The Importance of Net Income and the CAP rate in Self-Storage

There are only two things that determine the value of a self-storage property, the CAP rate, and the net operating income of the self-storage facility. Whether you are looking at a new property and trying to determine how much you should offer for that property, or you are looking at your own property and trying to figure out how much it is worth, you need to know these 2 numbers. The net operating income is for the property in question and you need to know what the CAP rate is for your area, to learn more about these two numbers and their importance keep reading.

The CAP rate is driven by the market. If your CAP rate is low, you are typically getting a lower return on your money as a buyer, but you can sell the property for a much higher price. If your CAP rate is high, you are typically getting a higher return on your money, and you are purchasing the property for a lower price. If your CAP rate is unknown to you, it is for an area, so a resource you can use is a local commercial Realtor. Once you know what the typical cap rate is for an area, then you can determine whether you are getting a good deal. If your CAP rate is higher than the area average, you are getting a good deal if you are buying. If your CAP rate is lower than the area average, you are getting a good deal if you are selling. For example, if the CAP rate for your area is 6.5% and you are able to sell your self-storage property for a 5.5% cap rate, you were able to get a great deal. On the other hand, if you are able to buy a self-storage facility for a 7.5% cap rate you are getting a great deal.

When you are looking at the formula for determining the value of the property, this is the equation, take the net operating income and divide that by the CAP rate. The net operating income is determined by taking the gross revenue and subtracting the expenses. When you are looking at a property to see if you are interested in purchasing that facility, you want to notice if there is a way to increase the revenue or decrease the expenses. Know that these two items will increase or decrease the value of the property.

Additionally, there are a few ways that you can increase the gross revenue. Seeing when the last time the current owner raised the rent, as many owners raise rents every 6 months. In contrast, other self-storage owners leave the rents the same until someone vacates the unit. If this is the case, a strategy that can be used is to go in and start to gradually raise the rates, until everyone is paying market rates. By doing this, you can put everyone on a regular rental increase to make sure that you are not losing income. Once you have raised all the rents up to market rates, then you will increase the value of the property, because your net income will also increase.

Another way to increase gross revenue is to look at the ancillary products that you offer. Do you sell locks or moving supplies like boxes, bubble wrap and packing tape? Do you offer any kind of pick up service or truck rentals to help people get their belongings to your facility? Each of these services allows you to increase your revenue. The more net income you have, the more your self-storage facility is worth. Ancillary products also increase the appeal of your self-storage facility over other facilities.

As you evaluate a potential property, look at their current occupancy rates. Are they low for the area or are they what you would expect? If they are low, what do you need to change to get your occupancy levels to where they need to be? Think of strategies and plan that would increase your net income.

Don't forget that you also want to evaluate the expenses side. Are there things that you can streamline or costs that you can cut? If there are ways that you can reduce costs, they will allow you to increase your net operating income and increase the overall value of the property.

Many people like to buy distressed properties and then fix them up and turn around and sell these facilities at the new market value. For example. If you are able to find an underperforming property that only has a net operating income of $75,000 and the area CAP rate is 6.5% then the current value of the property would only be $1,153,846. (You take the Net Operating Income and divide that by the CAP rate to get the current value of the property.) However, let’s say that they haven’t raised the rents in a very long time so you know that just by raising the rents you can increase the net operating income to $100,000 over the next year. You also know that they don’t offer any amenities and based on your past projects you anticipate that you can add an additional $5,000 to the net income in the first year. This means that without changing anything else, you would increase the value of the property to $1,615,384. That is an increase in value of $461,538 just by raising the rents and offering some additional services.

Understanding the importance of the net operating income and the cap rate in relation to the value of your property is critical. Make sure that you are doing everything you can to keep your net operating income high so that you can sell your property for top dollar when the time comes to move on to the next investment. Remember that buyers are looking at the CAP rate when they are evaluating your property to purchase. If you have a low net operating income, you are going to have a lower sales price.

As always,

Happy Investing