A Self-Storage Investment Journey, Chapter 2
A Self-Storage Investment Journey – Chapter 1
CHAPTER 1 RECAP
In the first chapter of this little saga, I shared why I like self-storage as an investment diversification asset, how you evaluate them (from a financial perspective), and where you find them. I closed the chapter having just agreed to a LOI (letter of intent) on a property, and that’s where I’ll pick up in this chapter. I am going to be very loose on some of the details until the deal closes, because I’m a little superstitious. If you recall in Chapter 1, finding deals has been a real challenge for me and I’m not going to give enough details on a public forum that would allow for any shenanigans. I’ll fill in the details along the way, however.
HOW I FOUND MY PROPERTY
In Chapter 1, I talked about how rare it is to find a good deal on one of the large commercial real estate listing websites. So of course, that’s where my deal came from. Several months ago, I saw a listing that caught my eye primarily because of the fantastic drive-up appeal. It was a Class A property, which meant it was fairly new and was in a great location. What’s a Class A property? Well, it depends on who you ask. When you talk about classes in commercial real estate, properties can typically be placed in 1 of 3 classes; Class A, Class B and Class C. Class A would be the top tier, Class C the lowest tier. Here is a simple definition of each class but there is plenty of subjectivity to these definitions. A broker will always try to position a property in a higher class if possible, so just make your own decision on where you think a property exists.
- CLASS A
These properties represent the highest quality buildings in their market and area. They are generally newer properties built within the last 15 years with top amenities, high-income earning tenants and low vacancy rates. Class A buildings are well-located in the market and are typically professionally managed. Additionally, they typically demand the highest rent with little or no deferred maintenance issues.
- CLASS B
These properties are one step down from Class A and are generally older, tend to have lower income tenants, and may or may not be professionally managed. Rental income is typically lower than Class A, and there may be some deferred maintenance issues. Mostly, these buildings are well-maintained and many investors see these as “value-add” investment opportunities because the properties can be upgraded to Class B+ or Class A through renovations and improvements to common areas. Buyers are generally able to acquire these properties at a higher CAP Rate than a comparable Class A property because these properties are viewed as riskier than Class A.
- CLASS C
Class C properties are typically more than 20 years old and located in less than desirable locations. These properties are generally in need of renovation, such as updating the building infrastructure to bring it up-to-date. As a result, Class C buildings tend to have the lowest rental rates in a market with other Class A or Class B properties. Some Class C properties need significant reposting to get to steady cash flows for investors.
My search has primarily been focused on Class C properties that I felt could have a strong opportunity to move “up” in class. As long as the neighborhood was safe, an older property can provide a lot of room for profit. You can’t fix a bad neighborhood, so I avoid those like the plaque. Females make up the largest percentage of self-storage renters and they want to feel safe when they go to their facility. That’s not my opinion, it’s proven through data driven surveys. However, gravel drives can be updated with black top, cameras, fences, automatic gates and lighting can easily be added. As long as the surrounding area isn’t a high crime zone, you can improve the drive up of almost any facility.
Back to how I found my property. As I mentioned, I initially saw the facility listed on one of the big websites. A quick back-of-the-napkin analysis told me it wasn’t something I was interested in because it had a really high expense to income ratio and the NOI wasn’t high enough to carry debt. I went ahead and added the listing to my favorites, just so I could see what it eventually sold for. Fast forward to last week when I received an email notification that there was a price drop on a property I was following. When I realized which property it was, I took another look and called the broker. He sent me a 2020 P/L and I immediately spotted some significant opportunities to not only reduce expenses but to also increase income. That’s magic when you want to increase NOI (I’ll go over those opportunities in detail in a future chapter, after I’ve closed the deal). After reviewing the P/L, I spoke with the broker again and just started asking probing questions until I finally asked, “listen..I like the property, but it just doesn’t work for me with the current price. If I paid cash, what would it take to buy it”? He told me there was probably about 100k wiggle room from the listing, which told me they really wanted to sell it since it just had a really large price reduction. I told him that was still over my threshold and offered a price I would be willing to pay (cash). He asked if I would submit that offer in writing so he could take it to his sellers. I quickly wrote up an LOI and submitted it to the broker. A few hours later, he sent back a signed copy with an increase in my offer price of $36,000. I accepted and we agreed to the general terms of the deal. A Letter of Intent (LOI) is the most non-binding document you can sign in the real estate world. It basically says that both parties think they want to do a transaction and it outlines some really generic terms. But there is no recourse if either party just walks away without ever getting a contract signed. The only reason I sign them is because if makes people feel like they are committed to the process.
