Self Storage Investing Newsletter

Memorial Day is the national holiday to recognize those who have served in the U.S. military. Years ago we looked at a large storage facility that served a military base – roughly 4 acres under roof. From that experience we learned that the U.S. military is a huge catalyst to storage, with most soldiers storing their belongings when on active duty. But we also learned how massive and advanced the military is and the strong resolve of those who serve. Keeping America free from harm is a huge undertaking, and most Americans have no idea of the constant work that goes into our freedom and the sacrifice that many make to keep us safe. If you have the opportunity, go out of your way to recognize those in the military and thank them for their service. Or buy them lunch. Or support charities that help those in need who have sacrificed for our country.

Have a safe and happy Memorial Day!

Have you ever played the “claw machine”? This standard amusement, that is found at every Walmart and arcade, is based on a trick. They deliberately position all the stuffed animals so that their foot or tail is stuck under the one beneath, so it’s impossible to pull them out of the pile (at least most of the time). While the claw machine may cost you a couple dollars when you fail, a self-storage facility can cost you hundreds of thousands of dollars if you get tricked. So how do you guard against the common tricks that sellers play?

Make sure there is a lock on every unit that is claimed to be occupied

While any smart buyer reviews all of the leases for every unit that is said to be occupied, you should also visually inspect each door to make sure that there is a lock on it. If there’s no lock on it, open it up and see what’s inside (it’s probably empty). While a truly corrupt seller can simply forge a lease and put a lock on a vacant unit, most sellers are not going to want to take their scheme to that level, which could potentially land them in big legal trouble. And even if the unit is vacant that is supposed to be occupied, that is easily remedied after closing with your marketing program, as long as there are not too many of them.

Look for “below the line” items

Some sellers try to sneak big dollar items at their self-storage facility to “below the line” which means that they are not shown on the typical profit and loss statement, but instead as a capital expense on the actual financial statement and/or tax return. Read the financials for the property from end to end, and don’t let the seller give you a short form analysis or some vague B.S. when numbers don’t add up. Any decent accountant can review these with you and spot the “below the line” activity that you need to be aware of.

Get all third-party reports – and don’t accept those provided by seller

Third party reports are designed to protect you and your investment. So you can’t accept these reports (Phase I Environmental, survey, title work, property condition, etc.) from the seller because they may have altered them or paid the provider to cheat. We know of one case in which a fraudulent seller took some white-out and erased the fact the property was in a floodplain. The buyer trusted the seller and never questioned the survey. Years later the property flooded and the deceit was revealed. The good news was that the seller had many assets and was forced to return the purchase price to the buyer. All third-party reports must come from those hired by you, the buyer, and never the seller. Too dangerous.

Build in some “fluff” for the unknown

With the full knowledge that there are lecherous sellers out there, it’s imperative to build a little “fluff” in your numbers as a security blanket and buffer. Don’t allow yourself to cut the numbers too tight and box yourself into a corner. Give yourself some leeway for a rainy day, so that you can withstand minor cheats by the seller.

Don’t get in the seller carry “trap”

One of the worst – and most ingenious – self-storage seller traps is to carry the paper on the deal on a short-term basis with the full knowledge that you will not be able to get it refinanced and will then lose the property back to the seller. They gain your down payment then (roughly 20% to 30% of sales price) and can then re-sell it again. There are rumors of sellers who have accomplished this trick on the same property several times. The solution is to 1) make sure that any property you buy and in which the seller carries the paper must be vetted to be possible to obtain bank lending and 2) seller note lengths must be long enough to allow you to hit target numbers and season them for a while before bank debt is approached, as well as to obtain bank debt.

Conclusion

A “claw machine” may provide fun amusement, but buying a self-storage property should never be subject to seller cheating. These tips will keep you out of trouble, coupled with outstanding due diligence. Benjamin Franklin once said that “diligence is the mother of good luck” and he was 100% correct.

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Some experts have suggested that the future of the enclosed shopping mall is partially to be found in self-storage. The theory is that, as retail shrinks as the result of the internet, those vast abandoned anchor stores and entire wings of malls can be retrofitted into self-storage facilities, along with entertainment venues and apartments. So is it time to start looking at these opportunities?

Understanding the opportunity

Giant, enclosed shopping malls were a big thing in the 1970s. They have mostly terrific locations in large metro areas with high population density. They also have great road frontage (normally highway) with high visibility, good roads and ample parking. But nobody needs all the retail space anymore. It’s estimated that 20% of all of these giant malls will shut down within the next five years. You’ve probably already seen this phenomenon in your area.

Amassing a short list

Just within a several hour radius of where you live there may be a number of potential mall closures. They are easy to spot because retail vacancy stands out like a sore thumb. Your list may be around 10 mall targets but may also contain other retail big box locations that have been scuttled. Obtain all of the street addresses on them.

Making offers

From these street addresses, you can go to the county tax assessor’s website and get the owners name and address. You can easily Google search these owners and get their phone numbers and email addresses, as well. Contact them and see if there’s any interest in selling these dinosaurs at a low price.

Contacting lenders

In many cases, the owners may owe more debt on these buildings that they are worth. In that case, they will ultimately go back to the lenders through foreclosure, and you can then contact the lenders to gauge their level of interest. You can find out the lender information through a title company if you can make a contact there.

