The first thing is to decide whether youre going to try to sell your property yourself or enlist the help of a broker. The following suggestions assume you are working with a professional; if you intend to sell your property yourself, assume the brokers responsibilities as described here. If you decide to use a broker to represent you, be sure to select the right agentsomebody who knows the self-storage business, knows your local market and has a track record of helping other owners.

Preparation will be your friend, regardless of whether you go for broker or the do-it-yourself route. Here is a five-point tip list on moving forward intelligently with your self-storage sale.

1. The right broker will establish realistic expectations of what the property will ultimately sell for and set an appropriate asking price to ensure you achieve that goal. By setting the asking price too high, you run the risk of not selling at all, thus missing the opportunity to achieve optimum value. Set the asking price too low, and you run the risk of leaving a lot of money on the table. In this market, one-quarter of 1 percent on the cap rate could cost you more than $150,000 on a property with a net operating income of $200,000.

2. The right broker will advise you which, if any, deferred maintenance issues should be dealt with before marketing the property. Unless your property is new, the buyer should not expect it to be in like-new condition. Therefore, it may not be necessary to spend much improving the propertys physical condition prior to sale. You should take the time to replace burned-out light bulbs, fix minor damage to doors and metalbuilding corners, replace faded or missing unit numbers, and generally clean up the appearance of the property. Have a seal coat applied if the asphalt is showing signs of deterioration.

If some aspect of your propertys condition might enhance rental rates or the marketability of the property, it should have been addressed long ago and probably isnt cost effective to tackle at this point. In other words, property value is mostly a function of current income, not what the income could be if you repainted all the doors, installed new landscaping or remodeled the office. Spending a lot on issues like these now is not likely to translate into a substantially higher sales price; it takes time for these kinds of improvement expenses to show up as increased revenue.

The most cost-effective way to achieve optimal value for your property is simply to be sure it is clean. The most you should have to do is a seal coat on the asphalt. The bottom line is your propertys income is achieved because of its appearanceor in spite of it. Many buyers look specifically for fixer-up properties because they believe they have a better chance of growing the income than with a newer property in perfect condition.

3. Inform the on-site manager. Sellers are divided on the subject of whether to inform their managers the property is for sale. Those who choose not to tell management are either afraid the managers will begin looking for other employment or they dont want to unnecessarily upset them.

You cant expect to keep your manager in the dark very long when you have countless buyers, brokers, lenders, appraisers, insurance representatives and engineers visiting the property, pretending to be interested in renting units and never actually doing so. The fact is your manager will figure it out sooner or later, and its best the news come from you. Also, if you keep the manager in the loop from the start, you can enlist his help in accomplishing a sale by making sure the property is presented in its best possible light.

Assure your manager the great majority of buyers wont seek a replacement. If the manager is not to be retained, explain you will provide a severance package, allowing him time to secure new employment. It is much better to have managers on your sales team than to keep them in the dark and run the risk they could harm a potential sale. You should, however, instruct your managers to direct all prospective buyers questions concerning the financial aspect of the property to you or your broker. You should also ask them to be completely honest when answering questions about physical aspects of the property.

4. Prepare for due diligence. Negotiating contracts can be time-consuming and expensive. Therefore, be prepared to respond to any offer you receive with a contract prepared in advance by your attorney or broker. You should be familiar with the contract, and it should allow for minor changes presented in your counteroffer. Request the buyer use this same agreement if negotiations are to continue.

Any contract will contain a list of items to be delivered to the buyer for review during the contingency period. Those items should be prepared in advance and delivered to the buyer quickly to minimize the time required for due diligence. Items typically included are:

• Last two years and year-to-date income and expense statements
• Most recent real estate tax bill and notice of valuation.
• Current rent roll.
• Most recent ALTA Survey and Phase I environmental report. (If you dont have these, get them done before marketing begins. Each respective engineer should understand the reports will be updated for the buyers benefit at a nominal charge.)
• Building plans, if available.
• Service agreements and contracts, including Yellow Pages, insurance, computer service, and any other agreements with outside companies.
• Preliminary title report.
• Copy of loan documents for the existing financing.

5. Prepare for financing. You should know whether your sale will require the buyer to secure third-party financing. If an existing loan can or must be assumed, you should know what it takes to accomplish that and be prepared to share the information with the buyer. If an existing loan must be paid off, you should know the cost, if any, and be poised to deal with it as well.

Considering todays low interest rates, your buyer will likely want to put a new loan on the property. You or your broker should contact a number of prospective lenders and be ready to furnish whatever documentation they may require; this will facilitate the buyers loan application. The probability of a smooth and timely closing will be improved if you can provide your buyer with specific interested lenders names and phone numbers.

Although there may never have been a better time to sell a storage property, it is still important to plan the process and follow the plan.

Bill Alter has been a self-storage facility sales specialist with Rein & Grossoehme Commercial Real Estate since 1986. He has been responsible for the sale of more than 80 storage facilities totaling more than 4,500,000 square feet and more than $120 million. Mr. Alter can be reached at 602.954.0217 or [email protected].

Storm Nolans story probably sounds much like your own. His company, Whitt Properties of Fort Smith, Ark., owns self-storage facilities. He likes the business. Hes pleased with the profit margins. Hes not so pleased, however, when it comes to finding markets for new sites.

It gets harder every day to find new, profitable markets because of the saturation of these areas with new self-storage properties, says Nolan, vice president of development. We have already expanded into other areas, and we knew we needed to continue diversifying to really grow our overall business.

Like many self-storage owners, company founder and President Chris Whitt, who launched the business in 1998, found himself grappling with two big questions: What would his next investment be, and would his team have the skills to make it a success? In addition to convenience stores, a shopping center, hotels and a business park, he found another worthwhile venture: short-term lodging.

New Product, Same Business Practices

Nolan turned to Value Place for Whitts next enterprise. Value Place, a new concept in lodging called short-term residential, is a hybrid of an apartment building and hotel. It provides apartment-like accommodations with weekly rates starting at $149, depending on the market. The franchise was founded by Jack DeBoer in 2003.

