From Equity Extraction to Risk Management: Tips for Self-Storage InvestingSep 01, 2023
Self-Storage Income: Maximizing Returns and Mitigating Risks
As a real estate investor, I've seen many approaches to valuing an asset and assessing its potential returns. However, there are a few fundamental principles that I always follow to ensure the best possible outcomes. I want to share some insights I’ve learned over the years from investing in self-storage opportunities, and how you can maximize returns while mitigating risks.
One of the most critical aspects of investing is Forecasting. This is an investment tool where investors attempt to estimate future performance of an asset based on a variety of factors and variables. However, forecasting can be challenging because there are too many unknowns. That's why it's essential to be conservative with your estimates. As a general rule, don't make assumptions that are too optimistic or that can't be backed up by data. Instead, focus on the known and set ways of valuation.
For instance, when investing in self-storage, we typically stick to a standardized increase of 4-5% annually after the first four years. Beyond that point, it's challenging to predict what will happen, so we don't build in cells or other speculative assumptions. Instead, we rely on proven methods like refinancing, which have a long history of being reliable, even in good and bad economic times.
Maximizing Equity Extraction
Equity Extraction is another critical component of self-storage revenue. The goal is to pull out as much equity as possible while still ensuring that the cash flow is consistent and sustainable. One of the most effective ways to achieve this is through refinancing, which can provide a predictable revenue number that is measurable and known in the market.
Banks have always used a set way of refinancing, typically at around 6.5 cap, regardless of the economic climate. By using this set rate, we can get a good idea of what our returns will be, without relying on speculative assumptions or gambling on market fluctuations. However, there are times when selling a facility may make more sense, as we'll discuss later on.
Avoiding Risky Assumptions
One of the biggest mistakes investors make is relying on overly optimistic or speculative assumptions. For example, assuming that the market will always go up, or that someone will buy the property for a much higher price than its value. These assumptions can lead to poor decision-making and leave investors vulnerable to market volatility.
In self-storage income, we avoid these assumptions by relying on known and proven methods, like refinancing, and by ensuring that our equity extraction is proportional to our cash flow. This approach may seem conservative to some, but it's also more sustainable and less risky in the long run.
When to Sell
Finally, it's essential to know when to sell a facility. There are two main reasons we would consider selling a facility. The first is when our equity creation is so high that our income to equity ratio is poor. In other words, when the equity we've created is disproportionate to the income we're generating, it's time to consider selling.
The second reason is when the drivers of the asset's fundamentals have eroded away. For example, if the demand for storage in a particular area has declined significantly, it may be time to sell. These two scenarios are the only times we would consider selling, as we believe that the most effective way to maximize returns is to focus on growing equity or returning money to investors.
The most significant benefit of investing in self-storage is the potential for high returns on investment. Investors have experienced three times their initial investment in some cases. This is because with self-storage, you get to keep all of the income generated from the property, rather than having to split it with a tenant or property manager. This is a huge advantage compared to other types of real estate investments where you may have to share the profits.
Refinancing vs. Selling
Another thing to remember is the importance of refinancing rather than selling your self-storage property. Refinancing allows you to keep the asset while also generating more income. This is because, as the property increases in value, you can refinance and pull out equity to reinvest or use as you see fit. This way, you continue to receive income from the property while also leveraging its equity.
In contrast, selling your property means you lose a portion of the equity immediately, reducing your potential returns. It's important to note that this strategy only works if you've purchased the property at a favorable price and have seen appreciation in its value over time.
One of the biggest advantages of self-storage investing is the potential for Risk Management. While self-storage is not entirely recession-proof, it does offer some stability during economic downturns. For example, during the 2008 financial crisis, self-storage investments helped investors weather the storm and thrive afterward.
However, it's important to note that self-storage is not immune to market fluctuations. It's still essential to do your due diligence when selecting a property and ensure that it meets your investment criteria.
In conclusion, maximizing returns and mitigating risks in self-storage income requires conservative forecasting, maximizing equity extraction, avoiding risky assumptions, knowing when to sell, and effectively managing risk. By sticking to proven methods like refinancing and focusing on equity creation, investors can experience high returns on investment while also managing risk during economic downturns. Ultimately, success in self-storage income requires careful analysis and due diligence when selecting properties to invest in.