Property values are a complex combination of performance and market conditions, both current and what’s expected in the future. The current self-storage market is dynamic and changing rapidly, so it’s very important to understand the worth of your property.
When discussing value, most real estate owners are referring to market value as it’s used by potential investors, lenders and government agencies. This is an opinion or estimate of the value at a specific date that takes into account the state of the market at that moment. Ultimately, the only way to know the true market value of a self-storage property is to expose it to a broad pool of qualified buyers, offering them the opportunity to bid for the asset. At the conclusion of that process, you can be confident the true market value has been obtained.
Let’s examine several different factors self-storage owners and investors should consider when determining the market value of a property.
Occupancy
You need to consider two types of occupancy when valuing a storage facility: physical and economic. Physical occupancy is the percentage of units currently occupied (number of units occupied divided by total number of units in inventory). Economic occupancy, on the other hand, is the percentage of units rented at full asking price (total actual collections divided by gross potential rent).
Discounts greatly affect economic occupancy. Although they can be an effective tool to get people in the door, it’s important to increase rents to asking price as soon as possible after a tenant has moved in. Additionally, since both occupancy figures are just a snapshot in time, it’s critical to have the most recent statistics and maintain these over time to show consistency.
Net Operating Income (NOI)
NOI is simply income minus expenses. This important figure is the foundation for additional factors discussed below. When calculating NOI, exclude depreciation, debt service, capital improvements and any non-operating expenses.
Capitalization (Cap) Rate
Simply put, a cap rate is the percent return an investor would earn if he paid all cash for the property (NOI divided by market value). However, when evaluating a self-storage asset, it’s important to consider three different cap rates:
- The current cap rate takes into account the facility’s most recent performance. This is typically the most recent three, six or 12 months of income and expenses.
- The pro forma cap rate looks at the future or projected potential of the facility.
- The market cap rate is the most complicated, as it’s constantly changing due to recent sales, economic outlook, supply and demand.
Your property can’t command a 6 percent cap rate if the market is accepting only a 7 percent cap rate for comparable properties. The many different metrics and factors taken into account when determining a cap rate for a specific facility are the reason why “cap rate” can’t be a standard figure.
Pro Forma Performance
The pro forma performance of your facility is what can be realistically expected by an investor in the first year of ownership. Can rents be increased to match the competition? Can expenses be trimmed to match those of large national operators? Are there additional income opportunities, such as tenant insurance, retail sales or truck rentals? If the answer is yes, the goal should be to persuade a buyer to pay you for as much of this future value as possible. Some additional items to consider in the pro forma analysis are possible increases in expenses, such as real estate taxes or property insurance.
Demographics
Population counts and median household income are important components in valuing a property. The large private operators and self-storage real estate investment trusts currently shy away from purchasing facilities in areas with lower population counts. In the current market, private equity is willing to pay lower cap rates for properties in growth markets, but this is dynamic and will change with the market.
Examine the one-, three- and five-mile radius around a facility to determine median household income and population counts. Compare the median household income around your facility to that of the state. Most states have a median household income of around $45,000. Consideration must also be given if your property is next to a military base, university or major housing development, as these will all lead to increased self-storage use.
In addition to knowing how many people are in the area surrounding your facility, it’s also important to count how many potential customers will see the facility on a daily basis. How many cars travel by your site regularly? Do you have prominent, well-placed signage? If a facility has a high traffic count but no sign, this could be considered upside potential if there are no restrictions regarding signage.
Market Status
Investors are always willing to pay a premium price for a property in a primary vs. a secondary market. Primary markets have high barriers to entry for new development. Buyers will be able to pay the lowest possible cap rate in these markets because they can expect consistent top-line growth.
Cash-on-Cash Return
This is the percentage return an investor generates on his down payment. If he puts down $1 million and the property generates $100,000 per year of free cash flow, then he’s earning a 10 percent return. Down-payment expectations vary by market and performance, however, most down payments will be between 25 percent and 40 percent of the property value.
Sale Comparable Analysis
Properties that have recently sold in your area affect the value of your property, as do assets that are under contract but not on public record. Because of this, you need to do a detailed analysis of the market to find out what buyers are paying for self-storage facilities in your area.
How does your facility compare to these facilities? You should review size, location, visibility, age, Web presence and unit mix. If you have access, it’s also helpful to know the current NOI of the facility. Understanding the sales comps will help you understand what the market bears for price per square foot and cap rates in your area.
Rent Comparable Analysis
In the five-mile radius around your facility, review all of your competition. Compare your rental rates and unit mix to theirs. Are you higher, lower or on par? Are there reasons for rents to differ, such as a differences between facility age, site amenities or personalized services? Rent comparisons are particularly important to run if you don’t use a revenue-management system. Many self-storage operators are adopting the use of these systems to maximize their profit and occupancy according to real-time market demands.
Financing Dynamics
When there’s a lot of financing available at low interest rates, it’s a seller’s market. This means cap rates will be compressed and values will increase exponentially. As interest rates increase or financing becomes more stringent, cap rates decrease because fewer people can afford to buy. As we all know, fewer people competing for an asset means lower sale prices.
To create a comprehensive evaluation of a property, it’s important to understand both the macro- and micro-economic picture. The self-storage market is currently experiencing record-strong operating fundamentals and record-high sale prices. In addition, interest rates are at historical lows and, therefore, with cap rates at historical lows, prices are at the highest level we’ve ever seen in the self-storage market.
Jay J. Crotty is a managing partner with BayView Advisors, a national investment sales and advisory firm focused exclusively on the self-storage market. Jay provides a range of advisory services including acquisition, disposition and recapitalization strategies, asset valuation, joint-venture structures, and debt and equity finance strategies. BayView team members have completed more than $1 billion in transactions throughout their careers. For more information, call 813.579.6363; visit www.bayviewadv.com.