A SIGNED LOI – NOW WHAT?
Once I signed the LOI, I started planning a visit to the facility. There is a person that currently lives on site, so we didn’t want to disrupt them and throw them into panic by showing up with a broker to do a formal inspection. We are only under an LOI at this point, so we need to keep things low key. My wife and I decided to make the 8 hour drive the next day, so we packed up and headed out. 6 of those 8 hours were on packed snow/ice and made for a really long day’s drive (the things we do for our passion). The next morning, we got up and visited the facility as a couple that was looking for a facility to store personal belongings. It was strange, because although there is live-in manager, the office didn’t open until 10:00 am. When we showed up, they were in the office and answered our questions, but had no desire to actually show us any of the units. We asked if we could just walk around to make sure it looked secure, and they happily let us wander around. It’s a beautiful facility with about half of the units being climate controlled and the other half drive up. Security cameras are everywhere, and when you walk into the climate-controlled buildings the interior lights are on a motion sensor. It’s in a great neighborhood and the fencing, signage and gate controls all looked perfect. It’s all concrete drives that are really wide, allowing for easy access (and less damage to buildings). This looks like a great opportunity so far.
As soon as we left, I got on the phone with an attorney that had been recommended by one of the members of a Self-Storage Investors group that I’m a member of. You’ll need to find an attorney in the same state that your facility is in to handle the Purchase Agreement. I also wanted an attorney that could establish an LLC in that state, as well as create our LLC operating agreement. Every property I own (with the exception of my primary residence) is held by a separate LLC that is formed in whatever state the property is located. Those LLC’s are held by a holding company in a tax/privacy friendly state, which is owned by a family trust. That structure is planned to do a couple of things; First, asset protection. If someone gets injured at a property and decides to sue, they are suing the LLC that owns that property. Their ability to get to assets beyond that entity is limited. Second, it allows for different ownership structures for each property. The property that I’m currently in contract negotiations for will be owned with 3 other investors. The LLC will be owned by the 4 of us, and I’ll be the Managing Member. Lastly, by having the family trust own the holding company, it will keep assets out of probate after my wife and I pass away. Please see my disclaimer at the bottom of this writing.
When you buy a facility, you need to make sure your budget includes start-up costs like attorney and accounting fees. For this acquisition, I budgeted $10,000 in Legal Fees. After my discussions with the attorney, I think I’ll come in closer to $7,500. Accountant fees will be around $1k. If I was financing the deal, I would have to include closing costs, points, broker fees, etc… Those costs are often ignored when someone talks about a deal, but they are real dollars, and you must account for them.
The acquiring LLC will look like this;
I will take 30% off the top as the sponsor. That means the remaining 70% will have to cover 100% of the costs. I like to keep things simple, so the LLC will have 100 units available. I take 30 of those as the sponsor, leaving 70 units to sell for securing the capital required to take down this deal without debt. For the purposes of this example, assume we need $2M for the purchase, $20K for working capital and $10K for Legal/Accounting. If we were financing, we would only need to raise the down payment, closing costs and initial working capital. However, since this is going to be cash, we need to raise the entire $2M. So $2M+20K+10K = $2,030,000. To get the unit price, we take the capital required and divide it by the units available. In this case it’s 2030000/70 = 29000, making each of the 70 units available cost an investor $29,000. For that investment, they will participate in their pro-rata portion of quarterly profit distributions, along with their share of the profits when/if we decide to sell. At this particular point, I think our plan is to drive the NOI to create a market value of $3M+ in 12-18 months, then do a cash out refinance for about 50-60% of the new market value. That will give us all a significant portion of our initial cash back, and still allow us to receive nice distributions for the long haul.
CHAPTER 2 WRAP UP
Ok, that’s enough for this chapter. As of today, I have a finalized Purchase Agreement for this property and will start the due diligence process quickly! I’ll cover that in Chapter 3! Thanks for reading. I really hope you get something out of it.
I’m NOT an attorney or a CPA, so this isn’t advice. It’s simply a description of what “I” do. It suits my purposes, and that’s what matters to me.