What a great time for the self-storage industry! We’ve experienced a record number of transactions over the last several years, and each year we seem to improve with regard to capitalization rates, rental rateS and net operating income (NOI), per-square-foot sale prices, and actual value for every dollar of NOI. Many are calling it a generational high in facility value.
The contrarian in me can’t help but think now may be a good time to take some chips off the table. It’s clear that some of the “smart money” has taken steps to pull out profit and hedge their bets by selling and repositioning their self-storage assets. Below are a few approaches facility owners might consider as they assess their own exit strategies and investment objectives.
Outright Sale
An outright sale is the most clear-cut and absolute path for an owner to take when considering an exit strategy, as it provides the greatest liquidity and certainty. Today, self-storage owners are reaping the benefits of strong market fundamentals, a fluid lending market, and an immeasurable amount of equity from willing and able buyers looking to invest in the industry.
Determining if you’re a “real seller” is the single most important decision any owner can make. A real seller is someone who has a defined reason to sell and is willing to price his property at a reasonable level for the market.
Serious buyers want serious sellers. When a buyer discovers a seller isn’t realistic about selling because of price, timing or market conditions, he’ll seldom get interested in that property again.
Overpricing a property isn’t harmless. The result is the seller offends his best prospects—and they’ll remember!
Refinancing
Many owners don’t think of refinancing as an exit strategy, however, you may want to run some numbers and talk with your accountant. Due to the dramatic increase in self-storage property values (we’ve seen a 20 percent to 50 percent increase over the last three to seven years), many owners have the option of refinancing most or all of their equity out of an asset, all while continuing to own and operate the property in a profitable way.
So, let’s do some math. If you bought a property in 2010 for $2.5 million and have experienced a 35 percent increase in value, your property is now worth $3.37 million. If you refinance the property and achieve a 75 percent loan-to-value, your total new loan amount would be $2,531,000. This scenario would allow you to pull out all or most of your equity from the property and still own it. Refinancing proceeds are tax-deferred and allow you to invest in other avenues to maximize your overall return on investment.
Obviously, the devil is in the details. You’ll need to work with your advisors to ensure the property can handle the additional leverage and you’re comfortable with the new financial structure of the loan. Refinancing isn’t technically an exit strategy because you still own the property, but if done in an appropriate manner, it can provide a liquidity and position you to grow your portfolio.
Operating-Partnership Units
Before we dive into the topic of operating-partnership (OP) units, I advise you to consult with your accountant, lawyer and other advisors to ensure you have an accurate understanding of your tax liability and the pros and cons of an OP-unit transaction. Over the last several years, we’ve seen stock prices for the four major self-storage real estate investment trusts (REIT) skyrocket. This is largely due to the overall investment climate and the robust performance of self-storage assets. To grow and create shareholder value, the REITs have been active on the acquisition front, pushing prices to historically high values.
We’ve seen many owners ask themselves, “What would I do with the money if I were to sell?” Most would face capital-gains tax (25 percent to 30 percent) on the net gain if they sold their properties for all cash. That can have a meaningful impact on the overall cash-on-cash return a seller could achieve.
Self-storage REITs have the unique ability to offer OP units as way of compensating an owner in a sale and allowing him to defer the capital-gains tax. In general, OP units act similarly to common shares. They pay a dividend and can be sold with a call to your stock broker, and their value fluctuates daily.
The key to an OP-unit deal is the liquidity and ability for an owner to sell them on a moment’s notice—this is what makes them worthwhile. Without getting into too much detail, depending on its size, an OP-unit transaction can be structured to accommodate the seller’s needs by offering a combination of units: some that act like common shares and some that act like preferred shares. This might give an owner a higher cash-on-cash yield and limit the fluctuations of the REIT’s share price.
However, know that with an OP-unit deal, a considerable amount of ongoing accounting takes place post-closing. Because of this additional cost and complexity for the buyer and seller, these deals have typically been appropriate for larger transactions. As you can imagine, if you received an OP-unit deal over the last three to seven years, the appreciation has far exceeded the performance of your property.
It’s clear this is a great time for the self-storage industry. Depending on your investment objectives, the current markets may be presenting you with opportunities that are unique to this real estate cycle. As Warren Buffet says, “You never know who’s swimming naked until the tide goes out.”
Ben Vestal is president of the Argus Self Storage Sales Network, a national network of real estate brokers who specialize in self-storage. Argus provides brokerage, consulting and marketing services to self-storage buyers and sellers and operates SelfStorage.com, a marketing medium and information resource for facility owners. It also offers panel discussions in which brokers from around the country share their insights on self-storage market fundamentals and economic trends in their regions. To access recordings, visit www.argus-selfstorage.com/presentations.html. For more information, call 800.55.STORE; e-mail [email protected].