Self Storage Investing Newsletter

The Holiday Season is here again. It’s a great time of year to reflect on what went right or wrong over the past twelve months, and project forward into the New Year. If you have a goal of buying a self-storage facility, then the holidays are a good time to put together your action plan so you can hit the ground running in 2017. While others are sitting around watching football on television and sipping eggnog, you can be reading and learning how to identify, evaluate, negotiate, perform due diligence on, renegotiate, finance, turn-around and operate a self-storage facility. There’s an old adage that says “think like a man of action and act like a man of thought”. The time to learn is now.

And we would like to take this opportunity to extend a sincere Happy Holidays to you and your family!

Since the U.S. Presidential election in November, there has been an upward movement in interest rates. Economic cycles apply to interest rates, which have fluctuated significantly over American history. So how can you minimize the impact of interest rates on your self-storage facility?

Use fixed rate debt instruments

The first way to protect yourself from interest rate volatility is to only use debt instruments with a “fixed” rate as opposed to a “floating”. Most lenders offer both, but they will try to manipulate you into thinking that the “floating” is more advantageous as it will start out at a lower figure. However, when rates rise, that “great deal” rate could become a nightmare. Fixed rates are the way to go.

Go for long loan terms

One way to protect yourself from an interest rate roller coaster is to lock in rates for as long a period of time as possible. We generally prefer loans that have ten year terms – not “amortization” (the overall period in which the loan is repaid) but the “term” (the length of time before the loan “balloons” and you have to refinance). But not all banks will go that long in the loan term, so you must simply shoot for as long a term as you can get. The bottom line is that the longer the loan term, the better – a seven year note is infinitely better than a five year note, which is always better than a three-year note.

Give yourself plenty of time to refinance

We always strive to attack the issue of refinancing a loan two years ahead. Why so long? Because it takes time to find the right bank, as well as to do all the third party reports and legal work to actually close and fund the loan. We figure that a two-year head start before the loan comes due will give us plenty of flexibility to find the right lender and, if that fails, to sell the property off before the loan ends. If you have a longer term note (like 7 to 10 years) you can also try to time your refinance to an attractive interest rate environment. If you have a ten year note and interest rates fall dramatically in year six, you might want to refinance to another ten year note years ahead of the actual due date.

Build in rent increases to keep your “spread” healthy

The key metric in making money in real estate is to maintain a “spread” of two to three points. The “spread” is the difference between the loan interest rate and the cap rate on the property. The point is that you need to allow for mechanisms to improve the “spread” during the life of the loan, so that you can afford a higher interest rate when it comes due. This lever might be higher unit rents, or greater occupancy, or both. The bottom line is that you need to always be pushing to increase the facility’s net income so that you have a safety cushion against higher interest rates.

Conclusion

It is a given that interest rates cycle. They have been going up and down for centuries. They key is to accept this risk and work out plans to hedge it. Rollercoasters should be reserved for entertainment and not for business risk.

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A peacock starts out as a plain pheasant until the age of two. Self-storage facilities took quite a bit longer to mature into a mainstream investment, but are now in full bloom. So how did self-storage become such a sleeper hit?

Stable revenue

The first way self-storage built a name for itself is through stable revenue. Most Americans view storage as a necessity rather than a luxury (although early self-storage was considered a foolish luxury for those that have too many material possessions). Since so many Americans have storage units, it has become a staple of many household budgets, and occupancy remains consistently high.

Solid performance in good times and bad

Many people were concerned when the Great Recession hit in 2008 that self-storage would be a casualty. The modern storage industry had never really been tested by a significant U.S. economy collapse before. Would Americans keep paying for storage or simply sell their stuff off and cancel their rental agreement? The answer turned out to be that economic instability actually improved occupancy in most markets, as people stored their belongings while losing their housing or moving to find employment. This was an important test and lesson learned, and it gave the industry renewed respect from lenders and investors.

Institutional-grade debt

One important statistic in banking that many people don’t know is that self-storage has the lowest debt default rate of any type of commercial real estate. This has created a huge appetite among lenders for such loans. In the beginning, building a self-storage facility required a great deal of luck in finding a bank. Today, there is every possible type of loan product, from traditional bank loan to CMBS debt. You can access the same lenders for self-storage that you can for all mainstream real estate products, such as office buildings.

The power of Public Storage

Every industry needs a leader, and Public Storage has done a terrific job of advancing the industry both in respect as well as operational improvements. Founded in 1972 by B. Wayne Hughes, it has grown to 2,200 locations and has remain profitable throughout. Public Storage’s signature look of orange roll up doors has become, to most Americans, the trademark of the business sector.

Conclusion

Self-storage began with nothing but a dream and no respect, and grew into a favored mainstream asset class of real estate. And it has done so in faster time than any other segment of real estate.

Don’t forget the decorations this Holiday Season! Don’t be an owner that fails to deliver on Christmas cheer! You can buy great decorations at the Dollar Store and Wal-Mart – don’t use the old “I can’t afford to decorate” excuse. Since Christmas is one of the driving forces of self-storage for many people (storing the tree and ornaments, not to mention excess gifts) you should give back and keep the Holiday Cheer flowing to your employees and customers. Remember that the holidays are a time to appreciate people, and most people enjoy the camaraderie of installing decorations. Make your office festive and you will find that your sales may spike from the good feelings it instills in your staff and customers.

Here is a photo of two different approaches and final results that we photographed at a recent real estate event. The car on the left belongs to a successful real estate investor who has earned the ability to buy nice things. The other car is someone trying to make a hardscrabble living buying and selling single-family homes. So why do all sectors of real estate not perform the same?

Working smart vs. just working

Many people don’t consider the fact that simply putting in hard work does not always yield results. If someone tries to dig a hole and it just keeps caving in, they could dig forever and still never end up with a hole. More important than the amount of work expended is the power of that work. “Working smart” means essentially putting in the least amount of effort to attain the desired result. Self-storage investing is “working smart” as the returns on investment are among the highest in the U.S. All you have to do is find an under-valued self-storage facility and turn it around and you could be set for life. Flipping single-family homes, on the other hand, will just keep you alive a month at a time.

The concept of risk vs. reward

Different asset classes of real estate offer different levels of risk. Self-storage has among the lowest such risk, as evidenced by the fact that it has the lowest banking default rate. However, flipping single-family homes is filled with risk, as you have to estimate the cost of improvements vs. the final value, and many of those assumptions may be incorrect. And for all that risk all you get is a small profit from each transaction.

Seeking out reduced competition

Very few people know about self-storage investing, but millions are involved in single-family home flipping. Success is often found in doing what everyone else is not doing. It is much easier to find good deals when you have less competition fighting you for them.

The simple metrics of financial performance

Some sectors of real estate make money. Others don’t. The total return of giant shopping malls has been terrible because you just can’t make money with those anymore in most markets. Self-storage, on the other hand, offers some of the highest cap rate and cash-on-cash return numbers in the industry. You want to go where the money is, and self-storage is a good target.

Conclusion

There is a strategy to which sector of real estate to invest your time and money in. Self-storage is a time-proven winner with many positive attributes. Other sectors, not so much.