Self-Storage Investing 101Oct 10, 2022
Self-Storage Investing 101
This is self-storage investing 101. The self-storage industry has been around since the 70s. It really took hold in the 90s and really started to gain momentum in the 2000s, particularly after 2008. Now it's all the rage and investors are all talking about it. They want to know what's going on. I’ve been in this space since the early 2000s. That was a time that was much harder to get into self-storage than it is now…everything from financing to operations…nobody wanted to do it. It was this weird asset class that a lot of people didn't even know would stick around after 2008, that all changed.
Where is it at today? What does it look like in the future? In 2020 the industry was worth approximately 48 billion dollars. That's changed a lot in the last two years, but it's predicted that the industry will be worth around 65 billion by 2026. That's a 5.4 compounded annual growth rate.
Now there's a few things that are interesting about that. First, that is a slower growth rate than the previous growth. In the last couple years, we've seen a lot more growth than that, but I think it's reasonable because self-storage is entering a maturity phase – it's coming out of adolescence and now it’s playing with the big boys. It's seen as one of the main staples of real estate investing. A lot of people want to get into it so we will probably see a more normal growth rate as opposed to the steep valuation and growth of the industry.
With that said, it offers a lot of opportunities now for people to get in because this industry has more than 50 thousand storage facilities in the United States. That's a lot of storage…that’s two billion square feet. So, what is driving this? What are the economics that drive it? What hurts it? Let's take a closer look.
What is driving the overall storage industry? I look at four things: Population, Regulation, Cost, and Relocation. Those are the main four drivers in self-storage. Let's break into them. First, Population increase is a staple of all economic growth. It's a big part, particularly in real estate. That's true amongst all asset classes.
The next thing is Regulation. Homeowner Associations in cities have gotten much tighter on what you can build on your property, what you can put on there…everything from RVs and campers…so you can’t just throw a shop up, right? You can't build something on your house, expand your house, throw a camper in the driveway. We don't allow those things anymore. As regulation is tightened, people don't have as much utilization of space on the property that they own. That's a benefit for storage and it's also a benefit when you're talking about how you can run a business. You just can't run it out of your house. I can't be shipping products from my house, and I can't start a business up in my garage. Apple wouldn't be allowed today with the HOAs. It wouldn't work out, so businesses also need a place to go.
The next thing is Cost. As we've seen a cost dive for consumer products (meaning your dollar buys you way more today than it did 30 years ago), the cost of real estate has skyrocketed because of this. Our same dollar can buy more, but we just have less with the same dollar to buy. Once again, this is the same for businesses. Businesses cost rent space. It has become very expensive. They need alternative sources and alternative methods. This bodes well for this industry.
The next is Relocation. Movement in general helps storage. A huge percentage of our renter base is short-term. Short-term rentals can result from many things. This can be moving houses, moving businesses, etc. They need a place to hold their stuff in transition. So, the housing market and the churn of the housing market is important. When it does good, the storage industry does good.
So, now what hurts self-storage? Obviously, there are things that we don't know. That's true in every industry. I don't know of what may come that may hurt self-storage, but over-supply and lack of demand are some of the big ones. This is the opposite of the things that we mentioned in the benefits section. Also, it can be a matter of Overbuilding of the asset. In other words, they're just putting so much product on the market that it saturates the market and revenues drop. Now, we see this all the time. In fact, I think self-storage is much more prone to be overbuilt than a lot of other industries. It generally happens on a micro level. It's within a four- or five-mile radius that this happens, so it's important to understand demand.
The next part is Technology Startups. With on-demand storage there may be different ways to store or move items around that are coming up. We've seen in the past, factors that are trying to take over the self-storage demographics and market. Now we've never seen anyone be successful in this. We see on-demand storage be much more successful in highly dense, downtown areas, but none of them have really taken over a large percentage of the market share. Consumers are still liking self-storage.
