If you are looking for a business opportunity or a commercial real estate play to invest in, I’m sure self storage has caught your attention.

It is most likely something you thought about but never investigated seriously or never made a real move on.

Now you are seeing them everywhere. You’re wishing you had pursued it earlier and wondering if it is too late.

Let me share with you Five Things To Know About Investing In Self Storage Today.

There are Few Variables That Affect the Net Cash Flow

This is perhaps the greatest positive feature this asset class has to offer. It’s what attracted me to it in the first place in the mid-1990’s.

At that time, I was in the commercial real estate office business in a significant way. We had a group of investors we would sell office buildings, manage and reposition the buildings for them, and then sell at the new and improved value.

What gave us such a close-up view of investment real estate was the fact that we managed the buildings for the owners.  Our track record was very good for the industry.

Our renewal rate for our tenants approached 85% which was above the national average. In other words, 85% of our tenants renewed their leases. This kept the cash flow in place with usually a 3% to 5% increase for the next three to five years.

Not bad.

However, in the mid-1990’s it cost the owners on average $5.00 per square foot. We had that budgeted in to cover the cost of painting, carpet to refurbish the spaces and incentives to keep the tenant from moving.

And yes, we got a renewal fee of 2% or 3% depending on the management agreement.

If that tenant moved out, it could cost the building owners up to $15 to $20 per square foot to modify the office configuration for a new tenant. The commission was between 5% and 6% of the new rental income stream.

We had years where our Net Operating Income (NOI) was quite high, but there was a negative cash flow for the owners.

The NOI is rental income less operating expenses. But below the NOI line on a financial report is where the loan payment and all the capital expenses live. After those line items and the reserves is where the net cash flow to the owners comes in.

Our clients would complain that these buildings were costing them money. Which was true. But we would remind them to look at the NOI. We have been increasing that year after year, thus the value of the building was going up as we predicted.

This is not an isolated event for office product.

Apartments have lots of capital expenses like carpet, appliances, and new toilets. Even retail has tenant improvements required for new tenants. Think how long a retail space may sit empty before a new tenant moves in. Even if there are no tenant improvements in retail there are almost always commissions to pay.

This is how commercial real estate works.

Until you get to self storage.

In the mid-1990’s I started working for the REITs as a commercial real estate agent, helping them find self storage opportunities.  I realized that self storage has very few capital expenditures below the NOI line.

In most cases, it is a steel building and a concrete floor generating rents close to, or in some cases above, apartment and class B office rents. Plus there were no tenant improvements, no carpet, no appliances, and no commissions.

Just a steel wall and a concrete floor.

In fact, if the “tenant” didn’t pay their rent, there was not even an eviction. The “tenant’s” items were auctioned off and the space went immediately back into production after someone swept the floor.

Amazing.

I began to see that the few capital expenses there were (blacktopping the parking lot, replacing an HVAC unit in the climate controlled space) could be covered with a small reserve fund.

How small?

$0.12 cents to $0.20 per square foot per year.

Again, in the office space business, we budgeted $5.00 psf in the mid-1990’s for lease renewals!

I also realized the net cash flows were very predictable in the self storage business. Rents can be increased as the market allows, not as a lease dictates. Since 2010, our company has averaged almost 6% per year rental increases. We use a 3% per year rental increase in our initial projections as we put a project into service.

As I began to explore investing in this business this was the feature that attracted me the most given my experience in the management business.

It still does.

Self Storage Appears To Be Recession Resistant

In the “Great Recession” from 2007 to about 2010 or so, self storage faired pretty well. On average each facility only lost 6% occupancy.

Compared to other types of commercial income-producing real estate that is very good. Retail got hammered. Office still hasn’t recovered in many markets.

But self storage did better than office, retail, hospitality, and apartments in many markets.

That is what seemed to catch everyone’s eye and caused a flood of money into the space after the recovery started. This fact is what drove rental rates as well as sales prices for self storage very high over the past six years or so.

The reason recessions don’t affect self storage is the type of customer. The self storage customer, for the most part, is someone in transition. About 20% of an average customer base is commercial tenants and companies, but the other 80% are “residential” customers.

When people’s lives are changing, they need self storage.

Good times create transition x bad times create transition.

As a practical matter, you may have to spend more time and energy on collections. You’ll also need to focus on keeping the economic occupancy within in 3% or so of your physical occupancy. But compared to other types of real estate, I would rather be in self storage in a recession more than anything else I can think of.

Special Knowledge Is Required and the Industry Is Evolving Fast.

We have covered some very positive aspects of self storage but here is something you should know before investing.

It is a specialized industry with specialized knowledge required to manage and run the business effectively.