DeBoer invented the extended-stay hotel concept and founded three successful hotel brands: Residence Inn, Summerfield Suites and Candlewood Suites. He also developed more than 16,000 apartments in the 1970s and the second-largest apartment developer in the United States.

Jack has always been a rule breaker and visionary. He doesnt accept conventional ideas or approaches, which makes him a fantastic and profitable entrepreneur, says Gina-Lynne Scharoun, president of Value Place Franchise Services. Scharoun is herself a new franchisee, having broken ground on a Tulsa, Okla., property in early 2005. Even DeBoers banker is on board. The owner of Kansas City, Kan.-based Security Savings Bank, he recently closed on a sevenproperty deal.

We first heard about Value Place last July and signed our agreement to develop seven properties just two months later, says Nolan. Whitt has already started construction on a facility in Bentonville, Ark., and will develop properties over the next three years in Little Rock, Ark.; Memphis, Tenn.; Reno, Nev.; and Addison, Texas.

What was so compelling about the venture? The development and operations were similar to self-storage facilitieseven the customer demographics were alike, says Nolan. We felt Value Place was a great way to leverage the business practices we already knew with a completely new product.

Thats a sentiment Scharoun has heard again and again. Self-storage owners want to make a good investment, without having to learn a new business, she says. Thats why they are very interested in learning more about Value Place.

The Specifics

Value Place plans to be the national low-cost provider of safe, clean, apartment-style lodging. In fact, the brand is built around four concepts: simplicity, low cost, safety and cleanliness. The product caters to business owners, contractors and others who need temporary lodging for job assignments or individuals who need short-term housing.

Before Value Place, most short-term residents had to settle for lodging that was dilapidated, overpriced or in undesirable areas, says Scharoun. We knew they deserved something better and wanted to provide a comfortable stay and options for extras.

Value Place offers studios, studio sleepers and studio doubles. All include a full-sized bed with storage underneath and a kitchen with fullsize refrigerator, stovetop and microwave. The studio sleeper includes a sofa sleeper. The double includes an additional full-size bed. Design and furnishings are straightforward and standardized, yet of high quality.

Amenities include towels and linens, cable TV and biweekly housekeeping. Residents can purchase or rent extras, such as dishes, cookware, utensils, VCR or DVD players, and high-speed Internet. The property also features locked, interior corridors and security cameras.

The 105- and 121-unit Value Place properties can be developed for about $30,000 per unit, according to Scharoun. Staff requirements, similar to self-storage, are very low: just four to five full-time employees. Streamlined operations and management procedures should be familiar as well: limited office hours, no food service, and a minimal number of check-ins and move-outs each day. A large percentage of residents stay for more than a week.

The facilities are very turnkey, says Nolan. Our employees dont need a high level of expertise to rent or maintain the facilities. That was a key consideration for us.Value Place can also be built on land suitable for storage sitesB-grade property bypassed by investors of higher-end properties.

Making It Work

Many self-storage owners are independent owners and want to stay that way. For this reason, they might question whether a franchise arrangement is right for them. According to Nolan, a Value Place franchise has several advantages:

• ExpertiseDeBoer and his management team have worked together for years at several successful hotel brands.
• Turnkey operationsValue Place uses proven procedures that incorporate Harvard Business School principles. Nolan says these smart yet simple operations and management models actually enhance control.
• Nationwide appealScharoun says the company has plans for more than 1,000 hotels over the next 10 years. The company estimates a market can support approximately one property for every 150,000 residents.
• Fast ramp-up of propertiesGenerally, self-storage facilities take anywhere from two to three years to reach occupancies higher than 90 percent. Scharoun says while performance may vary, a typical Value Place can achieve those occupancies in just six months. For example, one particular property had 67.63 percent occupancy in the first quarter of operation. By the third quarter, it was more than 95 percent occupied.
• Safety from a down economyThe travel industry is still trying to recover from the effects of 9/11. Scharoun claims Value Place is safer than most other lodging investments because many of its residents are regional and travel by car rather than plane to conduct business. Also, the affordable rates are attractive in a tough economy.

As we have with our former franchise groups for Residence Inn and Candlewood Suites, we do whatever we can to help ensure our franchise familys success, Scharoun says. The team often consults with franchisees bankers, helping them provide the necessary documentation for lenders. The company also offers innovative ideas for economical site selection. Its strategy is to select sites that are ahead of development demand but still high in traffic.

Nolan still believes in self-storage as a profitable investment and will continue to look for opportunities in the industry. In fact, Whitt just opened another facility last year. Its a good business, and well continue to look for markets, he says. Were just pleased to be part of an entirely new business concept with a lot of potential for growth. For more information, visit www.whittinc.com or www.myvalueplace.com.

Choosing the appropriate buyer (at the most opportune time) has never been more critical for an owner considering a sale. Following are some important issues to consider when selling a portfolio or single asset.

The Good News

Despite increases in short-term interest rates by the Federal Reserve, the nearterm outlook for self-storage dispositions remains optimistic. Ample liquidity in equity and debt markets, combined with low-cost debt, should continue to support acquisition values and keep downward pressure on cap rates.

Fierce competition among lenders benefits borrowers in terms of low interest rates and flexible terms. The conventional mortgage and commercial mortgage-backed security markets continue to drive the liquidity and low rates. Investor demand for securities is pushing conduit lenders to be more aggressive, creating competition from traditional funding sources. Leveraged buyers will continue to lead the market for pricing in transactions.

Concerns

As swiftly as capital has flowed into the market, it can just as quickly exit. Negative news such as falling rental rates or even defaults regarding one or more high-profile operators could affect investor sentiment toward the entire sector. A steady rise in interest rates will likely slow activity in highly leverage transactions, as the spread narrows between current cash yields from self-storage properties and the cost of financing. Even a gradual improvement in rents would only partially offset higher interest rates.

