Forced Appreciation - Self-Storage Style!

Hi folks! So, have we decided on the “hyphen” in self-storage yet? Or is it self storage?? LOL.

In all seriousness folks, let’s talk about the magic of forced appreciation! Now, the concept typically gets talked about in the multifamily context but today I am going to put in the context of…you guested it…self-storage!

We all know that the three core metrics in incoming earning real estate, or the holy trinity, are the Debt Coverage Ratio (DCR), Cash-On-Cash Return (CCR), and Capitalization Rate (Cap Rate). But, for the purpose of this discussion, I am going to talk about the Net Operating Income (NOI) and the Cap Rate. The NOI and the Cap Rate determine what the market or the buyer deems the property to be worth. Now, if the NOI of our property were to rise then the CAP would lower and the property value will increase.

This is where forced appreciation comes in. Now, you may be asking what “normal” appreciation is and you would be correct in asking such a question. Appreciation or organic appreciation if you will is the natural value gained over time of a property. For example, you single family home, which isn’t an income producing real estate property (unless you’re renting it). We all know that if you live in a good area and property values have increased over time then you will most likely get some appreciation gains when you sell. This is organic appreciation. You may very well get this with your self-storage property but most income producing commercial real estate properties are valued on the income they produce. Image that!

So, to boost the value of our property we want to boost the NOI of the property. Well, how can we do this? This is where value adds properties and a strategic plan come in to place. What I like to look for in an existing property is land to add more storage square feet (SF). This is true value add. Not just rent bumps, U-Haul rentals, and other goods sold. To make truly staggering profits on the sale of the property you need to add SF. Now, here is where some people get hung-up. You see when you add SF it costs money. It also costs money to lease-up the property. So, in effect you tend to see negative cash flows for the first year or two (sometimes more depending on the size). I urge you to look pass the cash flow in the first few year and towards the end game. Most of the value adds properties I have underwritten and seen executed well product equity multipliers in the 2.x -3.x range. Yes, double and triple your money in a five year period. Also, remember the costs of add SF in self-storage significantly less then in multifamily! No, stainless steel appliances, carpet, dry walling, no plumbing, less electrical...you get the picture. It's a metal box! :) 

When we underwrite these types of deals we build in (so will the bank by the way) money to build and operate the facility while in the lease up period. One key is to have an experienced property manager/operator that has done these types of lease-up and build outs before. Have an exit strategy. Have two exit strategies and do your homework! The main point here is that if you do these deals right you will be one happy investor and you will make your investors return for more!