The level of a person’s knowledge and expertise combined with their financial resources is most often the deciding factor in whether they build or buy a self storage property. This statement applies to private operators and self storage REITs, as well as the seasoned real estate developer. Each must make their own choice based on their desired return on investment criteria (ROI) and within an acceptable level of risk.
To determine whether you fit into the builder profile or the buyer profile, this article assumes that the reader has the financial resources to do either. Now the question is….
ARE YOU A BUILDER (DEVELOPER)?
Before you can answer this question, there are some critical factors that must be considered.
First, do you have a complete understanding of the market? Can you determine if the existing supply outweighs the market’s potential demand? No matter what class of facility is developed or how talented the facility’s management is, it will not lease up without required market demand. Today’s builder / developer must have the knowledge and abilities to properly investigate the competition within a trade area determining their strengths and weakness, their size, their occupancy level and each competitor’s rents. Once armed with this information, the seasoned builder / developer can prepare the financial projections necessary to determine the economic feasibility of a facility within a targeted market.
Secondly, after conquering the market question, do you have the required development experience necessary to go forward? Do you have a team of qualified development professionals…. architects, civil engineers, structural engineers, MEP engineers, environmental engineers, soils engineers, surveyors, land planners, real estate attorneys, title company, etc? Do you and your development professionals have the knowledge of the city, county, state and federal jurisdictional requirements for that market? Don’t make the mistake of assuming that building a self storage property is simple! Zoning and other jurisdictional requirements are now extremely complicated in most markets and their complexity is increasing every year.
How about design and construction experience? Do you have a design team that knows anything about designing self storage? Can they work together to insure the plans and specifications are completed in a timely and cost effective manner? Will they incorporate all requirements designated by governmental authorities while insuring that the design is most cost effective? Do you have a qualified general contractor? How many projects has this contractor completed? Making the right decision about the design and construction team is essential to a developer’s success. Choose a team that has a proven history working together and that have extensive experience.
Finally, construction is complete and the property is ready to start operating. Do you have self storage management experience? Remember this rule: no matter how well built a property may be, nothing happens without management. No facility leases itself. It’s the professionalism demonstrated by the smiling individual behind the counter that makes a successful store. An understanding of the customer’s needs, proper leasing techniques; “out of the box” marketing efforts and solid operations management procedures will always be the deciding factor in a facilities success.
THE ADVANTAGES OF BEING A BUILDER
If you answered “yes” to a majority of the questions above, you already know the advantages of being a builder / developer. WHY? Because you are in complete control of every aspect of design, construction and development! The finished product is your baby, your vision. You control the cost, as well as the cost effectiveness of your design. You are not a passive investor. You have the flexibility to make all the necessary changes to increase the property’s financial outcome.
So, what about financial return on investment (ROI)? Your ROI may vary significantly based on the market, the builder’s level of experience, and whether he chooses to hold the property for a long term investment through its operation, or a short term capital gain from its sale.
The long term capital gains scenario means “before tax” cashflow ranging from $100k to $250k annually, depending on the loan amount and the original equity put into the deal. ROIs range from 25% to 40%, also depending on the loan and equity. A property can be refinanced upon obtaining 90% stabilized occupancy. At refinance, the owner’s equity is paid back and the new loan is a non recourse loan.
Through the short term sale of a stabilized self storage property, the builder can realize a before-tax profit ranging from $500,000 to $3,000,000.
THE DISADVANTAGES OF BEING A BUILDER
Developing, designing and building a self storage business from conception to fruition is undeniably a gratifying journey. Nonetheless, all of the risks will rest firmly in your hands. The course is time consuming and labor intensive. Shortfalls in construction budgets and leasing costs come out of your wallet. Fair Market Value (FMV) is not realized until 90% of the property is leased, a goal that, contingent on the market, will be reached two to three years after construction completion. You are limited to regions that you know, or you spend tons of money researching new markets. Experience in the field is imperative. If you are not an expert in the self storage industry, you have no choice but to curb your risk by taking into service those who have earned their expertise.
ARE YOU A BUYER?
Your answers to the questions posed to the prospective builder can assist your verdict of buying verses building. However, there are other deciding factors. Perhaps you’re a real estate professional without local market expertise. Or you answered “yes” to most of the questions raised to the builder, but lack a qualified development team. Maybe you’re a first time investor, or someone who has money to invest but is concerned about risk. Whatever circumstance or reason that makes you a buyer, purchasing a functioning facility is far less daunting than starting from step one. Still, the decision to buy an established self storage property must be preceded by its own unique set of qualifiers!
As with any business venture and especially for buyers, the first consideration revolves around predetermined investment strategy and ROI goals. Buyer questions include…is this a good investment? Does it meet our ROI criteria? Do we have the level of financial resources needed to achieve our investment strategy? What is the level of risk? The questions continue.
The fall back qualifier to deciding to build or buy, once again, is a question of knowledge and experience. Do we have the adequate knowledge of the market? Do we…(insert all of the same questions posed to the builder, but this time with different responses.)
ADVANTAGES OF BUYING
The first and foremost advantage of buying is minimal risk. Buying a financially proven property with a track record of stabilization is one of the best minimal risk investments available. The market has been demonstrated through leasing and the property is well established in a verified market. Rents and operating expenses have also been confirmed. Contrasting the builders gamble with a 24 to 36 month “on the come” ROI, your money is put to work at once with an immediate ROI.
Further, a buyer does not need to possess all the knowledge and expertise of a builder. When the property is acquired, it is completely developed. Any problems or concerns are discovered through proper inspections and resolved before closing.
DISADVANTAGES OF BUYING
From the financial side, buying a performing self storage property will require the buyer to pay its fair market value (FMV) based on a sales cap rate founded on the property’s net operating income (NOI). Most often, if a property is financially sound, the buyer will pay a purchase price ranging from $500,000 to $3,000,000 in excess of the cost to develop the property. Therefore, the ROI is substantially lower for the buyer.
A buyer usually purchases the project “as is.” He is buying any unidentified problems. Some problems, for instance, unit mix modifications, become the buyer’s expense.
At the sale of a property, the purchase price frequently replaces an appraised value which, most often, is well below FMV. In such a case, the buyer’s taxes increase tremendously. The solution is to buy the property’s business entity. This is especially true if the business is a one asset entity such as a limited partnership. In this type of transaction, the partners are bought out so that there is no deed transaction to trigger a tax increase.
SUMMARY
Today’s self storage industry bears little resemblance to its ancestral past. In the 1960s, land was cheap and the “mini-storage” client asked for little more than space and a padlock. The Mom and Pop “developers” of the time constructed rows of unpretentious buildings delimited by a patch of gravel. Competition was virtually nonexistent, and return on investment was a sure thing; Pop took the money, Mom made a deposit. Simplicity was the tool of the trade.
Today, the self storage industry is evolving at a record pace and to new levels well beyond the dreams of most original industry pioneer’s. Even with the tremendous growth and the associated issues emerging from the industry’s “coming of age,” there is still one remaining truth! Whether you are a builder or buyer, self storage investing is still one of the best investment vehicles in the United States.