Competition from new self-storage development also limits purchasing interest of existing product. Income generated from properties and market values are no longer directly related. Many submarkets previously believed to possess strong barriers to entry no longer have this advantage. New facilities are getting approved in previously high-barrier markets with strict zoning regulations due, in large part, to the emerging sophistication in the aesthetics of new developments.

Types of Buyers

The increasing number of prospective purchasers makes qualifying each buyer more important. There are three distinct types of prospects for portfolios and for select single assets:

1. Existing operatorsThis group includes small, medium and large operators and REITs seeking to increase market share and achieve economies of scale.
2. New joint venturesThis group includes public and private joint ventures, pension funds, foreign investors and opportunity funds, each with capacity for placing funds from $20 million to more than $200 million.
3. New players entering the industry This third group of purchasers continues to expand and includes private investors seeking stable cash yields, 1031 tax-deferred candidates, and prospects seeking diversification from other property types, i.e., multifamily, retail and industrial.

Financial Interviews

Potential purchasers are now asked to provide in-depth information regarding ability to consummate a transaction. They must be prepared to disclose their source of funds, any approval process to close the transaction, and whether funds are provided through equity or debt sources.

Additional questions concerning debt requirements involve property appraisals. Many appraisers do not possess adequate information of recent self-storage transactions and have difficulty appraising higher-quality properties. Brokers specializing in these types of transactions may be helpful. A prospect may also be interviewed about equity commitments. Questions concerning internal-review committees and allocation amounts are specifically addressed.

Buyer Motivation

Some issues weigh more heavily than others in a prospects decision to acquire self-storage. Owners must be aware of these determining factors to assess the likelihood of closing a transaction without re-trading the price and agreed-upon terms. Some of these buyer motivations include:

Public Offerings. Self-storage operators weighing the future possibility of an initial public offering (IPO) may be motivated to bulk up their total assets to satisfy future public investors. Newly public companies often acquire stabilized properties that are accretive to company earnings. Nonstabilized properties that exhibit the potential to benefit from the companys repositioning expertise may also be considered.

Two companies that completed public offerings in 2004, Salt Lake City-based Extra Space Storage and Cleveland-based U-Store-It, proved to be among the most active bidders for self-storage. Prior to its IPO, Extra Space entered a purchase and sale agreement for the Storage Spot portfolio, with 26 properties and a price of $147 million. U-Store-It also entered an agreement before its IPO, for the 42-facility Metro Self Storage portfolio, listed at $184 million.

Committed Equity. Generally, newly formed joint ventures with previously committed investor equity must place funds quickly or risk losing their backing. Obtaining new rounds of equity is usually predicated on placing the original money. Additional motivation to acquire assets results when a prospect loses to a competitor for product.

Increasing Market Share. Prospects often pursue acquisition of properties in existing markets or those believed to be key to future development. Select assets are targeted in locations believed to complement existing holdings. Prospects also are aggressively pursuing select opportunities outside existing markets to add diversification and economies of scale to current assets.

Evaluating Offers

Evaluating competing offers for any sale has become more complex than ever. A matrix of submitted bids is used to highlight pertinent information for each (see above). Following are some of the categories used for comparison:

• Due Diligence and Closing TimeThe amount of time a prospective purchaser requires for physical, financial and legal due diligence is critical. A long duediligence period inherently increases risk associated with successfully closing a transaction. Debt and equity requirements can also change quickly in a dynamic market.
• Earnest MoneySignificant earnest money deposited into escrow may be a gauge of a prospects good faith, but the point when earnest money becomes nonrefundable distinguishes the best prospects.
• Financing ContingencyThe significant capital recently committed for self-storage makes this category even more important to sellers. Any offer requiring a financing contingency is less desirable than noncontingent offers. Prospects without a contingency may require fewer approvals for funding and, theoretically, close a transaction more quickly.
• Cash vs. Operating Partnership UnitsCapital-gains taxes are often a significant financial consideration for owners with a low basis in their properties. Public companies with an UPREIT structure provide a potential advantage by allowing owners the opportunity to contribute their properties in tax-deferred transactions using Operating Partnership (OP) units in lieu of cash. The OP units are similar to shares of stock in the company and do not trigger a taxable event until they are sold, while offering potential appreciation in their value.

OFFERING MATRIX Prospect Purchase Price Due Diligence Closing Date Earnest Money Finance Recent Purchase Comments Private Investor $15.5M 30 days 30 days $50,000 Yes No Owns multifamily Joint Venture $19.5M 45 days 60 days $150,000 No Yes Pension fund equity partner REIT $18.5M 60 days 30 days $185,000 No Yes Offers Operating Partnership units Mid-Size Operator $20.0M 45 days 45 days $100,000 No In past Owns in market Opportunity Fund $21.0M 30 days 15 days $200,000 No No New player Section 1031 Candidate $19M 90 days 45 days $100,000 Yes No New player, did not inspect property

• Seller FinancingOccasionally, purchasers will request the seller finance a portion of the purchase price to help achieve their projected target internal rates of return. Seller financing on select portfolios can be 10 percent to 25 percent of the purchase price. It helps to bridge gaps from insufficient loan proceeds with lower costs.
• Section 1031 Tax-Deferred ExchangesPrivate buyers seeking to consistently defer their capital-gains taxes are excellent prospects for primarily single-asset acquisitions. Many of these candidates are not initially aware of the specific management requirements of self-storage.

Every owner has myriad issues to consider when selling his property. But due to the vast amount of capital available, coupled with low interest rates, it has never been a more opportune time for owners to consider selling a portfolio or single asset.

Marc A. Boorstein is a principal with Chicagobased MJ Partners Real Estate Services and has been involved in the purchase, sale and financing of more than $500 million in real estate nationwide since 2000. Mr. Boorstein is a regular speaker and author concerning the trends within the self-storage industry. He can be reached at 312.726.5800 or [email protected].