Now let's talk about the assets themselves. Obviously with self-storage, they're roll up doors, we have indoor/outdoor storage, we have climate control, we have other different methods that people utilize, but when we're talking about storage, we're talking about people and businesses storing their belongings and renting the space for holding their stuff. Right now, this is a fragmented industry, especially when compared to other real estate industries. That's where the opportunity is. 52 of these industries are single owners and operators. They just own one facility. They're the mom and pops of the world. Now, point five percent of all the assets are owned by what we call the “top operators”. The top hundred operators, which I'm in, so I am a top operator. After that we go to thirty one percent. These are the publicly traded big boys and they own roughly about 31 percent of the market. That means there's huge inventory for you to get in and buy these assets and be successful in this industry.
Now, we've talked about the industry. How do I know if I should go in? If I shouldn't? What should I buy? Let's start with market feasibility. Remember, when I talked to you about the things that hurt self-storage? Over supply? Therefore, market feasibility is so important. When we're looking at market feasibility, we're really trying to understand two components: overall demand and then the next part is what is the demand? This is what I call the utilization. So who's renting? Why are they renting? What are they renting? Utilization and overall demand are very important. When we look at demand, we're really talking about the current total square footage on the market. We're looking at occupancies and rent increases to understand if a market is feasible. This is important today and for the future. I'll get to understanding future demand, but today you can overlap the total number of units within a population, and we can find out what the occupancy levels are. Is there demand? Is it growing? This also ties into market demographics. Is the population increasing? That's all tied into future demand, but finding out today where demand is, occupancy total, square footage, rates, rates increasing, have they been increasing? Have they been stagnant? Are they dropping? Is there vacancy? Those are what you want to look at to understand today's demand in that market.
When we're looking at the future demand, there are two things that are important. The first thing is market and demographics. Who's moving there? Why are they moving there? Are they renting housing? We just need to understand what's happening within the population. Understanding that also leads us to understanding utilization. How are people utilizing the storage? This is important when we talk about revenue management, and I'll get into that in a second, but understanding why people are renting, who they are, will help you understand how to price individual units. The pricing of units we view as product market fit. We are not selling a space; we are selling a product to a customer, and we need each different size and type. Indoor, pull-up, climate control, wine storage, 10x20, 5x5…they're all different customers and we need to make sure that there's a product market fit, because that'll tell us how much demand there will be moving forward and how much we can charge.
Let me give you an example. Future demand: if they're building a lot of apartment buildings, well in general, that may mean future demand, but also, we have to understand that generally speaking, the greater the density of the area is, the smaller numbers of units that are in higher demand. 5x5s are in high demand. Now, when you move out into areas that are more rural or have more space, that's no longer the case. 5x5s are in low demand and yet the big units are in high demand. You can see how if you mess this up, you can really screw up your revenue projections and you can really screw up your underwriting (more on underwriting later).
So, the next part of understanding future demand is that you need to understand what projects are being built and how they affect the market. What I mean by that is if you are in a market that has 200,000 square feet of net rentable storage (that's per capita), if there's two hundred thousand square feet and somebody down the road is building a hundred thousand square feet facility, that's a fifty percent increase in overall market supply. Fifty percent of that market hold that can generate that. Odds are you don't know, I don't know…so I would be wary. I would want to make sure that a market could absorb all future and upcoming supply.
Underwriting and Financing
Alright, now let's talk about the underwriting and financing. Underwriting storage facilities requires a unique set of skills because we look at those individual units as products. We're trying to get market fit. They each have their own demand. We don't rent them all the same and this is the basis that you need to understand in dynamic pricing. When it comes to dynamic pricing there are lots of software that you can use that track different pricing throughout the market. You don't need to make it that complicated. Remember, dynamic pricing just means you're individually pricing units. Not all 10x10s are priced the same. That doesn't make sense? If you have a hundred 10x10s open, the first one that you fill up needs to be at a discount because there's no demand. Now, if out of the 100 units, 99 of them are filled up, that means the 100th one should be at a much higher price than the first one. That's dynamic pricing. You can do it on your own. We did it and as people move out, we're playing with the street rate offering and we're trying to move customers to that rate.
