How to Value a Self-Storage Facility
Whether you are a first-time buyer of a self-storage facility or an owner looking to sell your facility and want to understand what it's worth, we hope the following helps shed guidance on the things to consider and calculate to figure out a value for a self-storage business.
Below are some terms and approaches that will help you determine the value of a facility for you and help you determine whether or not it is worth purchasing.
Physical Occupancy & Economic Occupancy
There are two types of occupancy in self-storage. Physical occupancy and economic occupancy. Physical occupancy refers to the number of rented units. So if a facility has 100 rentable units and all 100 of them are rented, the physical occupancy is 100%.
Economic occupancy is even more critical. How does economic occupancy work? If you have 100 units and 70% are rented at your current street rate, your physical and economic occupancy is the same: 70%. If you rent the additional 30 units you had left at half price, you now have 100% physical occupancy 70units+30units)/100 units; however, you are currently operating at an 85% economic occupancy. Why? Because for the 30 units representing 30% of your occupancy, you are only charging half or collecting half; thus, 70% + 15% = 85%. In this case, you are only collecting 85% of your total possible income.
How else do you see economic occupancies lower than physical occupancy? Most of the time, you will find that owners are not charging the same rent to all their 10x10 units, or perhaps concessions have been given to customers, such as a free month of rent. Or maybe tenants have past due rent or some of the units are used by the owner or friends for free. Lenders often find that many facilities have high physical occupancy rates and low economic occupancies. If you are buying a facility, you need to pay attention to economic occupancies. We have seen facilities where they are "full," yet their economic occupancy is 60%. So if you're planning to buy a facility and raise rents overnight, don't expect all your tenants to stay; you should bake in your underwriting a vacancy percentage.
Ultimately, you would like to see the physical and economic occupancy as close to each other as possible. From what we've seen during pre-pandemic times the average vacancy/bad debt is 15-20%.
What Is Effective Gross Income
Effective Gross Income or EGI is gross potential income (all units x rates) minus vacancy, concessions, bad debts. It's essentially Gross Income X Economic Occupancy.
For example, if the facility has 100 10x10 at a current rent of $100/month/unit
The gross potential income is 100x$100x12 months = $120,000
If 15% of units are vacant and 5% of the current renters are not paying, that is an 80% economic occupancy. Thus, the business is currently collecting $120,000 X 80% or $96,000, which is the effective gross income.
Is There Other Self Storage Income
Are there opportunities for additional revenue? Is there tenant protection or insurance sold? What about moving supplies/boxes? Rental trucks?
Total Net Income
Total Net Income is Effective Gross Income + Other Income.
What Is Net Operating Income
Net Operating Income (NOI) = gross rental income (total received) minus operating expenses ( payroll, repairs, utilities, insurance, technology, real estate taxes, etc.)
Rent Roll
Make sure you evaluate the rent roll before you acquire a facility. Hopefully, the owner has adequate record-keeping in place that will allow you to understand how long the tenants have been renting, what they are being charged if there are friends or family tenants, or past due rents. The rent roll will also give you a good sense if the owner heavily discounted the latest tenants to fill up the facility.
Expenses
Expenses are critical to the valuation of a facility as you need to determine the true Net Operating Income of a facility as Rents come in minus all expenses except debt services to calculate NOI. Typically for facilities under 25,000 ft, expenses tend to be a higher percentage of the revenue, perhaps 40-60% depending on the location, property tax rates, etc. But for larger facilities, the conservative expenses you should assume as a percentage of revenue should be 36-40%. Be wary of deals where the expenses are very low. Below are examples of expenses for self-storage facilities.
Property Tax: This is a large one; make sure that you understand that property taxes will significantly increase from what the current owner is paying. In most cases, the towns will take your purchase price and reassess the property to your purchase price, which means in some cases the real estate taxes could go up 2-7X from what the current owner is paying. Call the town assessor's office to learn how they approach taxes and put that in your underwriting.
Payroll: If you are not planning on being onsite or working on the business, who is? What kind of staff are you going to have and what will that cost be?
Repairs and Maintenance: Budget according to the age of the facility.
Landscaping & snow removal: Who will do this work, how much will it cost?
Utilities: Make sure you include all utilities, including internet services if required.
Marketing/advertising: How will people find your facility?
Technology costs: Do you have a website, do you have a tenant management system?
Bank and Credit card fees: If you’re accepting credit cards there are fees associated with that
If you are getting bank or SBA financing and are not managing the facility, you must include a third-party management fee, usually 5% of revenue. Similarly, the banks will want to see you set aside money for replacement reserves to have enough money to make major repairs or replacements when needed. You can estimate about $0.25 per rentable ft per year.
If you are getting bank financing or SBA financing, you must include all of these costs as your expenses and subtract it from the self-storage business effective gross income (gross potential income minus vacancy/bad debts). You may see self-storage businesses for sale that do not include all these expenses in their calculations, but you will incur all these expenses and the banks will require them in your underwriting.
What is Cap Rate in Real Estate and Self Storage?
Cap rate is short for capitalization rate; it's one of the key metrics to determine and assess the value of real estate. It's the rate of return of the investment based on the net operating income of the investment.
How to calculate the Cap Rate?
The most common formula is: Cap Rate = (Net Operating Income)/(Current Fair Market Value)
For example if a facility is for sale on the market for $2,000,000 and has a NOI of $100,000, the Cap Rate is $100,000/$2,000,000 = 5%. Meaning if you paid $2,000,000 for the facility in cash you would expect to get a 5% return in annual cash flow for your $2,000,000 investment.
If you are the facility owner and want to get a sense of what your property might be worth, you would take your NOI and divide it by the going cap rates for your area and the quality of the facility. For example, if your NOI is $100,000 and you have a 30-year-old facility in a rural market, your cap rate might be 10% vs. 4% for a new class A facility in Manhattan. Your facility might be worth in this example $100,000/10% = $1,000,000
What is Debt Coverage Ratio?
If you are getting financing from a traditional lender or the SBA, they will require that the Net Operating Income or NOI service the debt at least 1.3 times to consider the deal financeable. The banks look at many other considerations, but this is an excellent quick filter for investors to see if the bank would lend at a certain asking price.
The example formula is NOI is $130,000 and the annual debt service is $100,000 that is $130,000/$100,000 = 1.3, which is typically the minimum debt coverage banks want to see. If the NOI is $130,000 but the debt service is $130,000 that is a debt coverage rate (DCR) of 1, and that will be very hard to finance unless you put in more equity to lower the mortgage amount.
Many other things go into the valuation of a self-storage business. If you are a current facility owner and would like to know how much your facility is worth, please contact us for a confidential conversation and analysis.