Alternative Investing

Why Self-Storage Can be a Reliable Alternative Asset

• by John Manes
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The industry isn’t sexy or magic, but self-storage is a powerful asset that can grow your finances and solidify your future. It isn’t likely that you’ll find a self-storage facility on Madison Avenue or Rodeo Drive, and you probably won’t find one next door to a trendy, high-end restaurant owned by a celebrity chef. Ordinary looking warehouse-type buildings stuffed with people’s possessions don’t typically offer much “sex appeal.” The self-storage business isn’t a magical money-making machine either, and it isn’t recession-proof (but it is recession-resistant).  Nevertheless, these ordinary facilities have evolved into big business. They are a fast-growing sector that often turns out to be a solid investment. Self-storage investment provides you with a tangible asset that affords steady appreciation, allowing you to create wealth without being subject to a volatile stock market. Turnover is less of an issue than the short-term lease contracts might predict, and the large number of rentable spaces expose owners to less vulnerability to the sizable fluctuations in vacancy rate. These factors protect against the peaks and valleys so often evident in the stock market. Even following a recession, self-storage historically indicates strong resiliency. Storage is one of the best-kept secrets in commercial real estate investment. During the last 30 years, the returns for storage have reached 17.34%. Yet people tend to shy away from it because they lack broad knowledge of this asset class. Opportunities in Self Storage Self-storage investment is attracting single-family, multifamily and other real estate investors who are looking for an alternate vehicle to increase wealth. Here are a few of the opportunities it offers. Cash flow is stable. There are between 45,000 and 52,000 self-storage properties in the United States. As mentioned, the stabilized cash flow on a storage property prevents peaks and valleys. For example, if you buy a retail strip center with 10 tenants and one of them moves out, you’ve lost 10% of your cash flow. The average storage property has 500 spaces. Let’s assume that it’s 80% occupied, which means that 400 spaces are rented. If 10% of them move out, there is still a tremendous amount of cash flow because 360 spaces are still leased. People need a place for clutter. When the economy is bad, downsizing may become necessary. What do people do with the overflow that won’t fit into a smaller home? They store it. When the economy is good, and people are buying lots of “stuff” and growing their businesses, what do they do with the overflow? They store it. Ordinary investors can participate. Compared to other types of commercial real estate, self-storage involves little capital outlay. You don’t have to be wealthy to invest in storage. As an investor, you can also participate in the self-storage real estate market by purchasing shares of a REIT (real estate investment trust). Storage is recession-resistant. In an open stock market, you’re forced to evaluate regularly. In self-storage, you only evaluate when you sell. If the market is down and it’s not a good time to sell, you refinance, hold the property and let time heal the wound. The balance on the mortgage is being paid by the customers, allowing you to create a gap that strengthens your investment by holding the debt longer. Because money has a time value, return is reduced by holding the debt longer; but, in the end, you rarely take a loss on storage. The national historical average of foreclosure in self- storage is 2%. You’ll never lose money if you buy it right, run it right and time your sale right. What to Buy Buy undermanaged, under-enhanced and under-expanded properties. The primary advantage of buying an undermanaged, under- enhanced and under- expanded property as opposed to ground-up construction is instant cash flow. Of the 45,000-52,000 storage properties in the U.S., 12% of them are publicly traded and 17% of them are traded by private REITs or large institutional funds. The remainder are owned by one-off operators, or “mom and pop” properties. The market for these one-off properties is significant, because it’s easier to run and scale a small to midsize portfolio than it is to run a single property. A small to midsize portfolio will be able to achieve growth while decreasing costs because the cash flow immediately helps to pay your mortgage. Being undermanaged and under-enhanced adds value on the back end so that it is returned to the investors. Self-Storage Versus Multifamily From an operational perspective, you can swing the pendulum faster in storage than you can in retail or multifamily investment. Storage vacancies are easier to fill because once your properties are fully occupied, demand is higher. You can then raise rates on new tenants, generating an automatic rate increase from your current tenants. If the large institutional funds investing in multifamily would explore storage, they would move in a different direction. These funds typically want to place hundreds of millions of dollars in one shot. With a multifamily investment in a 2,800-door apartment complex, it’s easy to place $100 million. That doesn’t work with a $5 million storage asset. These large funds tend to overpay for multifamily, which can cause potential economic issues. Even a small hiccup in the proforma can create the inability to make a mortgage payment or pay a return to investors. Multifamily foreclosure rates are around 30% compared to 2% for self-storage, making self-storage a more stable investment with a better performance record. Another factor to consider is the multifamily expense structure. The cost to refresh an apartment after a renter leaves is $4,000-$8,000. The cost to refresh a storage unit is a broom and a dustpan. Self-storage expense ratio is 40%-43%, whereas multifamily runs into the 50%-60% ratio. Higher expenses lower NOI, which means you’re paying more on your cap rate. For the same cash, you can buy a more stable asset and hold it just as long to make more money. Find the Right Operators Hiring the right operator is a key success factor. Too many financial people