Youve decided to purchase a self-storage facility and you need to buy insurance. Many buyers want to know how much to put in their pro formas for this coverage. While there is no black-and-white answer, there are factors that contribute to the insurance premium. Knowing them in advance may help you determine what to expect.

Location not only determines the possible resale value of a property, it affects insurance rates. Insurance companies evaluate potential policyholders in terms of risk exposures and the unique characteristics of each site. Storage facilities in high-risk locations may pay more for coverage or have trouble obtaining it altogether. Businesses in low-risk areas generally face fewer obstacles. Following is a partial list of exposures that can affect insurance in your area:

Weather. Locations exposed to extreme weather conditions may be considered high-risk. Areas are usually divided into territories based on their history of loss from perils such as windstorms, hail, tornadoes and hurricanes. Facilities in regions with records of high losses will have higher rates than those in areas of low risk.

Fire-protection class. Location also relates to a facilitys level of fire protection, as the distance of a site from a fire hydrant and station will affect response time in the event of a fire. Call the local fire department to determine your fire-protection class code. Insurance companies use rating schedules, which assume a facility inside a city or town with adequate fire protection is safer than a property outside the city limits. Those outside the limits will face higher premiums. Insurance coverage can also be affected in areas with a limited water supply.

Neighboring structures. A facility faces external exposure when it is near any other structure or potential source of fire, assuming fire in the other structure could spread. This may affect insurance rates. As a general rule, your facility grounds and those of neighboring buildings should be kept neat and orderly. This puts all adjacent property at lower risk for fire than those surrounded by debris.

Crime. Self-storage facilities in industrial and inner-city areas may be more susceptible to burglary, vandalism and other criminal activity, which can also hike insurance premiums. Some statistical research can help you determine the amount and types of crime in an area. In addition, take a drive and see how well the community is maintained. Consider locations in neighborhoods that demonstrate pride of ownership. Facilities with access gates and strong security implementation will have better insurance rates.

Building Age and Construction

A buildings constructionwhether it be wood frame, brick, concrete or noncombustible masonryestablishes a basis for its insurance costs. The use of fire-resistant materials, as well as the installation of sprinkler systems, fire extinguishers and alarms, may reduce the amount of loss during a fire. The result is reduced risk exposure and lower insurance premiums.

A buildings internal structure can affect ratings too. Filling otherwise fire-resistant buildings with wood partitions, floors and stairways nullifies many of the benefits of its construction, while flame-retardant separations and doors can help preserve the structures integrity. The size and design of a facility will determine its overall value, which may also affect the insurance premium.

Finally, the age of a building is considered, as a facility will require additional repair as it gets older. Maintenance is vital. If you are purchasing an older facility, make sure it was properly cared for by the previous owner. Have it professionally inspected for items such as leaking roofs and proper electrical wiring.

Purchasing a self-storage facility can be exciting and lucrative. Identifying and correcting risk exposures and securing adequate insurance coverage is a good way to protect your business from property loss and liability. An insurance agent specialized in self-storage can help you identify the coverage you need.

This article is a guideline to aid in minimizing risk in self-storage. Theinformation it contains is intended to be of general interest and does notaddress the circumstances of any particular individual or entity. Nothingin this document constitutes legal advice, nor does any informationconstitute a comprehensive or complete statement of the issues discussedor the laws relating thereto.

Amy Brown is part of Universal Insurance Facilities Ltd., which offers a comprehensive package of coverages specifically designed to meet the needs of the self-storage industry. For more information or to get a quick, no-obligation quote, call 800.844.2101; e-mail [email protected]; visit www.universalinsuranceltd.com.

All sales and exchanges are taxable, unless a provision of the Internal Revenue Code claims their gain or loss is not recognized. Section 1031 is one such proviso. The rationale behind it is when a taxpayer exchanges an asset for another that is similar, there is a continuity of investment, and he should be able to defer payment of the tax. If there is a gain, it is carried over to the new asset. It is taxed later, in the event there is a sale or exchange in which no non-recognition rule applies.

Its a simple principle, but there are many regulations you must know to gain a working knowledge of Section 1031. The following will help you navigate the process as well as provide pointers on choosing an exchange professional, known as a qualified intermediary (QI).

Exchange Types

There are four basic types of exchange: simultaneous, forward, reverse and improvement. Lets take a look at each:

• A simultaneous exchange is used when two taxpayers have property they want to swap while retaining their original tax basis. This type of exchange rarely happens, due to the improbability of two parties being in such a situation.
• A forward exchange is used when a taxpayer sells his relinquished property first, and then acquires the replacement property. Costs for this transaction are nominal, and the documentation is relatively simple. Each forward exchange has issues, but they are easily identified and solved by a professional.
• A reverse exchange is used when a taxpayer locates suitable replacement property before the sale of the relinquished property. The IRS established a safe harbor for reverse exchanges with Revenue Procedure 2000-37, 2000-2 C.B. 308. There are two general types of reverse exchanges, depending on the property: exchange first, in which the QI acquires the relinquished property on behalf of his client, and exchange last, in which he acquires the replacement property. Transaction fees are higher than for a forward exchange. However, a reverse exchange helps solve the difficult issue of timing.
• An improvement exchange is a special type of reverse exchange in which a QI acquires a parcel of undeveloped land, obtains construction financing and builds improvements. He then transfers the improved asset as replacement property to complete an exchange. This structure helps solve another tricky issuevalue.

Exchange Basics

For each exchange, a taxpayer must follow all the necessary regulations to qualify for tax deferral. There are several basic foundations to Section 1031:

Like-Kind Property. Assets acquired in an exchange must be like-kind to those relinquished. Generally, in real estate, any fee-simple interest is like-kind to another. A leasehold interest with a term of 30 or more years (including options) is also like-kind to a fee-simple interest.

The term like-kind refers to the nature or character of a property, not its grade or quality. The propertys use is not relevant; for example, unimproved land can be exchanged for a multifamily building. Interests other than fee interests, such as leaseholds of less than 30 years, easements and transferable development rights, raise interesting likekind issues that often require analysis of state real-property law.