It is not hard, but not only is self storage a real estate play, it is an operating business. We approach it like a retail business. Our managers are trained in sales. We have a retail sales component. Managers are measured on closing effectiveness, especially as we lease up new space.

In many ways, it is like building a shopping center then opening a store in it.

It’s not hard to learn.  But you do have to learn or have a specialized management company run it for you.  Generally, you need 40,000+ square feet generating income before third-party management is cost effective.

The industry is also evolving fast. The big players, the REITs and larger storage companies, account for only about 20% of all self storage facilities.  However, they are running their businesses very different from the smaller mom & pop owners who account for the majority of the facilities out there

The REITs now use software available that can adjust pricing daily depending on the supply and demand of given day, week or month in a submarket.  They are using sophisticated online marketing and retargeting ads for their facilities. As they expand they are able to look at different submarkets and see the supply/demand in the areas being considered.

The good news is that we can do that too. But it is a skill set we have to learn and software we have to buy. Most smaller operators are not doing it and the gap between how the big and small players are running their businesses is growing.

My coaching is that if you are considering getting into the self storage business you must be willing to learn new skills, buy more software than you expect and learn more about online marketing than you ever wanted to learn.

You may not be the person executing everything, but you will be making marketing and business decisions based on data and information you receive on a daily basis.

Or you need to be willing to pay a management company to do it for you.

Yes, the smaller players are doing well now.  But as the industry evolves, and it’s evolving quickly, that is going to change.  The way the big players run their business compared to the mom and pop’s is going to mean consumers will see the big players well before they find the small players.  They will also be able to retain customers better.

This doesn’t mean it’s not a good business to get into.  You just need to be aware of what is going to be required.

One last thing I can tell you is that what we are doing now to run our businesses will be different five years from now.  Operators today must be willing to change and grow with the industry.

But this is probably true of most businesses.

Many Submarkets Are Overbuilt But There Is Still Demand.

As I write this in 2018, you are probably seeing lots of self storage being built.

That is where we are in the economic cycle.

Self storage is a submarket product. In other words, people rent units where they live or work. No one drives across town because they like the doors or the color of the facility. They rent where they live and work.

It is easy to track how many people live and work in a three-mile and five-mile radius. It is now also easy to see how much supply of self storage there already is in that submarket (mentioned in Number 2 above).

We also know how many square feet of storage per person is average for a market and based on the square footage available if there is demand or not in that market.

Today it is not hard at all to get this information.  I would always get a feasibility report from an industry expert to verify what your software is telling you.

But some markets still get overbuilt.

Your job is to find the markets where facilities are for sale. If you are going to build you need to find the markets where there is still demand.

And there are a still a lot. I see them every day.

The days of “Build It And They Will Come” are over. Know the numbers and the supply/demand of any project you are going to buy or build.

No Disruptors On The Horizon = Future of Growth

As I write this, I see no disruptors on the horizon. I think self storage has a long healthy life ahead of it for the next decade or two.

I am always looking for disruptors.

When PODS came out, I thought they would have a big impact on the self storage business. I was wrong. They barely made a dent.

In recent years a product hit the market called “Concierge Storage.”  The company picks up your stuff, stores it on racks, and then delivers it whey you ask to have it delivered.  It works much like record storage.

To my knowledge, there is not one profitable company in this space yet and it hasn’t gotten much traction since I heard about it five years ago.  It requires much more capital than self storage and is employee heavy.  It’s much more expensive for the consumer too.

People like being in control of their stuff. They would rather be able to access it 24/7 (even though few do).  They will put up with traveling to and from the facility (it is usually very close) to stay in control rather than paying more to have it taken care of for them.

Even the advent of electronic storage (cutting down on the amount of paper generated) has not had an impact on self storage.

Every decade a larger and larger percentage of the population uses self storage.

In 2008, it was about 8%. In 2010 about 10% of people have used self storage. This decade it could grow by 4%.

Not only are a larger percentage of the population using self storage, but the population is growing and creating even more demand.

As the baby boomer generation ages and dies, all the stuff they collected will end up somewhere. Much of it ends up in self storage facilities, often for years.  The younger generations keep it for sentimental reasons or are keeping it “just in case” they need it.

The Self Storage industry has a bright future and I see no disruptors on the horizon.

Conclusion

It is still a great business to get into, however it is an industry that is evolving fast.

Self storage is not as simple as many think and not as easy a business to run as it used to be. It is not hard or complicated, but it is becoming more sophisticated.

And where you do your business today is critical. You have to know the supply/demand dynamics of any location you are considering.

But if you go in with these considerations covered, you will have a fantastic business. I still believe self storage is the best business there is for the small investor who is willing to grow and evolve with the industry.