It appears as if the race to see how high self storage purchase prices can go has leveled off.

But make no mistake, they are still high and I haven’t seen much of a reversal.

It is still a “Seller’s Market.”

Does that mean we should sit on the sidelines and wait it out?

No!

But it does mean we should be very careful abut what and how we purchase facilities.   That translates, at least for our smaller investor group, into buying much less than we wish we could.

But opportunities are still out there.  Value-added opportunities such as expansions and conversations.

I’m running a class at the 2017 ISS (Inside Self Storage) Convention in April on this very subject.  I have also hosted many online classes on “How To Purchase Self Storage In Today’s Crazy Market.”

At the end of the day, knowing how to accurately analyzing self storage is the key to being able to pull the trigger.

As I work with people, I am seeing that those who trust their ability to analyze are the ones who buy. Those that are unsure of their numbers stay on the sidelines.

I have a lot a material in the blog on analyzing facilities, but I realized that there was no free series that addressed the analysis process step by step.  It’s covered in the paid courses and Video 2 of the Free Three Video Series.

I want to remedy that now in this four-part Series on “How To Analyze Self Storage In Today’s Market.”

This is in the context of buying self storage in a “Seller’s Market”.

Now I am going to make an assumption here. I am assuming you have created a Business Strategy and know what you need from self storage.

You may need a specific cash on cash return or a monthly income figure.  It doesn’t matter what it is as long as you have a specific “win” or the minimum target you need to hit.  (If not, you can go back to my last series “The Complete Guide to Creating Your Self Storage Business Strategy“.)

Self storage is like any other commercial real estate income producing asset in many ways (i.e. apartments, houses, retail, office and industrial).  But it does have its differences and these are what make it such a great type of investment to be involved in.  I’ll be discussing those differences in this series as well.

But before we get going into the finer details, let’s cover some basics.

Investment Analysis 101 Review

All income producing real estate is valued by taking the gross income the property generates, less the operating expenses (taxes, maintenance, insurance etc.). That number is called the Net Operating Income (NOI).

Theoretically, the rate of return a ready, willing, and able buyer is willing to pay for that income stream (capitalization rate or CAP rate), determines the value of the asset.  For example, take two different income producing properties:

1.  a low income, tax credit housing property, and
2. a Walgreens Store retail building where the tenant takes care of all maintenance, taxes and expenses (meaning all you do as the owner is walk to the mailbox and get the same check every month).

In this example, both properties generate a $100,000 NOI. The market CAP rate for the Walgreen’s property (i.e. what ready, willing, and able buyers are willing to pay for that $100,000 income stream) is 7%.  For a relatively hassle free, safe income stream, the market is willing to pay a price which would generate a 7% return. (This is calculated by taking $100,000 divided by .07). That places a value of $1,428,571 for that $100,000 income stream if the income is generated by a retail building with an AAA-rated public company as the tenant.

The low income tax credit example, which has more risk, more management issues to deal with, and a less secure income stream, may require a higher rate of return by the market.  A property of that type may command a 12% return (CAP rate). The value of that asset would be $833,333 (i.e. $100,000 divided by .12).

Same $100,000 NOI, but the CAP rate used will determine the value.

But that’s just how to calculate the value.  Let’s peek “below” the NOI line.

Not always, but usually, there is a loan payment.  Every industry has its own language so let’s learn it here: loan payments in investment language are called debt service.

And there are other expenses that don’t fall under “operating expenses”. These expenses are generally long term upgrades to the property itself or cost associated with getting new tenants.  Not ongoing expenses. Examples are:

• New roof
• New HVAC
• New parking lot
• Remodel office
• New bathroom fixtures
• Commissions to replace tenant’s who left after their lease was up

These are “Capital Expenses.“

What happens “below” the NOI line is what determines the ultimate yield of a real estate investment over time.

For example, if the low-income tax credit housing requires $30,000 capital improvements in a given year, that leaves a net $70,000 cash flow for that year.

The Walgreens property requires no capital improvements by the owner.   If capital improvements are required, the tenant pays, therefore the net income for that year would remain $100,000, the same as the NOI.

The less variable expenses “below” the NOI line on a profit and loss statement, the more accurately one can predict the yield and cash flow of a property over time.

This is what makes self storage such a good investment for smaller investors like us.

In self storage there are few capital improvements required. There are no commissions and no tenant improvements (fixing up a space to meet the new tenant’s needs).

There are very predictable and schedulable capital expenditures (paving, new roofs, etc.). The NOI can be projected with very few variables pulling against it. As an investor, that is the type of product which will generate the most predictable cash flow and therefore, less risk.

What has made the self storage market so crazy is that big players are willing to pay such low CAP rates for self storage. I just had a facility we purchased and expanded appraised for refinance, and the appraiser used a 6.9% CAP rate.

That is good for us in refinancing, but I could never pay a 6.9% CAP rate on a stabilized property and hit my business strategy unless I added more income.

It’s Crazy.  Hence, the “Crazy Market” class.

But there is a smart way to purchase, and the ability to analyze is the critical skill today for the small investor.

So that is what we are going to do in the next three Episodes. What I would like you to do is come to the next epode with a self storage property to analyze.

It would be great if it is one you are considering buying, building, converting, or expanding, but it doesn’t matter. Just have one.

The work we are going to do is going to be much more effective for you and make a difference if you are actively doing it instead of just reading and learning about it.

So find a self storage opportunity and bring it to the next episode and let’s analyze it together.

Some people make a career out of studying this business. It’s like buying a membership to a gym and not going, but feeling satisfied that you purchased the membership.

Let’s get off the sidelines and get in the game and learn how to buy self storage, even in a “Seller’s Market”.

Also, if you attend the class with me in April 2017 at the Las Vegas Paris Hotel for the ISS convention, this work you’re doing now will make a big difference in how that class will impact your business and your life.

See you next week with a self storage property.