Ok…for the first time in my storage career, I am in an adversarial relationship with some sellers on a project we have under contract. This is not an episode about that deal, but fair warning, it may be coloring my mood as I write about storage funds.
I came across an article in the ISS news feed about a special tax being levied on storage owners in Prince George’s County, MD. It is an annual $5,000 “Quality of Life” tax being assessed on storage facilities, firearms dealers, liquor stores, and tobacco stores.
So now, our industry (at least in Prince George’s County) is in the same league as firearms dealers, liquor stores, and tobacco stores, all of which cause real problems for a certain percentage of the population.
For many, our industry is in that same category. Imagine that.
How far we have fallen.
As soon as I read that, I thought of two things: (1) the predatory pricing that mostly REITs are responsible for, and I have written about a lot, and (2) storage funds.
Why Am I On It About Storage Funds?
To be clear, I am not categorizing all storage funds in my bad players basket. There are some that don’t do what I am going to describe as what I have seen. But many do, and in my opinion, it is this portion of the industry that is primarily responsible for the oversaturation in many parts of the country.
After the Great Recession and when the recovery started happening, many saw how well storage performed during that recession. That’s when the money started flowing and funds were coming out of the woodwork.
People started seeing large, sometimes unnecessary facilities going up everywhere. I am sure you have heard this from others as well, thought it, or said it yourself.
The Problem Funds Have
If you have been attempting to buy self-storage at all over the last fifteen years, you know how hard it is to find a good deal that generates a return.
Now imagine having $30 million, $50 million, or $100 million you have got to move out the door into storage deals.
Many funds raise that kind of money, and there is a cost owed on that raised capital, so fund managers have a problem called “I’ve got to deploy a lot of money.”
Given how hard it is to find good deals on existing projects, they started building. And if you are going to build, why not build big. If you can move $20 to $35 million out the door on a single project, that is better for them than, let’s say, $3 to $10 million per deal on expansions or conversions, even if the smaller ones cash flow better.
I have learned in life every problem one has today was the solution to an earlier problem they had in the past.
But you see, this doesn’t really apply to many funds.
Why?
Because often, getting cash out the door is a way bigger problem than having a great asset generating a great return.
For many managers of these large funds, that is a problem they will “fix” later. Their immediate need is moving money into storage.
So they built, and they built. They built as large as they could. Now, we are overbuilt in many markets.
Another problem I have seen with many of these funds is that the managers are personally incentivized financially to do deals with how their compensation comes. Primarily in the form of acquisition fees, or fees to get deals in service. Many funds make a large percentage of their profits upfront.
But investors benefit from the profits generated from the cash flow of a stabilized operating facility, which is often years after the fund managers have made their profits.
These facts are, in my opinion, a big reason for the extraordinary amount of storage inventory that hit the market over the last fifteen years.
Other Practices I See
Now I raise capital for deals, so I am not a socialist or communist, as is being bandied about today by many from the far right. But I do try to make each deal stand on its own and generate an above-market return for my investors and/or partners.
That is the main reason I decided not to be a fund manager, because I didn’t want the responsibility of having to deploy large amounts of capital into storage. I realized I couldn’t generate the same returns we are getting consistently if I have to deploy that much money.
But I have looked closely at the practices many funds use to raise capital. For many, they just need to have a Proforma that generates an above-market return. A drop in a future CAP rate in the Proforma, or a rental increase in the Proforma that may be higher than the current market but “we are sure we can achieve that,” or a slight increase in the lease-up projections, all can make a project look great on paper.
I remember calling one fund about a market we were in, and they were coming in with a huge shadow-casting 100,000-plus building. I got hold of the fund manager (a real feat in itself) and had a frank discussion about how this was going to be way overbuilt once they came online and, with the construction cost of over $120 psf (I saw their plans from the county approval process, which is public information) and the current rental rates, which would only drop when they came online, there was no way they were going to be profitable.
I must have gotten him on a good day because he agreed with me. But he said, “I know you are right, but we are going to do the deal anyway.”
How would you like to be an investor in that fund?
So yes, I am on it with many storage funds. And when I see our industry I love so much with a black eye, as I do more and more these days, I decided to do this episode to hopefully help purge myself of some of my resentment.
Now I have invested myself in funds as I have taken profits off the table, so I am not against funds as a whole. Just what I have seen a lot in this industry with some fund practices.
And if you are going to invest in a fund, do your homework. Make sure you are comfortable with the CAP rate used for future values. An extreme amount of overall return is calculated right there.
Know the rental rates yourself in the market as well as the trade area the project is going to be located in. Know the square feet per capita in that trade area. Don’t just invest money because they have a track record or have done a lot of deals.
Pay someone to review their deck and see if they think it is a good deal or a solid acquisition strategy for blind funds.
I think we can begin to restore the image of our industry if we (1) cease the predatory pricing strategies used by so many today, and (2) put discipline and common sense in acquisition strategies (which will cease overbuilding in areas that don’t need more storage today).
Do I feel better after writing this?
ABSOLUTELY.
