Value-added projects for self-storage | Inside the self-storage
In residential real estate, there is a phenomenon known as âover rehabbingâ. This is a strange concept because you might think that the more you improve a property, the more its value increases. Unfortunately, as many overzealous and overzealous homeowners have discovered, every dollar spent on exotic hardwoods or a hot tub in the living room doesn’t yield the expected return on investment.
Flash info: As a commercial asset, self-storage is no exception to this phenomenon!
According to the standard business valuation, the capitalization rate (cap) is one of the methodologies used to establish the value of a self-storage facility and should be at the forefront of decision-making when approaching value-added projects. While there aren’t many home improvement options available for simple storage structures, there are plenty of opportunities to spend money in a way that won’t necessarily increase the value of the property.
When it comes to making physical improvements, you have to be smart. Invest in improvements that make sense, not only aesthetically, but also financially, both short and long term. Here are a few tips.
A formal approach
The beauty of facility improvements is that there is a multiple of return for every dollar of increased net operating income (NOI). The cap rate is calculated by dividing the NOI by the value or the price. If a self-storage property is trading at a cap of 8%, for every dollar that the NOI increases, the value of the facility increases by $ 12.50.
Any upgrade that affects the trade cap rate also results in a return multiple. By improving the class ranking of a property, say from a C to a B, the cap rate will decrease. If a facility with an NOI of $ 100,000 is upgraded so that someone buys it at a cap of 7% instead of 8%, there is an increase in profits of over $ 178,000.
- $ 100,000 / 0.08 = $ 1,250,000
- $ 100,000 NOI / 0.07 = $ 1,428,571
- $ 1,428,571 – $ 1,250,000 = $ 178,571
When considering value-added projects for your self-storage facility, any investment that could improve the asset class and increasing the NOI should be a priority. For example, taking traditional units and converting them to air-conditioned spaces could result in higher rental rates as well as better class. The increase in utility spending would prevent you from capturing 100% of the rate increase, but if due diligence provides the basis for an overall positive impact on NOI, then it’s doable.
Let’s say adding air conditioning results in a 25% increase in NOI, from $ 100,000 to $ 125,000. If this $ 25,000 Also improves the asset class and compresses the cap rate from 8% to 7%, it increases the overall valuation to over $ 535,000. If this $ 25,000 IsNT changing the asset class will only increase the valuation by $ 312,500. While waiting for the cost of conversion, this juice is probably worth a squeeze.
- $ 100,000 / 0.08 = $ 1,250,000
- $ 125,000 / 0.08 = $ 1,562,500
- $ 125,000 / 0.07 = $ 1,785,714
- $ 1,785,714 – $ 1,250,000 = $ 535,714
- $ 1,562,500 – $ 1,250,000 = $ 312,500
Value, not vanity
Focusing on the appearance of the facilities is the easiest way to waste money on a value-added project as it does not directly improve the business valuation and may not upgrade the class d ‘assets. Painting the doors and improving the scenery can make your self-storage property more beautiful, but that’s not enough to elevate it from Class C to B.
However, if a lack of new paint and rugged landscaping causes clients not to want to rent there, then upgrade those items. will lead to an increase in NOI and therefore valuation. The good news is that unlike residential assets, utility This is what most customers look for in a storage facility, not trimmed hedges and azaleas.
That said, there are some functional elements that will improve the appearance and bring more benefits than an indirect increase in valuation. For example, paving and fencing may or may not attract more customers, and are unlikely to justify an increase in rental rates, as these are generally expected site features and not viewed as amenities by customers. Yet to pursue such a project could increase the asset class, resulting in an increase in value through the compression of the capitalization rate. Additionally, an overlooked advantage of this type of project is loanability.
Some self-service storage loans have physical requirements. For example, commercial mortgage backed securities lending have some of the most favorable terms in the market, but generally require a facility to be paved and fenced. These loans also carry a minimum amount in the millions. If a property qualifies for a loan and the loan is assumed by a new owner, it can increase the price a buyer is willing to pay. A favorable mortgage may not increase the explicit value of the facility from a selling price point of view, but it will result in a higher cash return.
Real estate improvements are not just about increasing value, but to keep this. Too often self-storage is treated as a ‘set it and forget it’ investment. While this strategy may work for a while, entropy will inevitably ensue and the value will decline over time outpacing inflation and appreciation. For homeowners, resisting the urge to defer maintenance protects the valuation of facilities. When planning a sale, maintenance events can generate a higher price.
The prevalence of deferred maintenance is high among âmom and popâ owners, who represent the majority of class C and -B establishments. This gives buyers the opportunity to acquire these sites and gain immediate value-added opportunities, as the majority of physical upgrades will lead to increased equity (if purchased intelligently).
That said, adding exotic hardwood or a hot tub to your self-storage facility still won’t result in a return on your investment! So, carefully weigh your options and invest wisely. Choose value-added projects based on their positive impact on the asset from a financial perspective.
Steven Wear is Director of Marketing and Director of Acquisitions at Impact Self Storage, which buys and develops storage facilities nationwide, and vice president of Titan Wealth Group, which sources and underwrites off-market storage contracts across the country. He graduated from the University of Illinois at Urbana-Champaign and lives in Chicago. For more information, send an email [emailÂ protected].