How to invest in self-storage
If you want to invest in self-storage, the first decision you will need to make is deciding how you want to invest.
The easiest way to invest in self-storage is by purchasing shares in a self-storage real estate investment trust (REIT). This is the most passive investment option that requires the least amount of time while still receiving a return on investment through dividend returns.
Active Participation in Self-Storage
However, if you would prefer to actively participate in self-storage, you can invest in your own self-storage facility. There are two options when it comes to actively investing in self-storage:
- Developing a self-storage facility from the ground up.
- Purchasing an existing facility.
Developing a self-storage facility
This is the most cost- and labor-intensive method for investing in this industry; however, it can be extremely lucrative if done properly. It takes a high level of experience, knowledge, and resources to help make this a successful endeavor. Newly built self-storage facilities are considered Class A storage facilities and have the highest value in the storage market.
If you choose to develop your own self-storage facility, you will want to begin by identifying a parcel of land to purchase in a market that has a high demand and low supply of storage units. Ideally, the site location will have at least three acres for construction, although multistory buildings can be built on less acreage.
It's important to check with the local municipalities to ensure you understand their zoning, permitting, and development procedures and that the facility can be developed at the site as intended. The lower the land and construction cost, the better your return, so it's important to find the right site at the right price.
The building should be constructed to meet the local demand, providing the desired unit mix for the area while meeting local building, fire, and safety codes. The developers should be forward-thinking, developing a building that will appeal to the big buyers -- the REITs. Look at similar facilities owned or built by REITs like Public Storage (NASDAQ: PSA) and follow suit, designing buildings that match or exceed their standards and amenities, such as climate control.
Keeping construction costs and timelines to a minimum is a crucial step in a successful development project. Most investors choose to have a project manager who can help facilitate and manage the day-to-day operation and construction of the facility.
Once built, the property will be in "lease-up" mode, meaning the facility will be actively marketing for new tenants and leasing the units as fast as possible at current market rates. This can take several months to a year, depending on the facility's size. Having an effective marketing plan, properly priced units, and quality management in place will help expedite this period.
Once the property is leased up, the developer can hold it long term, complete a cash-out refinance, or sell the property to a third party buyer (likely a REIT).
Purchasing an existing self-storage facility
If you choose to take the alternative route and purchase an existing facility, the first step will be finding a self-storage facility to purchase. You can search online at industry websites like LoopNet, Crexi, Argus Self Storage, or List Self Storage or work with a commercial broker. Additionally, you can market to facility owners using direct mail marketing.
Just like other CRE properties, self-storage facilities are listed and sold based on capitalization rates, or cap rates, which directly relate to the property's net operating income (NOI). This is how much cash flow the property produces after accounting for all income and expenses. The higher the cap rate, the better the rate of return for the buyer and the higher return investment is likely to be achieved. Do a cash flow analysis, looking at all expenses relating to operating the self-storage business, including:
- Real estate taxes.
- Property insurance.
- Advertising or marketing.
- Management fee (at least 5% of gross rents suggested).
- Payroll (for larger facilities).
- Office supplies.
- Phone or internet.
- Credit card processing fees.
- Online software.
- Lawn care and pest control.
- Repairs and maintenance.
- Trash service.
- Miscellaneous fees.
The property should have sufficient cash flow to cover all expenses as well as any debt service; however, if the property is underperforming, it may not have sufficient cash flow to cover expenses until the property is improved.
Most existing self-storage facilities are Class B or C facilities, especially those owned by mom and pop investors. Many times they are older in age, have some wear and tear, and are likely not performing to market standards. This allows buyers to add value by making capital improvements, increasing rents, expanding, reducing costs, and applying better management practices, among other activities.
Ideally, you want to find or create a facility that has:
- Multiple unit sizes advertised at market rents.
- Attractive building or buildings (fresh paint, clear branding, manicured lawn, appears safe).
- Proper drainage (meaning units won't flood or freeze shut during inclement weather).
- Proper signage with facility name and number easily visible.
- Automatic gate with 24-hour access.
- Proper lighting (ensuring the facility is safe at night).
- Security cameras.
- A website with online rental and payment capabilities.
While not every facility requires all of these items, adding these features will increase the property's value. If you're in a rural area where there is only one other facility and a few thousand people in town, it's unlikely the cost of adding automatic gates and security cameras is warranted for the market demand. Investors should meet market standards.
It's also good to keep in mind that some areas demand climate-controlled units while others do not. For example, climate-controlled storage in Florida is standard, because of the high humidity and extreme heat in the summer. Your facility's location will help dictate what features to include.
Once a facility has been identified, you will negotiate a purchase price based on your cash flow analysis and desired rate of return or yield. It's important to make your offer based on the current operation of the facility while keeping in mind the potential pro forma projections of the facility. After a price has been agreed upon, the buyer will want to secure financing and conduct due diligence within the inspection period outlined in the commercial contract.
Due diligence can include:
- Reviewing current and past three years of profit and loss statements and balance sheets.
- Reviewing seller's past three years of tax returns.
- Reviewing current rent roll.
- Verifying income and expenses (matching to bank statements).
- Ordering a survey.
- Phase I inspection (needs to be bank ordered if obtaining financing).
- Appraisal (needs to be bank ordered if obtaining financing).
After closing on the sale, the new owner will have to handle the day-to-day management of the facility, including:
- Renting self-storage units.
- Collecting rent.
- Paying sales tax.
- Maintaining the facility.
- Sending late or lien notices.
- Handling lockouts and/or auctions.
The management of a storage facility will vary based on size.