I have made many mistakes in my self-storage career, but one of the biggest I made early was when I purchased an existing facility with a record storage business.
I am writing this because I have seen and worked with a lot of people buying self-storage projects with other businesses wrapped up in one transaction.
Car washes and record storage are the most common, but I have also seen some retail businesses located in commercial spaces that are included in the sale.
I wrote about it in my book Creating Wealth Through Self Storage. It was in the case study at the end of the book. But given that it was a few years ago and many in this community haven’t read it, I thought I might explain what it was so you can avoid the same mistake.
Valuing A Business
In short, I used the wrong valuation method to determine what I could pay for the record storage business.
I used the same valuation method to determine the value of the record storage business that I did for the self-storage portion of the deal.
Big mistake.
Today, I see more car washes and self-storage together than record storage and self-storage, but the principle is basically the same.
In determining the value of a self-storage facility, one usually projects what the income is going to be, what their operating expenses are going to be (your expenses, not the Seller’s), subtract operating expenses from income, and come up with a net operating income (NOI).
I basically did this for the record storage business as well and applied the same CAP rate to it as I did on the storage portion. I also assumed the record storage income would continue to increase at the same rate for me as it did for the previous owner.
Both were big mistakes.
Self-storage, even though it is an operating business, is valued in the same method as most all income-producing real estate assets are by using the income approach. In other words, income minus operating expenses and applying the prevailing CAP rate to the NOI determine what one can pay or what the storage project is worth.
Most businesses are valued differently than real estate is valued.
I am not an expert on business valuation, so I would suggest finding someone to assist you in putting a value on the other business besides the self-storage portion of the deal. I sure wish I had.
In essence, what I do now when looking at a business other than self-storage is run two or three different scenarios and see if all are within a few percent of each other.
First, I would take all the assets, the buildings the record storage is in, for example, the trucks to deliver files, and subtract the liabilities, and that is the “Book Value” of the business.
I want to know that, but I don’t use it to determine what I can pay for the business. It is compared with the next two methods.
The second method I generally use today is to take gross earnings (income) and multiply that by a number my CPA or business broker would tell me to use for that industry, say 5. So, if the business makes $200,000 a year, this would put a value of $1,000,000 on it.
Next, like self-storage, I determine the EBITDA (close to a NOI in real estate). EBITDA stands for earnings before interest, taxes, depreciation, and amortization.
Depending on when and what the industry is, there are different multiples for this number. So, for example, a multiple might be 4 for gross earnings and eight for EBITDA. I would take the EBITDA and multiply that by 8 in this case.
With self-storage, I would take the NOI and divide it by the prevailing CAP rate to determine its value.
With car washes, I also do something a little different. I have talked to multiple car wash owners who take the value of the equipment package inside the wash and the life of that equipment package and then deduct that as an expense yearly.
For example, if it costs $200,000 for an equipment package for a car wash tunnel and the life of that equipment package is estimated at ten years each year, they add $20,000 to the expense line. This is what more than one seasoned car wash owner has told me.
How one comes up with a business value is often very different from how we come up with a real estate value.
Don’t do what I did.
Another mistake I made in this record storage acquisition, besides how I valued the record storage business and assumed how the income would grow, was not understanding that record storage is a business-to-business enterprise and storage is mostly a business-to-consumer business.
I closed on the record storage business just before a major downturn in the economy (Feb. 2008). My self-storage business dropped 8% in occupancy, while the record storage dropped over 20% in revenue.
Businesses usually immediately felt the financial impact of the economic downturn.
As we all know, economic downturns can actually create demand for storage for consumers.
Fortunately, the economy recovered, and time healed most of my mistakes, but this project never quite hit my proforma numbers. We sold and made a profit, but not what I thought and projected we would.
This experience really helped me realize the beauty of self-storage. Even in the worst economy since the great depression, this project lost only 8% occupancy.
Our storage operating expenses were able to be controlled, so our storage NOI didn’t suffer anything like retail, office, and even apartments did in that downturn.
However, my experience in the record storage business was quite different.
Now, I am not saying I don’t buy car washes or, record storage or any other business in a self-storage transaction.
Just learn from my mistakes, analyze them, and look at them through a different lens than self-storage.
I love the storage business, and this transaction deepened for me that appreciation for what the storage business is.
Good hunting.
