Yes, I am seeing more distressed self-storage being marketed.
It is actually something I didn’t see very often early in my career.
I can remember telling people things like, “If you see a distressed self-storage facility, odds are you don’t want it. It is usually distressed because of fundamental reasons in the trade area that you can’t solve.”
I don’t say that anymore.
I don’t say that anymore after (1) the building craze from 2015 and after and (2) since interest rates and construction prices went soaring.
What “Distressed” Properties I Get Excited About
I am seeing today a number of properties that are new construction, just received a CO (certificate of occupancy), and are on the market for sale.
Historically, these look like the furthest thing from distressed assets there is.
Yet, from all indications… they are distressed.
Why?
The bank says so.
Why?
They are upside down. They owe more than they are worth.
A few weeks ago, I talked about one such property. It was a completed facility of close to 50,000 sq. ft.
I could tell that it was underwritten at 4% something interest and most likely a 5% or 5.5% CAP rate for reversion pricing in order to get the construction loan.
All 50,000 sq ft was built (why in the world did they not phase it in?), and they were about 5% physically occupied and 1% to 2% economic occupancy. Open for a month or two.
If one extrapolated out the income, at their asking rates and 85% occupancy, it was worth around $2.7 to $3 million.
It must have cost north of $4.2 million to build.
That is what a distressed self-storage project can look like in the 2020s.
Why Do These Assets Underperform?
There are a number of reasons why this is happening today, but basically, they fall into two main categories:
- Economic landscape shifting.
- Overbuilding
There are some, and soon to be more, properties like the above.
If self-storage has a downside, it is the fact everything is in slow motion.
It takes about a year now to get entitled to build. It may take another six months to a year to build.
Then lease up takes another two and a half years to stabilize.
It can often be three to five years before a return on investment is generated.
What if your interest rate doubled during that time, rents went down 15% to 20%, and future values went from a 5.5% CAP to a 7% CAP?
You have a distressed property.
Now for overbuilding, I went on a rant last time I wrote about this. I won’t do that here, but suffice it to say that with approximately 60% of funds in the storage space, which did not exist five years ago, I had a lot of money to place.
After they bought all the 5 CAP properties they could find, they started building. And they built big.
A lot of these construction loans are running out now, and banks are relooking at the projects. Also, there are a lot of facilities that have to refinance their original five-year loans.
My experience from 2008 Times tells me they will either have to pony-up more cash into the projects or sell. Many will choose to sell.
So don’t be fooled. In the 2020s, the distressed property can be shiny and new.
The Buy
The real art will be to acquire these properties at prices that work for you.
In many cases, a Buyer may not only be dealing with the Seller but the Lender as well.
Another term I remember from the 2008 era was “short sale.”
The way I propose one purchase these assets is to run your lease-up analysis using real (i.e., current rates or current rates less 10% or something) rental rates at current lease-up absorption numbers.
If a project has been open for two months, and you are 2.4% occupied, your absorption rate is 1.2% per month. Don’t use the number you think you can do. Use what is happening.
What will the project be worth when stabilized at a 7% CAP rate or something using current rental rates, or slightly less? Base your offer on the profit you need or want, knowing that value number.
A lot of wealth can be created during this time.
I can remember in the last big downturn (the 2008 Times again), I watched one guy from Indianapolis do very well.
What he would do is go to the bank holding the loan on a distressed asset and tell them what he could pay and why.
Although they didn’t particularly like what he was saying, they got it and understood.
Next, he would say, “If you will allow me to buy this at the real value and provide the loan, by the way, here is my plan and strategy for the property, but if you do this for me on this deal, I will buy another project from you that you had foreclosed on and get it off your books.”
“Oh, yes, I will also need a loan on that one too.”
That way, he would get two assets.
If you have a loan rolling on a good asset with a low loan-to-value, offer for them to get the loan on that property (a safe deal for the bank) in exchange for letting you buy the distressed storage at the value you need.
Think benefits.
What benefit can I offer the bank or the Seller, and still get the benefit I need to do the deal?
If a Seller isn’t in enough pain yet, just wait.
If someone else steps up and is willing to pay more, let them.
There will be more coming down the pike.
We are only limited by our creative thinking.
Conclusion
Many of us have known only one way to be in the self-storage business.
That is in boom times, blowing and going.
In my opinion, now is a time to be cautious but ready to pounce.
As an industry, we have never experienced a downturn with this much existing products in so many markets and trade areas and rental rates trending down in the major markets.
However, this new reality creates opportunities.
Opportunities like we have been discussing in this article.
The benefit of being a small investor is we can pivot and pivot fast.
My goal for you to pivot into some real exciting opportunities over the next year or so.