The next thing to understand is the revenue model and pricing is understanding the asset. So, when we're talking about the product market fit, what is that asset being offered to the market? What we're looking for is the top-end charge and the low-end charge and then I divide up all the competitors based on quality and offerings. Where do you fit? If I buy a low offering, maybe a gravel drive-up with no security storage facility, then I want to charge the same as a multi-story, indoor, climate controlled, heavily guarded facility. That's probably unreasonable. Nobody's going to pay the same prices for those. So, when you're looking at pricing and revenue, when you want to underwrite the facility to understand projections and where it may be lacking, where it can go, make sure that you're getting comparable products. What's the top-end? What's the low-end? Where do you fit and where can you drive those revenues and offerings?
The next thing we look at is seasonality. We need to remember that in storage, there's a seasonality amongst renters. Spring to Fall, we have lots of renters and it really tracks the movement of housing and the availability and ability to move into storage. Now, there are some areas where you have high demand, and you have dense areas. They don't have any seasonality at all, but understanding the revenue fluctuations when I'm underwriting, I want to look back at that storage facility and I want to look at all the seasonality. What were the highs and lows of occupancies? Where did we have infill? The reason being is you want to adjust prices and you want to be ready for that and compensate for that. When you're full you want to charge a high price. You may want to give discounts though in the off season. It's also known that in the off season, renters generally rent longer so they're a higher priced target. So, you give them the discounts. Super high demand in the summer months, they generally stay less so you get less revenue. From them, you want to charge a high price, but you probably don't want to give discounts because you know they're not going to be there.
It needs to be worth it to you and your business seasonality is important. Fees and upselling sign-up fees, so when you come in what kind of fee structure is the storage offering? This can be a major generator of revenue and I'm talking sign-up fees or processing fees. There's a lot of different fees that you can charge. Is the storage facility you're underwriting charging fees or are they not? How is that going to look and how is that going to be built into your facility? Do they have high delinquencies and they're not charging late fees? That's a problem. You want to get rid of your delinquencies and you want to charge late fees for those that are delinquent. That is an important motivator to incentivize people to rent from your storage and it also helps you compensate for all the people that end up not paying you. Leave and you have to sell off the unit which you get pennies on the dollar. Contrary to Storage Wars, we don't make money when we sell people's stuff. That's a net loss. Almost a hundred percent of the time you have to charge fees to try to make up for it because what happens is that when you sell that unit, you can only collect the money that was owed. So, if you sell a unit for ten thousand dollars and they owed a thousand dollars to you, you can only collect a thousand dollars. You can't make a profit on that now. Vice versa, they owe a thousand dollars, and you sell it for 20 dollars, you don't get to make up for any of that. So, you want to build in to make sure there are fees, the right incentives, and you want to be able to collect the revenue that you're owed so you don't lose out.
The Upsell and Expenses
Next thing is upsells: boxes, trucks, insurance – these are the big ones. Are they offering insurance? Do they have any upsells? These are all lines of revenue you need to be looking at when underwriting to see how you can improve what needs to happen with that facility. The next thing we need to look at when underwriting are the expenses. Now, this is an important one and this is one that we see people get wrong all the time because when they attribute the expense ratio to the facility, particularly in small markets and small facilities, they don't attribute any labor. You may have the owner that does all the work. In fact, he may work three to four days a week, but then when he goes to sell it, he doesn't include his own labor. That makes no sense at all unless he's going to work for you for free and that's what I ask. You don't include labor into the expenses? Are you going to work for me for free? If not then we have to do it, because all they're doing is taking their labor in the form of profits which you don't get. That's the wrong way to underwrite. Labor needs to be included. The other mistake that we see a lot of in expenses, is they don't adjust at the new tax rate. This is a big one. A lot of people get hammered by this because what happens is they buy it, the cost basis that they're buying it is much higher than when the other person either bought it or built it, the tax rate adjusts, but yet they sold it with the tax old tax rate and that could be two, three, four times as high and all of a sudden, the numbers were completely wrong.