Qualified Property. Property involved in a 1031 Exchange must be of a qualified use. Only relinquished property held for investment or productive use in a trade or business is eligible. The replacement property must also be held for investment or productive use in a trade or business. Excluded assets include inventory; stocks, bonds, notes and securities; and partnership interests. Personal-use property, such as a vacation home, is generally not eligible.

Time Lines. A 1031 Exchange also involves strict time restrictions. First, there is an ID period, during which the taxpayer must identify a limited number of replacement properties in writing to the QI. It begins on the day the relinquished property is sold and ends on midnight of the 45th day thereafter (irrespective of whether that day is a Saturday, Sunday or legal holiday), counting the day after the sale as day one.

The taxpayer must also adhere to timelines for the exchange period itself, which begins on the day the relinquished property is sold and ends on midnight of the 180th day thereafter (irrespective of whether that day is a Saturday, Sunday or legal holiday), counting the day after the sale as day one. He must commence and complete his entire transaction during this period; however, there is an exception: If the taxpayers tax return for the year in which the property is sold is due before the last day of the exchange period, the time frame will be less than 180 days, unless he obtains a filing extension. For example, a calendar-year taxpayer with an April 15 return due date who begins an exchange after Oct. 17 will have a shortened exchange period.

Taxpayer Identity. Also important in a 1031 exchange is taxpayer identity. For the purposes of federal income tax, the person selling the relinquished property must be the same one acquiring the replacement property. This may be an issue in situations that involve partnerships, tenant-in-common arrangements and mid-exchange corporate reorganizations. The use of a single-owner entitydisregarded as separate from the owner, such as single-member LLCto acquire replacement property will not change the identity of the taxpayer.

Proceeds. The taxpayer must avoid actual or constructive receipt of sale proceeds. If he receives proceeds from the sale of the relinquished property during the exchange period, the transaction will be a taxable sale, not a tax-deferred exchange, even if he ultimately receives property from the QI. The taxpayer can receive proceeds from a party to the transaction other than the QI, such as the buyer or the title company, at the time of sale, though the proceeds will be taxable.

Generally, there are only three circumstances in which the exchange proceeds can be released to the taxpayer:

1. At the end of the 45-day identification (ID) period, if there is no other identified property for the taxpayer to acquire.

2. At the end of the exchange period.

3. After the end of the ID period but before the end of the exchange period. This is true only if the taxpayer has acquired all of the replacement property he is entitled to receive under the exchange agreement. Otherwise, the proceeds can be used by the QI at the taxpayers direction to buy identified replacement property and pay certain transactional expenses.

There are many other regulations that must be followed to qualify for safe-harbor treatment. A QI should be able to provide you with additional information regarding the overall procedure.

Choosing the Right QI

The most important step in completing a 1031 exchange may be choosing the right QI. What should a taxpayer look for in a professional?

• ExpertiseAn intermediary should have multiple years of experience in handling significant exchange transactions. One who has worked with significant sophisticated taxpayers and their advisors has a wealth of experience to share.
• ProfessionalismYoure only good at what you do every day. Many QIs operate an exchange business as well as a law or accounting practice. The QIs sole business should be facilitating exchanges.
• CommunicationMake sure the QI clearly defines his compensation package. He should also communicate important deadlines and provide reminders.
• Personal ServiceThe QI should offer assistance in resolving issues relating to structuring and completing your exchange through the entire process, beginning to finish. His services should complement those of a tax advisor.
• ReferencesAsk the QI for references, then call the contacts and ask about his knowledge and experience.
• Security of FundsBe informed about the financial institution the QI uses to hold funds. For tax purposes, money should be in an account in the QIs name. Your access to funds during the exchange period will be limited by applicable regulations, but your signature, as well as that of the QI, should be required to initiate any money-related transactions. You should receive a confirmation of receipt, documentation on all transfers and monthly statements.
• FlexibilitySome QIs, particularly institutions, are inflexible about their paperwork, even though their documents may not accomplish your objectives or provide you sufficient protection. You need a QI who can be flexible in meeting your legal and tax requirements.

A Section 1031 exchange is a valuable tool that should be given consideration whenever you sell a property. The challenges that arisewhether related to partnership, timing, value or replacement propertycan often be solved. The 1031 is a strategy worth exploring because, to quote Winston Churchill, There is no such thing as a good tax.

Thomas E. St. Jean is president of Compass Exchange Advisors LLC, a Qualified Intermediary based in Kingston, Mass. He can be reached at 781.582.8000 or [email protected]. Nicholas Malagisi is president of Storage Realty Advisors, a commercial real estate brokerage firm specializing in the sale of self-storage facilities, primarily in the Northeast. Malagisi has participated in the sale of more than $93 million worth of self-storage properties since 1993. He also prepares feasibility studies for new projects. For more information, call 716.633.9601; e-mail [email protected]; visit www.storagerealty.com.

• Smaller facilities just might be the newest opportunity in todays competitive self-storage environment. If it were feasible to make them work in urban markets, imagine what else might be possible:
• Existing operators could build small satellite facilities that share operating expenses with an existing site.
• First-generation facilities could renovate, eliminating the resident managers apartment and all on-site management, upgrade electronic security systems, and target unit mix to a specific local demand, allowing them to compete with newer sites.
• Investors such as attorneys, accountants, contractors and other entrepreneurs could use their existing offices to serve as the center of operations for small satellite facilities that would share operating expenses.

Which brings us to the million-dollar question: Is it financially viable to build this type of small, automated facility in a major market like Los Angeles, for example? I think the answer is yes. Following is a demonstration of why.

A Sample Site

Lets take a look at a sample project and potential income using two different approaches: replacement cost and direct capitalization. We have a 15,000 square-foot facility on a 40,000-square-foot site. Instead of on-site management, it has a kiosk and heavy electronic security. The unit mix is designed to serve the specific needs of the local market. The facility has 150 units ranging in size from 50 to 150 square feet, with the average unit size being 100 square feet.

