A Rental Rate Increase Perspective
Wouldn’t life be easier if we could just make our rents a little bit lower than everyone else in town? Leasing would be a piece of cake and the facility would always be full. How could that be bad for business?
The complicated answer to that very simple question goes back to the very nature of business itself. The more managers understand about the factors that influence rental rates the more they are able to support a rate increase with enthusiasm. A study of rental rates falls into two fields, the somewhat philosophical application of basic business principals, and the in-the-trenches reality of the market place. The highest and best rental rate is usually a balance of business principals pushing rates as high as the reality of the marketplace will allow. While managers have daily real life experience in their market, they often aren’t aware of some of the governing business practices at work in the background.
In our industry the general purpose for having a store is to create income for investor/owners. The greater the income, the more valuable the investment. As managers we are entrusted with their investment, their store, and charged with the duty of making it as valuable as possible.
Value is often measured by Return On Investment (ROI), or estimated using a Capitalization Rates (Cap. Rate). An example of Return on Investment would be if you bought a savings bond for $20 that matured in one year and you received back $25. You made $5, or 25% on your initial investment of $20. Your Return On Investment was 25%. Investor/owners look at all different types of business to see what is going to give them the best Return On Investment for the money they have available to put into a project. One of the reasons that the self storage industry has grown so much in recent years is because the ROI has been high in comparison to other similar business. Once they have put their money into a self storage project it is the investor/owners expectation that they will get a return on their investment that is similar to the industry standard. That doesn’t always happen, there is always risk involved in investing, but that is the basic idea. In order to achieve, maintain or increase anticipated investment return, rents have to be based at the maximum the market will bear. As a store manager your ability to increase income and/or decrease expense helps generate the greatest potential Return On Investments.
The Cap Rate is a method often used when a property is for sale to estimate the value of a business. The Cap Rate is an estimate of what people are willing to pay for a particular type of property, based on what has been paid in the past. Different types of industries have different ranges of Cap Rates. For self storage in recent years the Cap Rate ranges from about 8 % to 11% depending on the market place and the condition of the property. How rental rate increases affect the Cap Rate value of income is demonstrated on the table below. For the purposes of this discussion we are going to talk only about income. (The actual Cap Rate estimate of the market value of a property is based on income less expenses except mortgage payments & taxes, or Net Operating Income, rather than income alone)
For an idea of how this works, check out our Unit Mix Summary tool inside the Self Storage Toolbox.
With just moderate rate increases of $2 to $4 based on unit size, income increased by $1,500+ per month. But the overall value of the property increased by over $189,000. Conversely, a drop in rates reduces the value of the property in the same manner.
So, from the investment perspective, and the value of the property at any given time, it is extremely important that rental rates be at the highest the market will bear. But how do you determine exactly what that is, and how do you raise rates without loosing customers? That is the second field of our study. The in-the-trenches reality of the market place.
Starting with what we know from experience: Customers want the lowest possible rate, preferably two for the price of one, with a free pen and a piece of candy. And, there are other guys down the road that they swear will give them that very deal.
The first thing we have to do is know all the guys down the road. Not just where they are and what they look like from the street but what they actually offer the customer compared to what your facility offers the customer. That includes both the facilities physical attributes and the rates and discounts they really offer.
Knowing your competitions actual rates and discounts can be tricky. It is common in the industry for stores to survey each others prices, but some people are truthful and some are not. Sometimes you have to find a way to go and actually shop the store in order to get the real picture. Once you have the real picture, how do you use it? It has two purposes, first, so that that you don’t raise your rates higher than the market will bear, and second, so you can compare the rates charged to the features offered. If you have the best facility, you should be charging for the quality you offer, not trying to compete with the lowest price in the market.
No one expects to be able to buy a Cadillac at a Kia price, self storage should be no different. The problem is that while the general public knows the differences between a Cadillac and a Kia the average customer doesn’t recognize the quality differences in self storage facilities. In order to justify your rates you have to be able to educate your customers on what features your facility has that your competition does not offer. Simple things that you may take for granted like insulation in the ceilings in non climate control buildings or windowed doors and mirrors at the corners of interior hallways evidence your facilities strengths and should be used as selling points.
Let’s say that you have examined the market place and determined that a rate increase is justified. How do you handle it? The least invasive way to initiate a rate increase is to apply it only to new rentals and customers that have been at your facility over a year. New customers are not going to be aware that their rate is higher and long term customers understand that over time inflation is a fact of life. Rate increases should be kept small on existing customers. It is better to do two small increases over a period of time than to do one large increase and risk losing good tenants. If you do lose a few tenants don’t be overly concerned. Remember the overall financial picture and how much value the facility has gained. Your new prices are fair. You will be able to replace the move outs in short order, and at higher rents!
What if you look at the market place and you determine that overall your rates seem to be about what they should be? There may still be an opportunity to increase revenue on specific sizes or types of units. Look at your rental statistics. If you have any group of units that seem to be rented 100% all the time that indicates that the demand is greater than the supply and the rates should be raised. Don’t feel that you have to keep your rates balanced between unit sizes. If you have a high demand for small units then you should charge high prices for small units.
Maybe it would be easier to have the lowest rates in town, but it definitely would not be good for business. You deal with your tenants every day. Some of them have rented with you for long periods of time and you may feel an emotional tug against increasing rates. Investors and owners can seem like shadow figures in the background but mostly they are people just like you and me, using their investments to put their kids through college, take care of aging parents, or live on for retirement. Being the best manager that you can be means understanding your business, your facility, your community, your customers, and your commitment to the investor/owners that have placed their trust in you. Raising rates is just part of the natural flow of business, justified by the marketplace and your expertise at presenting the benefits of your facility to your clients.