The next thing you need to understand when you're dealing with your overall expense ratios and total expenses is what you want to get in actuality. What is everything going to actually cost you to run? Are you going to run this unmanned? Are you going to have a person on staff? If it's unmanned, do you have call centers? Do you have third party vendors? Do you have someone coming on site? All those things need to be added into your expense load and expense ratio and adjusted for your operations. Generally speaking, on larger facilities we see approximately a 35 percent expense load for that facility. That's not including debt. That's purely operational expenses. We also attribute a six percent management fee, (which is standard) to that so you can write that and underwrite that on big facilities. With smaller facilities it gets harder, but if you're going to run an unmanned one that doesn't mean you should say, “oh this is my expense ratio and it's going to be unmanned” yet you have all these expenses.
One of the most important things that a lot of people either miss or they don't get right is capital expenditures. Often with capital expenditures, people think it's not as big in self-storage. I say, “well that doesn't make any sense”. You're talking about how it's not as big as far as the percentage goes, so what it cost is irrelevant because it only matters what it cost as a percentage of what you get. In self-storage, although we don't have huge capital expenditures, we're getting a lot less than somebody that's renting an apartment for $1500 and they're renting a $100 unit from you, so the expense load to repair roofs, the expense load to replace cement, fix gates…that may be a high expense load taken from that revenue. You've got to make sure you get that right.
When we're underwriting for a storage facility, we always put in two percent that we are allocating to our repairs and maintenance fund. Up front we have a third party give us a quote and an estimate and we have everything looked at. We look at gates, gravel, doors, roofs, you need to have all that looked at and you've got to get an idea of what it would cost to fix anything that may be broken. That needs to be built in up front. From there, the two percent is allocated to a savings account for repairs and maintenance in which it is reserved when those things come up.
The key to operations and understanding how you're going to manage this is to first determine if the facility is going to be staffed or unstaffed. Who will manage it? Is it going to be you or will you have a third party manager? If it's a third party that you're just hiring out and paying them the six percent or five percent plus all their fees. If you're going to be operating it though and you want to be paying yourself for those management fees, you need to understand how. How are you going to manage the person? How are you going to hire them? You need to understand all the liens processes that need to happen. You need to make sure that you have everything lined up. If it's unmanned, the same things apply.
When you manage an unmanned facility, it is much heavier on technology. They're both super reliant on tech. Tech is a huge part of storage now and it's one of the main advantages you have in operations. When taking over a facility, the revenue management, operating, sales, having people come in and out, how you process those people coming out in and out, how you advertise and attract tenants – these are all a major part of the operations. When we look at an unmanned facility or even a manned facility, tech is important. We're looking at different property management systems. You have things like SSM, you have Tenant Inc, you have Open Tech. You have different AI liens that can automate. They're starting to automate the liens process. The big thing that you need to remember is how do we do payments, move ins, move outs, lock checks, liens, sales on that facility. How do we use technology to automate or speed that up now? There's no such thing as an automated facility. We have unmanned facilities, but that just means somebody comes around once a week and they check on things, they clean out units, you need to get it ready for the next customer. All this stuff that I’m talking about is back-end software. You also have the front-end hardware. Things like gate access, gate control, door access, door control. Are you going to have an electronic system that does that or are you going to manually do it with a lock? How do you give the new customer a lock? These are all things you need to figure out and you need to understand we work heavily with the advertising and the revenue management so we want to make sure we're getting as many new customers as we can to fill up so we can keep driving those prices. You want to have a cloud-based signing like we do. That way you can have off-site sign-ups and you can advertise, have them sign up, all done off-site, and the tech allows you to. You can do it right within a property management system.
For bigger facilities, it's a different game. With bigger facilities you need people on site. I have a facility that would be considered fully automated which means that somebody from another state can rent and they can move in, or they can move out, they can do everything, and they never even have to talk to another person. With that said we still have our call center. We still have multiple people on site because it's a huge site and it cannot be unmanned. You're always playing this game with size and resources. I always look for the expense and operations the ROI or what am I going to get out of this and when is it appropriate to hire somebody. That depends on when they can upsell and if they can do things that will get us that revenue that will compensate them plus make it worth our time.