The Pros and Cons of Self-Storage Investing
The year was 2016 and I was a newly minted Director of Acquisitions tasked with finding multifamily properties to buy. It was a rough year. I underwrote deal after deal, but I couldn’t make the numbers work to match our investment strategy. After some internal discussion, we decided to focus our attention on a different asset class: self storage.
At the time, I knew nothing about self-storage, but after underwriting multiple deals and closing on five in nine months, I realized self storage is one of the best real estate investments a small, private investor can make – even better than multifamily. Based on my experience, I want to share five pros and a few drawbacks of self storage investing that every investor should keep in mind.
Approximately three-quarters of self storage owners own just one or two facilities. The remaining owners are sophisticated or institutional investors who own roughly three or more. What does this mean for potential storage investors? It presents an opportunity to acquire facilities from local owners who are accessible and prepared to sell. Due to the age and size of these facilities, they usually aren’t targeted by institutional investors. As a result, the private investor has the opportunity to acquire overlooked facilities that produce excellent cash flow.
Lower Expense Ratio
Self storage has a roughly 35 to 40% expense ratio, meaning that for every dollar in revenue, about $0.35 to $0.40 is used to cover expenses. The remaining $0.60 is your net operating income. This ratio is considerably lower than some asset classes, for example, multifamily. Why is this? Self storage has fewer unexpected expenses and CapEx costs. There are no leaky toilets, pipes that burst, broken fitness equipment, and so on. As for CapEx, you can expect to pay for gates, roofs, doors, etc., which all need to be repaired or replaced. The difference is that you know when those items are coming due for that work. As with all types of real estate, there can be surprises, but the repair expenses in self storage are more straightforward.
From furniture to vehicles to seasonal decorations, people store all kinds of goods. One may use storage when moving or for business. When tenants default on their payment, their items are auctioned, which is not as costly or emotionally involved as an eviction can be.
When someone rents a unit, they sign a month-to-month rental agreement, not a long-term lease. If rents are increasing in your market, you can raise rents to capture that potential revenue. Tenants are typically sticky; meaning, they most likely won’t move out due to a nominal increase in rent. Where would they go? Down the road where the next facility is charging the same amount? That’s unlikely.
Self storage is the only real estate asset class that the Small Business Administration (SBA) will lend on. Like an FHA loan where a homebuyer can put as little as 3.5% down, a buyer utilizing an SBA loan can purchase a self storage facility with 10% down. In contrast, most other types of loans may require a buyer to put 25 to 30% down. The SBA will also provide funds to cover renovation or CapEx costs, which can be helpful for small investors that may not have the upfront capital needed for repairs. There are some trade-offs with SBA loans, so it’s advisable to look at all financing options before deciding which is best.
There are plenty more reasons to choose self storage as in investment, but those are the big ones. Now for the cons.
Last year, my car was in the shop for repairs. Naturally, I took an Uber from my office to pick it up. During the drive, the topic of self storage came up. My driver turned to me and asked, “Do we need any more storage?” Great question.
From 2008 to 2018, self storage construction spending tripled, reaching nearly $5 billion.
You’ve probably witnessed it pop up around your city. What’s the downside of this popularity? Investor’s demand is causing storage facility prices to trend higher resulting in lower returns. As a result, the storage investing landscape is more challenging to navigate, although not impossible.
Rental Rate Decreases
Just as the month-to-month nature of storage allows for rental rate increases, the opposite is true. If market rents are declining, then a facility is susceptible to those price shifts. It’s not uncommon for long-term tenants to be upset when they hear about specials like “2 months free” for new customers.
Let’s say a 10x10 unit rents for $100 per month. After applying that 35% to 40% expense ratio, you’ll have about $60 to $65 in NOI. Compare that to an apartment unit that rents for $1,000 per month. After a 50% expense ratio, an owner would end up with $500 in NOI, a drastic difference compared to a self storage unit! The returns for both asset classes can be similar, but the cash-flow dollar amount can be vastly different. Most investors don’t consider this difference when jumping into self storage.
With lower operating costs, fewer headaches, and alternative financing options, I have no doubt investor demand for self storage will continue. If you are considering adding self storage to your portfolio, I hope you’ve found these points helpful as you weigh your options.