Cost Approach. To estimate the cost to develop this hypothetical facility, I relied on Marshall & Swift Valuation Services for estimates of direct construction costs. The base building specifications are:

• Construction class(S) Steel
• QualityLow-cost
• Number of storiesOne
• Height per story14 feet (base)
• Total floor area15,000 square feet
• Base cost$16.39 per square foot
• Current cost adjustment1.06
• Location adjustment (Los Angeles)1.14

The final direct cost (base cost multiplied by the current cost adjustment multiplied by the location adjustment) is $19.81 per square foot.

In addition to direct building costs, there are indirect costs: real estate taxes, legal and accounting fees, lease-up, facility setup, and technology (kiosk and state-of-the-art security). Of these, lease-up is the largest. It represents the revenue lost during the time between when the doors first open and stabilized occupancy is reached. In this scenario, I assumed lease-up would take approximately six months. The estimate for setup and security takes into consideration the added cost of a kiosk and its monthly fees as well as extra security cameras and alarms.

Replacement-Cost Approach Direct Costs Building Costs 15,000 SF @ $19.81 PSF = $297,150 Site Costs 25,000 SF @ $3 PSF = $75,000 Subtotal $372,150, or $24.81 per net rentable SF Indirect Costs Real Estate Taxes $6,468 Legal and Accounting $3,722 Lease-Up $115,000 Setup/Security $100,000 Subtotal $225,190 Subtotal Improvement Costs $597,340, or $39.82 per net rentable SF Entrepreneurial Incentive 20% of improvement costs plus land = $239,468 Subtotal $836,807, or $55.79 per net rentable SF Site Costs 40,000 SF @ $15 = $600,000, or $40 per net rentable SF Total Replacement Costs $1,436,807, or $95.79 per net rentable SF

 

Income Approach. To prove the financial feasibility of this hypothetical project and model the direct-capitalization approach to value, I used third-quarter 2004 operating performance reports for Los Angeles, produced by Self Storage Data Services Inc.:

• Rental RateThe monthly rental rate for a ground-level, nonclimate-controlled, 10-by-10 unit in Los Angeles was $150. To be conservative, no ancillary income is included in our example, even though late fees would be collected as usual at our sample site.
• VacancyFacilities in Los Angeles were operating with a 7 percent physical vacancy rate. To be traditional, I used a 15 percent vacancy rate in our model.
• Gross IncomePotential annual gross income for 15,000 square feet at $1.50 per square foot is $270,000. If you subtract vacancy at 15 percent, you have an effective gross income of $229,500.
• ExpensesTotal expenses were based on the analysis of hundreds of larger facilities and adjusted to reflect the lack of an on-site manager; but they included 5 percent for an off-site manager and maintenance personnel. Total expenses were $4.41 per square foot of net rentable area, or 29 percent of revenue. Subtract this from your effective gross revenue, and you get a net operating income of $163,405.
• Cap RateAs of press time, cap rates for traditional investmentgrade facilities in Southern California were in the mid to high 7 percent to low 8 percent range. I used a 9 percent cap rate to reflect any perceived risk. At this rate, and with our net operating income, we end up with a final value of $1,815,611, or $121.04 per rentable square foot.

Direct Capitalization (Income Approach) Scheduled Gross Income 15,000 SF @ $1.50 PSF = $270,000 Subtract 15% Vacancy $270,000 - $40,500 = $229,500 (Effective Gross Income) Subtract Expenses $229,500 - $66,095 ($4.41 x 15,000 square feet) = $163,405 (Net Operating Income) Overall Value $163,405 / .09 (9% cap rate) = $1,815,611

Development Yield

Using a cost approach, our facility value is $1,437,000, or $95.80 per square foot. Using the income approach, the value is $1,816,000, or $121.13 per square foot. These leaves a 26 percent spread, providing an additional entrepreneurial cushion of about $380,000. That brings the profit to higher than 50 percent, more than twice the profit on traditional facilities.

Development yield (net income divided by total construction costs) is 11.4 percent ($163,405 divided by $1,436,807), which suggests the project is, in fact, feasible. When we go back into our examples and use a more realistic vacancy rate, add modest late fees, and consider sharing expensessuch as advertising, maintenance personnel and administrativewith other facilities, projections get very exciting. The point is if our hypothetical project can work in Los Angeles, where land costs are $15 per square foot and real estate taxes are more than $1.50 per square foot, it should work most anywhere.

A Final Solution

At this point, not all of you are convinced of the feasibility of this innovative concept. But there are markets in which it will work. In fact, it has been working for some operators.

Small, unmanned facilities may be an additional source of income to supplement existing self-storage operations. They can also be a source of revenue for professionals in other industrieswithout a need to invest large amounts of capital. Finally, they could be the answer to those first-generation facilities trying to compete with the sizzle of newer sites.

Charles Ray Wilson, CRE, MAI, is president of Charles R. Wilson & Associates Inc., a firm specializing in the valuation of self-storage facilities nationwide. Mr. Wilson also owns Self Storage Data Services Inc. (SSDS), a research firm based in Pasadena, Calif. For more information, call 626.792.2107; e-mail [email protected].

A cap rate is a basic valuation tool that represents the projected one-year return of a property as if it was purchased with all cash (no financing). The advantage of using a cap rate is it accounts for vacancy and credit losses, as well as all operating expenses. However, there are limitations. For example, a cap rate doesnt take into consideration financing or any incometax implications. Nonetheless, its an effective tool when accurate information and the correct methodology are used.

The Calculation

The key to any valuation using a cap rate is determining an accurate net operating income (NOI). NOI is gross income minus operating expenses (excluding interest and depreciation). For example, a property with gross income of $300,000 and expenses of $100,000 has an NOI of $200,000.

A cap rate is determined by dividing a propertys NOI by its sales price. For example, a property with an NOI of $200,000 and a sales price of $2.2 million has a 9.1 percent cap rate.

