I know this is close to heresy, but especially in the world of self storage, but…STOP USING CAP RATES.
The way they are being used in marketing self storage today is misleading, bordering on fraudulent.
Who should stop using them?
Well most importantly, Buyers should not use them to determine what they can pay for a self storage facility.
Real estate agents should stop using them in their marketing packages. Or if the do, they need to be clear on what exactly that 5% CAP rate is based on.
Is it a 5% CAP rate on trailing 12 Sellers income stream?
Is it a 5% CAP rate on the agents (or Seller’s) future 12-month projection?
Big difference.
It can be well over a $1,000,000 in difference. I’d say that’s pretty big.
Now I know CAP Rates are the industry standard. That’s true.
It started about 30 years ago as a way to quantify income producing real estate and compare values in a methodical way. It was cutting edge. It had a lot to do with institutionalizing commercial real estate and bringing the industry forward as a legitimate investment vehiclel for investors.
But come on a 4.65% CAP Rate? Really?
I saw that in a self storage package recently.
And it ended up being a 4.65% CAP rate on some bogus “Proforma’ income stream that is so far from anything that will ever happen. It was beyond laughable.
It is almost like there is a contest today to see who can have the most far fetched income stream in a package. I am almost tempted to start having monthly contest and announcements showing the winner.
Now does that agent really think anyone will, can, or should pay a 4.65% CAP rate on an income stream?
Do you think REITS (who they obviously think is the Buyer) is paying a 4.65% CAP rate on an income stream?
Well, that agent and many others will say “Yes, they are!”
But they’re not.
I’ve worked with them and believe me, they are not paying 5% CAPS on income streams. They may be paying what the agent thinks is a 5% Cap, but I can assure you, in their world they are not. They know exactly what they are going to get in returns, and it is not 5%.
What they are doing is what every buyer should do. They don’t just work up some first year pretend financial scenarios and come up with an offering price based on some “ego” centric CAP rate.
They do the work to lay out a holding strategy:
- what are the sources of income?
- how much will they go up?
- what will operating expenses be over the hold of the asset?
- What capital improvements needed during the holding period and calculate how much needs to be set aside monthly to fund it.
What they pay is based on the returns they need to get over a hold; not some bragging right CAP rate number that in reality is irrelevant.
So the work they do is what every buyer should do.
What YOU should do it.
My courses, all these articles, every product I have created and sold are all about supporting us, the small investor, in doing what we need to do to be successful and compete with the big guys.
The FREE 3 -step video series on “How to Buy In Today’s Competitive Market” is about what we should be doing.
And this is it:
- Have a real, planned out holding strategy. Know what your target return is, why, and the time period in which you want it or need it.
- Lay out a holding period projected cash flows using key benchmark industry assumptions. (This is self storage, you can do this more accurately here than our brothers and sisters in the retail, multi family, industrial, or single family world ever will be able to).
- Figure out what purchase price hits that return to achieve the strategy, then offer it.
- If there is a fourth step, it would be rinse and repeat.
But stop using CAP Rates to determine what you can pay for a property, and eventually real estate agents will stop using them to put a sales price on a pretend income stream.
If you want to come up with a value on previous income streams, use a CAP rate.
If you want to come up with a current value, and you use last years NOI; that is a good use of a CAP rate.
But stop using CAP rates on FUTURE cash flows, especially far fetched, pretend ones, and claim that it’s today’s value.
Or at least if you do, say you are doing it and be truthful about it.
As a Buyer, it is up to you to cut through this CAP Rate noise. It has never been more important than now to do the real work of analyzing and figuring out the real economic future of a project.
You can do it.
