rent controls and other tenant friendly regulation.
- Ease of Management
Managing a self-storage facility is remarkably easy. In fact, I plan to operate only automated facilities with minimal on-the-ground staff (5-10 hrs per week), advanced/integrated software and 24×7 call center. This will allow for immediate rental, unit assignment and gate code assignment all from someone’s smart phone. Compare this to a normal multi-family, office building or retail space where it takes hours and/or days of face-to-face time and paperwork to accomplish the same thig.
- Favorable Market Conditions
The demand for self-storage continues to rise, as more people make lifestyle changes and want to store their belongings. The outlook for the market continues to be extremely positive.
- Availability of Debt
Lenders love the self-storage market because, historically, it has the lowest foreclosure numbers in the CRE lending space. Small community banks, credit unions, private lenders, family/friends are all willing participants in funding the acquisition of self-storage.
- No On-Site Tenant Lowers Risks
Tenants of a self-storage are onsite for only a few minutes at a time. As a result, they are not around long enough to have the typical accidents and liability claims that you see in other forms of CRE. This also allows for lower insurance premiums, which helps with that lower cost to income ratio.
- NO Toilets
If you know, you know!
EVALUATING AN INVESTMENT
The thing about evaluating self-storage as an investment, is that it is extremely similar to the way you evaluate multi-family. Unlike single family homes, CRE valuation is really all about the Net Operating Income (NOI). Simply stated, the value is based primarily on the cash flow the property produces, along with the CAP rate associated with that particular asset class in that particular market. I won’t try to fully explain CAP rates here because I think it’s more of a voodoo science than anything. However, it’s an industry standard number that will give you an idea of the value of your property. It is supposed to represent your anticipated return after one year, assuming you paid cash. Theoretically, a low CAP translates into less risk, nicer facility and high price (lower return). The higher the CAP, the lower the price (higher return), and higher risk of the facility. For example, a property with an NOI of $100,000 and Sales Price of $1,000,000 would be a 10 CAP (NOI/Sales Price = .1 or 10), meaning a 10% return year 1 if you paid cash. Right now, self-storage facilities are selling for anywhere from a 3 Cap to a 12 Cap, depending on the property and location. My goal as an investor, is to acquire at a higher than market CAP(discounted price), then increase NOI, which can substantially increase the market value. That’s where the gold resides, and that’s what I hope to do!
FINDING THE DEAL
One of the first things I’ve learned in acquiring a CRE investment property is that it’s an extremely competitive market! I’m a value-shopper, with fairly strict underwriting guidelines. I want a property that provides nice cash-on-cash returns, provides good cash flows, is wholesale priced and most importantly, has a value-add opportunity to improve the NOI. For self-storage, a value-add opportunity means the ability to raise rents, expand the number of units, eliminate operating costs, fill empty units, add RV parking, etc.. The more value-add opportunities that exists, the more I like the property.
The first thing needed to find an investment property is to define the markets you want to operate in. I am staying out of large markets like Denver and Dallas because you are competing with REITS that have deep pockets. Initially, I wanted my first property to be located within a 2 hr drive from my house, but that just doesn’t seem like it’s in the cards for me. I do have a property that is about a mile from my house that I keep inquiring about via direct mail. I finally received an email from the owner this week telling me, in a very polite way, that he’s not interested in selling. I’ll send him a follow-up in 6 months because life changes. I’ve now expanded my search to anywhere West of the Mississippi that I can reach with a 2-hour direct flight. I’m looking in smaller markets, like Santa Fe, NM and Casper, WY. There is still plenty of competition in these markets, but it’s more of a level playing field. An issue with the smaller markets can be the supply/demand numbers. A good rule of thumb is to be in a market that doesn’t have more than 8 square feet of storage space per person in your market. More storage than that indicates a possible over saturation of your market. It’s hard to fix a demand issue. Another important item to know is that the self-storage market is really a “micro-market”. You need to evaluate your property based on your micro-market which is usually defined in a 1 mi, 3 mi and 5 mi radius. Unless it’s an extremely rural area, beyond 5 miles is outside of your market. That’s a really important fact to keep in mind as you evaluate your potential property.
There are a lot of ways to find a deal, but there are also a lot of people fishing in the same pond. You have to be aggressive, creative, and have the ability to make a decision quickly. Most people who are trying to acquire CRE, start with websites like Loopnet, CREXI and a host of others. The problem with these sites is that by the time they are listed, they’ve been passed over by other investors that have relationships with the listing brokers. This means you are looking at properties at a retail price. I look at these sites constantly but have employed other acquisition strategies as well. I’m spending most of my effort looking for “off-market” opportunities – meaning properties that haven’t been listed.
Direct mail and cold calling is how a lot of properties are acquired. It’s a time consuming, tedious task but it only takes one response to make it worth the effort. I start by using our good friend google to find properties in the markets I want to be in. When I see one that isn’t owned by a large REIT (like StorQuest and Public Storage), I use google earth and street view to take a closer look and actually measure the property. If I like what I see, I start digging into the county tax records and state filings to find the owners. From there, I put together a quick letter to the owners that simply tells them that I want to acquire their facility and can close fast. I also make sure they know that I will make a fair offer, not a bottom feeding offer that will insult them. I provide them my contact info, then have Joanie hand address an envelope so there is a better chance of it getting opened. I try to send 3-5 of these per week. I’ve received 2 responses, and both let me know they weren’t interested in selling at this time however they would keep me in mind if that changes. I’ve also cold-called a few owners. Personally, I hate this method but it’s fast and easy. The people I’ve contacted via phone calls have all been super nice, and I’ve followed up with letters providing my contact info. With both direct mail and phone calls, I will keep sending follow-ups about every 3 months just in case life changes for them.
Another strategy for finding properties is by calling self-storage brokers in the markets I’m interested in and letting them know I’m a serious buyer. They get a lot of these calls, so you better have your act together when you call, or you’ll never hear from them again. Talk about things like CAP rates, NOI, trade values, value-add. That’s their language and when you speak it, they’ll know you are serious. I’ve had one broker that I contacted throw me a deal, but it wasn’t the right project for me. I was able to make this conclusion within about 12 hrs and let them know why I was passing. They were appreciative of the quick evaluation and follow-up, and I’m sure I will hear from them again.
NEXT CHAPTER IN THE JOURNEY?
I’ll stop chapter 1 here but will follow up next week with chapter 2 which will include Making an Offer, Getting a YES, financing and what’s next. I will do these chapters based on where I am in the process. I’ve currently got a 30,000 square foot property under a Letter of Intent and will be traveling out of state this week to finalize a purchase agreement. Following that will be a 30-day due diligence process that I’ll be documenting in this series. If you have any questions along the way, please feel free to shoot me an email at email@example.com or call me at 303-214-5084. I’d love to help you anyway I can.
See ya next week — Scott