Accuracy Counts

To correctly calculate a cap rate and get a fair comparison of properties, you need to obtain accurate income and expense information for each property and confirm the computation for each was performed in the same manner. When determining the NOI of any property, the income is usually easier to verify than expenses. There are many sources to help determine actual revenue collected, such as rent rolls, occupancy reports, management summary reports, revenue-history reports, deposit reports, etc.

The area of operating expenses is where more discrepancies occur, as these items must sometimes be extracted from categories not specific to the operation of the facility. There may also be missing expenses that should be included, for example, payroll for an on-site manager (unless the plan is to operate the site remotely), third-party management fees, replacement reserves, insurance, advertising, and repairs and maintenance. Please note that operating expenses do not include any debt service or depreciation, so these items should be excluded.

Once the correct NOI has been established, a buyer can use a cap rate to obtain an initial assessment of any property. Conversely, a seller can use it to establish an appropriate asking price. Regardless what side of the transaction you are on, absence of a correct NOI renders any valuation using a cap rate meaningless, so thorough due diligence is a must.

Market Rate

Its easy to see that a lower cap rate produces a higher sales price and is better for a seller, while a higher cap rate produces a lower sales price and is better for a buyer. Setting aside the goals of both parties, the market will ultimately reflect equilibriumwhat buyers are willing to pay and sellers are willing to accept. This will be the point at which similar properties in the same market will sell.

When there are enough sales of like properties in a single market and their NOIs were calculated in a similar manner, a market cap rate is established. At this point, the market has essentially spoken and, with few exceptions, the vast majority of properties will sell very close to this cap rate. Buyers who make below-market offers and sellers seeking above-market prices dont consummate many deals.

In practice, the market cap rate is considered more of a range than an exact number, given that no two properties are exactly alike. There are many characteristics that differentiate similar facilities, such as age, location, occupancy history, deferred maintenance, land for future expansion, etc. The range typically covers half a percentage point, for example, 9 percent to 9.5 percent. The upward or downward movement of this range primarily depends on external market factors such as interest rates, the availability of capital, the number of properties for sale, and the number of prospective buyers at any point in time.

The widely held belief that the spread between interest and cap rates remains narrow regardless of other factors is based on the realization that real estate values are directly influenced by the cost of financing. Lower debt service means investors can obtain their desired internal rate of return, or yield, over a projected holding period at a higher purchase price. As a result, real estate values rise (and cap rates decline) as buyers compete for properties.

For example, during the recent period of low interest rates and more-than-adequate flow of capital, cap rates appeared to reach record lows. On the other hand, when interest rates rise, the opposite occurs. Higher debt service means prices tend to decline (and cap rates rise) for buyers to obtain their desired yield.

Again, a cap rate isnt the only available tool, but it can play an important role in self-storage valuation. For buyers, it is often the first method used to filter potential acquisitions, providing a quick and efficient way to determine whether a property warrants further examination. For sellers, its a quick and fairly accurate method to determine what a facility will sell for in a market. The important thing to remember is a cap rate, like any other valuation method, is only as accurate as the data used in its calculation.

Rob Schick is senior vice president of Revel & Underwood Inc., which was established in 1973 and specializes in the disposition and acquisition of self-storage facilities. He has more than 15 years of experience in investment real estate sales and represents self-storage buyers and sellers throughout the United States. For more information, call 800.875.5439, ext. 166; e-mail: [email protected].

Construction Corner is a Q&A column committed to answering reader-submitted questions regarding construction and development. Inquiries may be sent to [email protected] .

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Q: The back drive at our facility is dark, and the camera posted there shows only a black picture at night. Installing lights would be expensive. Are there any other solutions?

Jack in Springfield, Mo.

A: Aside from the cost of installing them, lights can also be expensive to operate. There are good day/night cameras on the market that may work for your situation. Some have an auto iris that adjusts to varying brightness. These are good if there is some available light. Another option is night-vision cameras that switch to black-and-white operation at night. These have infrared LED illuminators that emit low-level light invisible to the human eye. In the daytime, they operate as regular color cameras. Make sure any cameras used outside are weatherproof.

Q: What are the basic requirements for installing a keypad at a facility gate?

Stacy from Little Rock, Ark.

A: Keypads generally require wiring, which is best protected inside conduit. If possible, conduit should be installed from the keypad location to the gate motor and back to the office gate controller. Some keypads can store codes locally, eliminating the need to run conduit back to the office. This may be an option if the keypad is for a gate used by few people, such as at a rear facility entry. In this instance, the keypad would still need to tie into the gate motor. Keypads also need something on which to sit. A gooseneck or bollard could work. Keep in mind the wire must pass through the gooseneck to the keypad.

Rod Davis is the installation manager for QuikStor, a provider of self-storage security and software since 1987. For more information, visit www.quikstor.com.

The Self-Storage Broker

The first thing to do is to contact a qualified self-storage broker in your market area. There are a number of agents who specialize in this field. A reputable professional can give you a tremendous amount of market knowledge, including local sold and rent comparables and, most important, information on new self-storage facilities in the planning stage, under construction or in lease-up. Finally, a good broker can help the first-time self-storage investor with the following questions:

1. What type of return can you expect?
2. How much should you spend?
3. How do you make an offer?
4. What do you do about management?

What Type of Return Can You Expect?

Self-storage has always maintained a higher cap rate than all other investments in the real estate market. A few years ago, storage facilities were selling in the 9 percent to 11 percent cap-rate range. Today, the cap rates range from 7 percent to 8 percent. For the sake of comparison, apartments are selling at a cap rate of 5 percent to 7 percent.

Take a look at this recent example: A buyer had $2 million in certificates of deposit earning approximately 1.5 percent. The facility he purchased sold at a 6.9 percent cap rate. He put the $2 million down on a new mortgage of $3 million, at a 5.9 percent fixed interest rate for 10 years, in a nonrecourse loan. The buyer was now looking at a return of approximately 8 percent with a property that had rental and operational upside. In addition, he now has an appreciating asset with a depreciation schedule. Which sounds better, a 2 percent return in CDs or an 8 percent cash-on-cash return from day one?

