I heard you laugh. Don’t try to hide it.
The first time I heard the term “value-add” applied to self-storage, I almost laughed aloud, too. It didn’t compute for me. Like many of you, I worked in single-family and multifamily real estate for years. Value-adds meant something clear to me: changes or upgrades to a property that increases the value. For rental properties, these changes increase income to get there.
For those in the single-family or multifamily arena, typical value-adds may be new countertops and cabinets, or fresh paint and lighting, or new flooring and toilets.
In self-storage, a realm that consists of four pieces of sheet metal, a floor, and a door (plus a few rivets), it was initially hard for me to conceive of value-adds. But I was so wrong, as you’ll see.
The power of a dollar
Amazon founder Jeff Bezos famously took the light bulbs out of the company’s vending machines in buildings across the nation. Why would he do this? Because he understands the power of a dollar.
The electricity, the bulb, and the maintenance tech’s time to change it was a waste of dollars for the company. And a dollar means a lot at Amazon.
A dollar saved or earned monthly equates to $12 annually straight to the bottom line. Amazon’s stock trades at a price-to-earnings ratio of about 60 today, but it has averaged about 131 over the past five years.
This means that $12 in additional income translates to a stock value of about $720. That’s the power of a single dollar saved at Amazon!
Commercial real estate operates under a similar formula. That’s why I believe the Forbes 400, the wealthiest Americans, almost all invest in commercial real estate.
The value formula for commercial real estate is:
Value = Net Operating Income (NOI) ÷ Cap Rate
Higher-income (the numerator) leads to a proportionally higher asset value. And higher cap rate (the denominator) leads directly to a lower asset value.
Self-storage and other commercial real estate operators seek to increase income, the variable they have the most control over, to increase asset value. And since most use some leverage, the return on equity to investors is multiplied even further.
For example, a 25% increase in income translates to a 25% increase in asset value (assuming a steady cap rate). Now suppose there is 66.6% loan-to-value (LTV) leverage on the asset. This 25% asset value increase translates to a 75% increase in the value of the equity. Here’s the math:
Value = 1.25 x NOI ÷ Cap Rate -> 1.25x value (a 25% value increase)
25% value increase divided by (1 – LTV) = increase in equity value
So 25% ÷ (1 – 0.667) = 25% ÷ 0.333 = 75% increase in equity value
The bankers don’t share in this upside! Of course, investors need to realize the downside can be equally devastating if income drops. And the cap rate plays a significant role as well.
The power of a dollar in self-storage investing
We’ve established the powerful multiplier effect of a dollar in the realm of commercial real estate. And I’ve hinted that value-adds in self-storage can get you there. Let’s consider 10 common self-storage value-adds and translate those into the projected asset value increase. I will suggest the physical change first, then explain the math leading to the change in projected value.
In the past decade, cap rates for self-storage have compressed dramatically (read: higher asset value), and I’ve seen many deals sell for cap rates below 5%. I will use a more conservative cap rate of 6% (0.06 in our formula) for this exercise.
Lease 40 vacant storage units
The revenue from this should drop right to the bottom line. Assume a lease rate of $125 per unit.
40 units x $125 x 12 months = $60,000 increase in NOI
$60,000 NOI ÷ 6% cap rate (0.06) = $1,000,000 increase in asset value
Before we go on, consider how this could impact your wealth. It’s similar to the impact of Jeff Bezos’ light bulbs!
Raise unit rent by 10%
Raise the rent 10% on your apartment tenants and they may leave. Raise storage rents by 10% and tenants probably won’t spend a weekend and rent a U-Haul to move their stuff down the street to save $12.50. Especially when they have a month-to-month lease and expect to leave soon. Assume initial rent is $125 per unit, and your facility has 500 units.
10% of $125 = $12.50
$12.50 x 500 units x 12 months = $75,000 NOI increase
$75,000 NOI ÷ 6% cap rate = $1,250,000 increase in asset value
Add truck leasing
This is a classic example of a value-add with no upfront investment. And truck leasing often leads to more storage rentals and ancillary sales. Assume commissions from leasing U-Hauls total $2,000 per month.
$2,000 x 12 months = $24,000 NOI increase
$24,000 ÷ 6% cap rate = $400,000 increase in asset value
Ancillary retail sales
Professional operators usually sell retail items through a showroom/leasing office: locks, boxes, tape, scissors, and more. Assume $1,000 monthly.
$1,000 x 12 months = $12,000 NOI increase
$12,000 ÷ 6% cap rate = $200,000 increase in asset value
You may be able to erect a billboard or lease to an operator. Assume $1,500 in monthly revenue.
$1,500 x 12 months = $18,000 NOI increase
$18,000 ÷ 6% cap rate = $300,000 increase in asset value
Add tenant insurance
Insurance companies provide revenue-sharing partnerships with self-storage operators. It can add up, as you will see here. Assume 500 units at $5 per month.
500 units x $5 x 12 months = $30,000 NOI increase
$30,000 ÷ 6% cap rate = $500,000 increase in asset value
Charge late fees
Many mom-and-pop owners don’t enforce payment policies, which leads to late payments. Buy this facility, enforce the policies, and charge late fees when violated. Assume 25 delinquent tenants at $15 monthly.
25 tenants x $15 x 12 months = $4,500 NOI increase
$4,500 ÷ 6% cap rate = $75,000 increase in asset value
Boat and RV parking
Many storage facilities come with extra land unused by the prior owner. There is a significant demand for boat and RV storage right now, and top operators often incrementally gravel or pave vacant land for this purpose. Assume $5,000 in monthly revenues for our example.
$5,000 x 12 months = $60,000 NOI increase
$60,000 ÷ 6% cap rate = $1,000,000 increase in asset value
Propane, ATM, or cell tower lease
There are probably other leasing opportunities, but I have seen these three in various scenarios. Let’s go with $3,000 per month here.
$3,000 x 12 months = $36,000 NOI increase
$36,000 ÷ 6% cap rate = $600,000 increase in asset value
Add climate-controlled units
There is an increasing demand for climate-controlled units. Facility owners own the land, have marketing in place, and know the demand. Adding a beautiful new building can raise the appeal of the whole facility and contribute a significant stream of income. Costs will vary, of course, but they will likely be a small fraction of the value increase. Let’s assume we add 200 units generating $150 per month.
200 units x $150 x 12 months = $360,000 NOI increase
$360,000 ÷ 6% cap rate = $6,000,000 increase in asset value
Start analyzing today
A good investment begins with a solid plan built upon solid math. Quickly and efficiently analyze a potential real estate investment using BiggerPockets’ investment calculators. We’re here to help you maximize your profit while lowering your risk—no matter your strategy.
One dollar in increased income at a time
I just showed you how to add over $10 million in value in the self-storage arena. One dollar in increased income at a time. Readers can poke holes in the numbers and fanciful summation, but the logic is sound. Self-storage facility owners have these types of opportunities and more to raise income, elevate asset value, and provide investors with substantial returns.
I’m not laughing at the prospect of value-add self-storage anymore. In fact, I wrote a book on the topic, and BiggerPockets Publishing is releasing it this month. If you’d like to learn more about the nuts and bolts of operating or investing in self-storage, you can get your copy here.
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.