Being creative sometimes allows you to build successful deals from seemingly hopeless beginnings. In self-storage investing it’s the ability to think outside the box that makes some deals possible. In this episode of the Self Storage University podcast we’re going to review some strategies that allow you to take deals that are never going to work and put them back on a solid footing using just one ingredient: creativity.
Episode 20: Let's Get Creative Transcript
When people think about creativity, they normally think about making a pot, painting a painting, possibly coming up with a new way to change the decorations of their living room. But in self storage investing there's also the need for creativity to make really difficult deals possible. This is Frank Rolfe, the Self Storage University Podcast. We're going to be talking all about getting creative, trying to apply creative ways to make deals that seem nearly impossible to work, suddenly have a future.
Listen, first start off with the concept of seller financing. Now, we've all seen properties where the price is simply too high and in traditional bank debt there's not a darn thing you can do about it because if you pay too much, you'll never be able to pay the bills, pay the mortgage, or make any money at all. But there is an alternative when the seller is stuck at a price and won't come off of that, and that is if they carry seller finance, also known as seller carry. In seller financing the seller acts as the bank. They not only sell you the property, they also provide the mortgage. So when the seller provides the mortgage they have a whole other avenue of making the deal work for you. So how does that work? How can you pay too high a price and still make it happen with seller financing? Well, the terms of the note have a lot to do with the profitability. If you pay a high price but the note has for example zero payments due in the first year or two while you try and build up occupancy, or it starts with a really low interest rate like 1% year one, 2% year two, 3% year three, or it just allows you to pay interest only for a period of years. These allow you to get the time, the foothold you need, to get the property turned around before the payments ramp up. Banks don't offer anything like that. The most a bank will typically offer you would be an interest only note for the first few years, but still t a really high interest rate compared with what the seller can do.
Now there's no guarantee the seller will do these things with you, of course. You'll have to get them to do it out of the necessity to get the deal done, and because you perhaps bonded with the seller and convinced them they need to carry. But many a deal has been solved despite a high price through seller financing. Here's something you have to think about. Typically the note through a bank is going to have about a 25 year amortization, and based on the bank it will have a term of five or ten years. But when you're trying to do a deal with a seller because he's asking to do much, it's not going to do you any good if you can't get that property fixed before that loan is due. So if a guy says to you, "I'll carry the financing but only for a year," that won't do you any good at all. You'll never get it fixed enough in a year and seasoned enough to go out and get bank loans. So don't let them sucker you into a deal where you will lose your down payment because you can't replace the loan. That's called a term default. You make your payments, but you still can't pay it off when the balloon hits and you lose the property. So for a seller financing deal to work for you creatively, it can't be short term. It has to be longer term in nature. How long? We typically like to see deals that are at least five years in length, but preferably 10 years in length. Why is that the right term? It takes you typically a few years to fix the property, but then you want to season that for a couple more. Then you want to give yourself at least a year or so to get that new note. So as you can see, short term notes, seller notes will simply not give you that creative license you need to solve it before the balloon comes due.
Another option is what we call the Master Lease with Option. Now how does that work? Well what you do is you pay one fixed payment to take over the entire property. You actually that to the owner of the property, not really the seller at this point but the owner who has now master leased it to you. During your master lease you take the steps necessary to fix it so you ultimately can buy it at a set price known as the option price, and you can get a mortgage on that. So it's basically a way for you to take control of a property and fix it before you own it. Yes, I would agree it's a strange construction. However in many cases it is essentially. Here's where a master lease is most essential. Let's assume that the owner of the storage facility basically they over paid and there's a mortgage on it due, which is greater than the value of the property currently. What can you do? You can't buy it because you can't get a mortgage high enough to pay off the sellers mortgage. So it's stuck.
However, the master lease for the option allows you to go in there and fix the property, increase the occupancy, raise the rent, cut the cost, get it where it's a better package, and then go out to get the loan now at the higher value to pay them off. The beauty of the master lease with option is it's typically somewhere between zero down or very little down, and you don't have any risk because if your plans don't work out, if you're unsuccessful in all your many ways you thought you were going to fix the property, well you simply give it back to them and do not exercise your option. It's a very, very advantageous structure for the buyer. It's just not as advantageous for the seller typically. That's why it's typically something people do when there is no alternative. But again, a master lease with option is a very creative way to fix certain deals that simply will not work.
Another thing you can do is to subdivide the property. Let's assume you've got someone who wants to sell you the storage facility and that price is reasonable, but then they want this enormous additional amount for some raw land that comes with it. What do you do? You're a storage investor. You're not really a land investor. And when you take the land and the storage and add them together you can't come up with the price that makes anything work. So what is your option? Well, one option is to buy the property but just the storage portion. Subdivide it and let the seller keep whatever it is that you don't want, that you don't think you want to pay for. So let's assume the guy has got 40 acres of land and a self storage facility that's all contiguous, but you can't make the numbers tie. Well maybe you can just let him keep the 40 acres of land. That can often be a salvation, and particularly in properties where the seller has this overly generous idea of the value of what comes with the storage facility.
Remember that if you're a storage investor, you're an income property investor, the land investors are typically more of a speculator. The problem is the banks don't like making loans on speculation. So you're not going to be able to get much of a loan, much of a value from the appraiser for that additional asset like the raw land. So often the solution to those deals where it's a hybrid storage and any other use - it could be land, it could be some other form of commercial building - is to just trim it off and let the seller keep the part that you don't want. It's really not that hard to subdivide. If you go down to the zoning department of any city you'll find that subdivision is readily available and typically not that costly or time intensive to do in most markets. But sometimes that can be the creative difference between making that deal happen or not.
Now the final thing that can make almost any deal that doesn't seemingly work seem to potentially work is the concept of zero percent down, coupled with nonrecourse debt. That is often the solution to almost anything in life. You say well, I'd buy that if you can do it for zero down and you carry the debt at nonrecourse, because you then have nothing at risk. So why would you not do a zero down, non recourse deal? Well, I wouldn't waste your time if you think it's completely unsolvable because if you're buying something under those terms traditionally it make very little money or actually loses money while you fix it, so you are going to be investing money into it probably every month that you own it until you can get whatever the problem is solved. Cut that cost, raise occupancy, or raise rents.
I would also not get involved in anything that's illegal, so if the property does not have legal zoning or permit, I wouldn't get involved in that. I wouldn't get involved in anything that potentially has an environmental hazard with it because again I don't want to put my name on that tile. Don't even want to be in the loop of the title if it's environmentally contaminated. But most of the time, 99% of the time, any storage facility you look at could very well become a target if the seller would give you a zero down and non recourse debt structure. Now, why the non recourse portion? Because if you don't have nonrecourse stat and you defaulted on the loan, they could come after you for the full amount of the loan. Therefore you have everything at risk, not nothing at risk. Also, remember that on a zero down deal you return level would be infinite because you would have no money in it. Even if it made a small amount of money, you'd still look like a genius investor because your rate of return would seem substantially higher than it would otherwise.
So the bottom line is whenever you look at those deals and the deal doesn’t look like it's going to work, doesn't look like the price is proper, the price is not supportable by the net income, there are assets with it that you don't want, you don't have to give up. Many a deal has been solved when people take creative deal making into consideration. There's been a lot of great deals that we've done over the years that have focused around not just the deal but the way the deal was constructed. So there's more than just price to any deal. If it has all the other attributes that you like, the location is good, and everything else thumbs up, don't just give up on it simply because it's tough. Get creative. Think about what can I do to make this deal possible, and sometimes those create the best deals. This is Frank Rolfe, the Self Storage University Podcast. Hope you enjoyed this and talk to you again soon.