How Much Should You Spend?

The first thing to consider is how much down-payment money you have available and how much of a loan you want to put on a facility. The rule of thumb in todays market is a down payment of 30 percent, though it may be higher on a lower-priced property (one with a purchase price below $1.5 million). The trouble with these facilities, however, is most of the large self-storage mortgage companies are not interested in placing a loan below $2 million.

How Do You Make an Offer?

A potential buyer should start the purchase process with a letter of intent, which briefly addresses some of the larger issues: the purchase price, down payment and loan terms. It identifies the period of time in which the buyer will receive a loan commitment in writing from a lender for the new mortgage. It also outlines details of the inspection or due-diligence period, during which the buyer will conduct research of the facilitys books and records, market area and overall operation. Finally, it should include a target date on which the buyer and seller can expect to close the deal.

After the letter of intent is signed by both parties, the buyer and seller can agree on what type of purchase contract to use. In some cases, they will choose a boiler-plate real estate contract from a state authority or an in-depth self-storage purchase contract. In others, the buyer or seller may request to have his personal attorney draft the document.

What Do You Do About Management?

The due-diligence period is the best time for the buyer to determine if he plans to handle his own on- and offsite management or hire a third-party company. On-site management involves the daily operation of the facility, including answering phones, renting and cleaning units, dealing with delinquent tenants and, most important, getting the money to the bank. Off-site management includes staffing, paying bills, keeping track of receipts, balancing the books, marketing and overseeing any lien sales.

Most small individual investors hire an outside firm that specializes in the management of self-storage facilities. These companies can literately make the investment like a triple-net lease, while the owner/ investor just gets a balance sheet, profit-andloss statement and, most important, a check at the end of the month.

Self-storage is a great business. It enjoys ease of management and operations, and has the highest return of all real estate investments. The trick is to make sound decisions and buy right.

Carl E. Touhey is a self-storage specialist in the real estate firm Bancap Self-Storage Group Inc., which has brokered more than $600 million in self-storage transactions. In the past two years, Mr. Touhey has brokered more than $70 million in the Northern California market. He and his family own self-storage facilities in Florida, New York, Texas and Vermont. For more information, call 650.368.2216; e-mail [email protected].

Most business owners would like to try new money-making opportunities with little or no risk. Its easy to say, but can be difficult to do. If you already have a self-storage or moving and storage operation, you have little or no business risk when you provide commercial recordsstorage services using the records storage lite (RS-lite) model I have addressed in my past several columns.

Is It Risky?

The introduction of a new service and the uncertainty about its potential can create riskthe possibility of loss, damage or any other undesirable event. Most businesses desire low risk and hope for a high probability of success and profit. When considering records storage for your operation, ask yourself: Where is the risk, and how significant is it?

Any change, good or bad, includes some potential for hazard. Your own analysis will usually reveal potential dangers: investment costs, equipment and software, sales potential, personnel and labor costs, and unpredictable demand. According to risk-management experts, there are three things you need to know when facing a new venture: What can happen? What could result? And what can be done about it?

What Are the Costs?

The costs for implementing records storage in a self-storage environment include those for space, people, processes and management. In the storage business, many of these requirements are already in place. Now you just need a method of records-storage operation, including sales templates and training, software (a small-business edition) and racking (one unit at a time).

Is There a Right Size?

When it comes to operating records storage in self-storage, there are no hard and fast rules about market or facility size. RS-lite can work in any community, modest or high-end properties, even in multiple storefronts (see last months column). You set the rules and decide what services you will offer. Simply determine where you want to begin. You can always take things up a level down the line.

Is There an Exit Strategy?

One of the most fascinating things about the records-storage business is the service contracts are what make the value, not the real estate. As a self-storage operator, you already have your real estate investment. Records storage simply dwells within it. If you want to get out of the business, just sell the contracts to a competitor.

Today, there are many more buyers than sellers in the commercialrecords market. Books of business are much sought after by industry players. Of course, selling contracts presumes you have the right agreement in place with each client. The industry standard contract is tried and true and offers many benefits including: long terms with an evergreen clause, withdrawal penalties, price increases, limitations of liability and more. It is available from the industry trade association, PRISM International (www.prismintl.org).

Is There a Downside?

In the past, there have been several drawbacks that have kept self-storage operators from entering the records-storage business. Today, however, because of the current use of technology, strategic outsourcing, batch processing and personnel abatementall parts of the RS-lite operating modelthere are few if any downsides.

Technology makes the processes simple. Outsourcing most of the work provides greater control and decreased cost. Getting the client or an outsourced resource to do the work at the right time makes the reduction of staff not only possible but easy. (For more information, refer to my column on Manpower for RS-Lite in the November 2004 issue, available at www.insideselfstorage.com.)

How Profitable Can It Be?

There is no ancillary service in the storage business that matches the profitability of records storage. Some would argue for art, boat/RV or wine storage, but they simply dont experience the same volume as records storage, which can be a thousand times greater.

Storage by the cubic foot means you rent air space as well as floor space. And records storage means long-term, renewable contracts. Many professionals in the industry say it creates permanent revenue, simply because each clients volume grows every year. Records accounts stay with you long after self-storage clients have moved on.

When it comes to risk, you need to know what can happen, what could result, and what can be done about it. If you decide on records storage, you can easily construct a low-cost model with an early exit strategy. If you like the business, you can take it to a higher level with no lost steps. What could be better than low risk, low cost, high profits and a built-in exit strategy?

Regular columnist Cary McGovern will be exhibiting at the Inside Self-Storage Expo in Las Vegas, Feb. 23-25. He will also present a seminar on Records Storage Lite. Mr. McGovern is the principal of FileMan Records Management, which offers full-service assistance for commercial records-storage startups and sales training in commercial records-management operations. For help with feasibility determination, operational implementation or marketing support, call 877.FILEMAN; e-mail [email protected]; www.fileman.com.