6 Keys To The Self Storage Business Bottom Line
Self Storage Investment Opportunity
True commercial development of self storage began in the late 1960s by the pioneers of the self storage business, who recognized a growing demand for residential and commercial storage. These were the real-estate developers who ventured out and set the stage for the industry that we know today–an industry that has doubled in.
The self storage industry is no different than any other industry if one compares supply-and-demand economics. As the demand for residential and commercial storage has increased, so has the need for facilities that supply it. The tremendous industry growth experienced over the last 25 years can be attributed to greater public awareness of the economic and personal advantages of the product. This continued increase in demand, teamed with excellent investment potential, has made self storage one of the leading growth industries in the country since 1978.
Once an industry’s demand has been established, the driving forces behind those goods or services necessary to meet it have always been capital and ROI. To understand self storage’s potential as an investment, one must first understand its basic economics. Table 1 is a financial model of a typical self storage development, explaining the “bottom line” of such an investment. There are a variety of self storage development costs in different markets across the country. Therefore, this model uses national industry averages to represent individual development cost, rents and project size. It assumes an equity participation of 20 percent of the overall cost, with the remaining 80 percent being financed.
The Cost of Storage Units Investment
The “Statement of Cashflow” in Table 1 shows that a self storage facility with 40,000 net-leasable square feet, in a market with $9-per-square-foot annual rents, will generate $450,000 in gross annual rents at 100 percent occupancy. Other income is derived from late fees, retail sales, administrative fees, truck-rental commissions, etc., and usually accounts for additional income of 5 percent.
A 10 percent adjustment to the total projected income is common because it represents normal projected vacancy and collection losses. Achieving and maintaining an average occupancy of at least 90 percent should be the goal for every development and should be used to evaluate the project’s investment potential.
Normal operating expenses generally range from $2.75 to $3.25 per gross square foot of the development. This variance in expenses is due to the variable cost in different markets, such as property taxes, manager salaries, and utility costs.
The net operating income (NOI) is the balance of the development’s income after operating expenses have been paid. Maintaining the highest possible NOI is extremely important because it is used to determination the facility’s present and future value. NOI should be from 60 percent to 67 percent of the effective gross income of a development.
Debt service for this particular financial model is based on the loan amount of $1.59 million, an interest rate of 10 percent and an amortization rate of 25 years. Debt service completely depends on the financial arrangement negotiated with the lender. The investor’s financial health and lender’s perception of risk involved will oftentimes determine the interest rate, loan amount and amortization period.
With the determination of a development’s actual NOI and the debt service to be paid over time, a projected cashflow is derived. In the financial model provided in Table 1, an investment of $397,615 has generated positive cashflow of $117,761 or a 29.6 percent “cash-on-cash” return on investment. This is a typical ROI for self storage investors, which is one of the main reasons for the industry’s tremendous growth over the last 25 years.
Self Storage Development Cost
Also listed in Table 1 is a complete list of average development costs for the startup of a self storage business. Here again, there are variables, but most are confined to the actual cost of the land and construction expenses.
One of the greatest variables and single most deciding factors for determining a development’s feasibility is the actual cost of the land to the development. The financial analysis provided indicates the purchase price for the land is $3.25 per square foot. However, due to having a site coverage of approximately 45.91 percent, the net cost of the land per net-leasable square foot is $6.82. A development’s net-leasable square footage is totally dependent upon the allowable coverage of the site. Maximizing net-leasable coverage on the site is dependent on factors such as zoning setbacks, easements, utilities, building-code compliance requirements, and the topography and actual physical layout of the site. Normal site coverages range from 35 percent to 50 percent.
As to the cost of construction, site work and utilities are the greatest variable costs. Normal site-development costs range from $4.25 to $8 and, again, depend totally on the actual topography and physical layout of the site. Clearing/grubbing, excavation, storm drainage, utilities, etc., are all site specific and their costs will vary from one site to another. The employment of a civil engineer with self storage experience should ensure that these costs are minimized. Beware of land cost below market values. Most often, a low land price means there is a problem that will require great site-development expenditures.
Of course, the cost of construction depends on the type of self storage product one develops. However, the building costs vary only slightly compared to the variable costs of the land and site development. The average cost for construction, including site work/utilities, ranges from $23 to $28 per gross building square foot, or approximately 67 percent of the overall development budget.
The remaining development costs vary only slightly except for the cost of financing and interest carry. An investor’s financial health and his abilities to negotiate will determine these costs. The typical self storage development cost ranges from $34 to $42 per gross building square foot. Again, this variance is dependent on land, construction and cost of financing. However, it is important to remember that there is a relationship between market rents and development cost. The higher the costs are in a market, the higher the rents will be.
The financial model provided indicates that an investment of $397,615 realizes a 29.6 percent cash-on-cash ROI once the development has maintained a 90 percent occupancy. Furthermore, it shows that the future market value of the business, based on a capitalization rate of 10 percent and the existing financial conditions, would be $2.85 million. Therefore, an investor could realize a $864,425 profit upon the sale of the business at a future date.
Another important financial statistic to notice is the break-even occupancy for the model in Table 1. This particular model projects that an occupancy of 65 percent will cover all operating and debt-services expenses. Normal break-even occupancies on debt services in self storage deals range from 60 percent to 72 percent. This is well below normal break-even occupancies for other types of real estate. The lower than average break-even occupancies associated with self storage developments minimize the investor’s risk and give him more flexibility to deal with market or economic fluctuations.