Getting ahead of the pack

If the future of many retail centers is to convert them into self-storage, it can’t hurt to get ahead of the pack. While the opportunity may not present itself until several years from now, there’s no reason not to be ahead on the learning curve.

Conclusion

Self-storage may be the future for much of the abandoned retail space in the U.S. While the jury is out, it’s a logical next step in may cases.

Conduit debt (also known as CMBS debt) is a special product that offers 70% LTV on appraised value – regardless of what you paid for the storage facility. This means that if you have created value through greater net income, then you will be rewarded at refinancing with a higher valuation and, potentially, a “cash-out” situation. This means that you will effectively get all your down payment back from the original purchase, plus additional cash out based on the new effective value. And this “cash out” is tax free since it’s effectively a loan. In addition, these conduit loans are non-recourse and feature low, fixed interest rates and long loan terms. But how do you get one? If your deal is over $1 million, then the answer is using a loan broker, and the best in the business is M.J. Vukovich at Bellwether Capital. We’ve been using him for years and he essentially creates the loan request, meets with the lenders, helps you in the selection, negotiate the final terms and shepherds the deal to closing. In exchange he gets a small commission that is a bargain for the amount of time and expertise rendered. For more information call him at (612) 335-7740 or email him at [email protected]. You’ll be glad you did.

Like mobile home parks, self-storage facilities are a unique class of real estate. Their unique operation and construction means their risk is unique too. With that in mind, here’s some advice on managing your investment risk both broadly and economically:

• Seek an insurance agent that specialize in Self Storage owner insurance. The agent will be able to advise you best and offer coverage via insurance companies that specialize in self-storage operations. Here, you’ll get a broader coverage package which includes more for less.
• Insure your buildings for their true rebuild cost at today’s construction rates. Don’t insure them for their purchase price, tax assessed value or what you built them for ten years ago. Underinsured properties will result in insurance settlement checks far short of what you need to repair or replace your buildings and improvements;
• Buy BOTH loss of income coverage with extra expense AND extended loss of income coverage. The former will cover your pre-catastrophe amounts of income from the time of the disaster until it is reopened. The latter will provide you with pre catastrophe amounts of income for another six months after you reopen while you are leasing up the property. Many don’t have the latter. Paying your mortgage with no income isn’t fun;
• Add “Sale & Disposal” coverage. This will protect you in the event that a tenant’s property is mistakenly sold or disposed of and they claim all of that “junk” you threw away or sold for $75 is now magically “priceless treasures;”
• Seek “Pollution Clean-Up” coverage too in the event either your employees or a tenant causes a pollution spill on your property. If bought as part of the overall coverage package with a program self -storage specialty insurance company, it may not cost much or any more and will provide you with a helpful pile of cash if a tenant’s hazardous contents spill all over your property;
• Include some “Employee theft” coverage too. Unless you as the owner are going to be the only one working there, it’s likely that employees of yours will have the opportunity to collect some of your receipts. Time-tested collection procedures are a must, too;
• Borrow a tenant rental agreement form from your Self-Storage Association or another operator. The best agreements will include waivers of liability in your favor regarding tenant owned property as well as set rules of conduct for all tenants and visitors; and
• Offer all tenants insurance coverage for their contents. There are simple to use insurance programs available to which you may refer your tenants. This also puts them doubly on notice that protection of their property is up to them, not you.

Proper insurance for your self-storage facility is attainable and affordable. Make sure you have the right coverages so that you never have to worry about losses when problems arise.

Kurt D. Kelley, J.D.
Mobile Insurance
800-458-4320 ext. 17

Many parts of America go through cycles from old and new and rich and poor. A neighborhood that was terrific and new in 1920 can become old and rundown by 1980 and then hip and thriving again in 2020. A huge amount of money has been created by spotting these trends and investing in them ahead of the pack. Self-storage is no different. If you can buy a facility or build one when times are cheap – and then hold it while the area improves significantly – you can literally make a fortune. So how do you do it?

The strategy

You’ve heard the old adage “buy low and sell high” and that’s how simple it is here. You are buying property inexpensively because people have lost hope for the neighborhood, and then when it turns around the values go up exponentially. It’s probably the most simple business model on earth.

Clues to determine the future of a blighted area

There are some factual items that can prove out the future resilience of an area. One is the future highway development plans. These are of public record and can be found either through city hall or the state highway department. Another source of data is the home prices displayed on Zillow. Or you can add in the chamber of commerce publicly announced new developments and leases. There’s actually quite a bit of factual data out there.

Watching for signs of turning

You can get many more subtle clues of neighborhoods that are transitioning for the better simply by driving through them and watching for signs of new development or new storefronts or simply new for sale signs that suggest the beginnings of real estate interest in that market.

Mitigating your risk

If you feel that a market is about to turn, don’t get carried away. The real money is in buying low and selling high, not buying high and selling higher. You need terrific deals to make sense of the risk in buying into these areas. What if you guessed wrong? You need to buy cheaply enough that you can sell it cheaply in the worst case and not get burned.

Conclusion

Neighborhoods rise and decline and rise again. Take advantage of these cycles with your self-storage investments and you can get an exponential leap in value potentially. “Buy low and sell high” is not just an expression but a business model!