Understand that financial models are only projections. A variety of internal and external factors can affect the overall financial performance of a development and the investor’s ROI. However, the financial model in Table 1 is truly representative of the typical self storage business and projects what the investor can normally expect from his investment. Self storage has been and will continue to be one of the best investment vehicles available in this country.
In Comparison to Other Real-Estate Investments
One of the best ways to compare real-estate investments is to look at the performance of self storage and other real-estate investments during the past decade. Recently, my company completed an in-depth study of the performance of multifamily, office, retail and self storage developments in Texas, Oklahoma, New Mexico, Colorado and Louisiana over the past 10 years. The study focused on the failure rate of those developments that opened between 1980 and 1987 and were operating during the economic recession that began in those states in the mid-1980s. The results of the study are as follows:
- Multifamily = failure rate of 58 percent
- Office = failure rate of 63 percent
- Retail = failure rate of 53 percent
- Self storage = failure rate of 8 percent
The number of self storage properties that ended up for sale in the FDIC or RTC’s real-estate portfolio were substantially less than other real-estate properties during the same time period. Of this 8 percent in self-storage failures, a considerable number of businesses were taken back by financial institutions because they were collateral for loans on other real estate.
Why is there a substantial difference in success between self storage and other real estate? What are the key elements that give self storage the extra edge for surviving tough economic times? The first thing an investor must understand is what happens to the end user–residential and commercial customers–during the swings in a market’s economy.
Self Storage Market
During times when a market is experiencing an economic recovery, business begins to thrive, employment opportunities increase and the sales of new and existing single-family homes start to climb. One would expect self storage properties to do well; most often, they do. An evaluation of typical self storage property rent rolls during this time would usually show a high percentage of mobile customers–people moving into the market for the first time or customers “buying up” from starter homes.
On the commercial side, increased business activity means an increased volume of self storage commercial tenants. Conversely, when the economy starts to falter, the same happens to the business, employment and real estate in general. However, the reverse effect still causes the same mobility that most often benefits self storage. People begin moving out of the market or selling their homes and moving into smaller homes or apartments.
Commercial businesses downsize or look to self storage for a more economic means for storing inventories. A staggering economy does have a negative impact on self storage, but look at how self storage properties compare to other real estate projects. During downswings in the economy, multifamily occupancies drop as much as 25 percent, while office and retail occupancies drop as much as 30 percent. Who are the office and retail tenants? Businesses that have either failed, downsized operations and moved to a cheaper property, or completely moved to another market. This is lost income to office and retail properties, and it is not recovered until the market’s economy improves.
Self storage will also have an initial drop in occupancy, which differs from one market to another, but usually averages between 15 percent and 20 percent. However, a typical leverage self storage property has a break-even occupancy rate between 60 percent and 72 percent. Compare this to leveraged multifamily, office and retail properties with a break-even occupancy rate between 80 percent and 90 percent. Which real-estate investment has more room to absorb market declines?
Self Storage Rental
Rents are another key to the success of self storage properties. The average annual rent ranges for the real-estate surveyed in our study are as follows:
- Multifamily–$7.5 to $12 per square foot
- Office–$14 to $24 per square foot
- Retail–$16 to $20 per square foot
- Self storage–$6.5 to $12 per square foot
Self storage rents fall within the range of other real estate projects. It is not uncommon for customers to pay the same or more per square foot for storage as they do for living in an apartment. This rent comparison is even more enlightening when comparing rents to average development cost per type of real estate. The average development cost per real-estate property surveyed is as follows:
- Multifamily–$60 to $70 per square foot
- Office–$50 to $100 per square foot
- Retail–$50 to $80 per square foot
- Self storage–$34 to $42 per square foot
When comparing both rents and total development costs, self storage most often has rents that are slightly less. But self storage has a total development cost that is a third to one-half that of multifamily, office or retail properties. To the investor, this means a considerable less investment or loan amount to be serviced while having comparable rents to other real-estate investments.
The cost of operating and the actual management requirements is another key element that is appealing to investors. As stated earlier, self storage operating costs range from $2.75 to $3.25 per net-leasable square foot. Compare this to operating costs for the other real-estate properties surveyed, which range from $3.50 to $5 per square foot. Apartments, office and retail properties have to continually maintain the grounds, appliances, plumbing, electrical fixtures and a variety of other maintenance concerns, which usually require a maintenance staff.
There are apartment “make-readies” and interior remodeling for new office and retail tenants. In comparison, self storage usually has one or two managers and very few of the maintenance “headaches” associated with “live-in” tenants. In general, a self storage investor has very few of the problems associated with other real estate properties.
The “bottom line” in comparing self storage to other real-estate investments is that the investor can realize much higher ROI for the typical self-storage property than for other real-estate investments. Secondly, the investor’s initial investment is a third or one-half that required by other real-estate investments. Due to the lower break-even occupancies, the investor should anticipate investment cashflow sooner and a much lower element of risk in relation to economic declines and their effect on lower occupancies and rents. The investor does not have to worry about additional capital requirements relating to tenant improvements or continual maintenance.
The advantages for investing in self storage mentioned above have been and will continue to be the key elements for its success. The self storage industry’s future is very bright. The industry will continue to mature along with demand for its use. Those investors who venture into self storage will discover what the industry pioneers did 25 years ago: Self storage is one of the best investment vehicles available in this country, now and in the future.
Download & View Table 1: Financial Model
A. Statement of Cashflow
B. Statement of Development Cost Annual
C. Project Specifications
D. Development Financial Variables
E. Development Financials