For Your Knowledge

The Ugly Duckling of Real Estate Investments Comes Into Its Own

Self-storage investments in the United States have grown exponentially since their humble beginnings in the mid-1960s, when the first self-storage facility – or mini-warehouse, as it was known then – opened in Texas. Back then, and even through the 70s and 80s, self-storage facilities were industrial and epitomized the word utilitarian. Just about anyone could throw together a shack and stick it on the side of the road, or put a sign on the front of an old, rundown house – and violá, there was a new self-storage facility.

It’s no wonder that the self-storage niche was once referred to by many investors as the “ugly duckling” of real estate ventures.
However, as the years passed, this unassuming niche matured, becoming the real estate investment equivalent of a beautiful swan to property investors throughout the United States. According to the national Self-Storage Association (SSA), self-storage is defined as “facilities offering rental on a month-to-month basis where the tenant applies his lock — hopefully one that you have sold him from your retail sales inventory — and has sole access to his unit. No bailment is created by the facility, i.e., no care, custody or control.”

The SSA represents the $18.5 billion (annual revenue) self-storage industry, which is made up of storage facilities with a total combined size of nearly 2 billion rentable square feet. According to the SSA, today there are about 55,000 self-storage and mini-storage facilities in the United States. Self-storage facilities have expanded all the way to Wall Street, where several self-storage facility real estate investment trusts (REITs) have gone public via the New York Stock Exchange. And as of 2005, one in every 11 households in the United States rents a self-storage unit, which is a 50% increase from only ten years earlier.

Intrigued yet?

What’s Driving the Trend

If you’re like many investors, you’re starting to see the pot of gold at the end of the self-storage rainbow. However, self-storage is no longer the “if you build it, they will come” no-brainer, effortless investment it was back in the 1970s and 1980s, when there was little to no competition in the industry. Today’s consumers want quality and convenience, not a hastily constructed, cheaply designed, shack on the side of a dirt road.

Before you start writing checks, you need to take some time to learn about self-storage customers, and understand their needs. So, let’s look at self-storage customer must-haves.

Today’s consumer wants security, flexibility, excellent customer service, and an aesthetically pleasing place to store his or her things – even if those things are nothing more than his cancelled checks from 10 years ago, or the moth-eaten dresses her Great-Aunt Lila willed to her. But today’s consumers aren’t just people who need a place to keep their extra furniture or personal possessions, they’re also local businesses, from banks to retail shops to grocery stores; they’re work-from-home employees, individuals with Internet-based companies, and pharmaceutical reps; they’re RV and boat owners, wine collectors, military personnel, and college students; and many others from all walks of life, who have an ever-growing amount of “stuff” and nowhere to put it.

According to Poppy Behrens, the Executive Editor of MiniCo, Inc., who has six years of experience in the self-storage industry, the customer base can be divided into four types. The largest is residential customers, who, according to the 2006 Self Storage Almanac, represent approximately 76.9 percent of self-storage customers. Next are commercial tenants, who on a national basis represent 17.6 percent of self-storage tenants. However, that being said, Behrens points out “there are some markets where you can see the commercial component reach as high as 50 percent. Take Honolulu, for instance, where they have a lot of retail storage, from people who do business from carts and kiosks… they have nowhere to keep their inventory and their back stock, so they’ll turn to self storage.” The other two types are military tenants and college students, representing 2.3% and 2.8% of the market, respectively.

Let’s focus on the first two segments of your likely client base to determine which is more appealing to you as a prospective investor. We’ll begin with residential customers.

Several types of residential communities seem a natural choice for locating a self-storage facility. Consider areas with a large retirement or nearing-retirement population, or where many couples whose kids are grown and out of the house are downsizing from their large homes into smaller, easier-to-care-for homes (or condos). These people may not want to part with their possessions, but rather store them nearby.

People who are moving into expensive, but less spacious real estate – for example, downtown lofts, or trendy renovated urban-area condos – need handy self-storage facilities for storing (and occasionally, switching out) their belongings.

Now let’s look at the commercial self-storage tenant. A small retailer may not need a large warehouse for additional inventory; and a local small business owner might not be able to afford to lease expensive office space simply as a storage closet for archived records. In both cases, a nearby self-storage facility is often the ideal mini-warehouse, or the perfect space for old files, documents, and other records. Another great use of the self-storage unit is as a small scale distribution space for stock that needs to be replenished quickly and at the last minute.

Self-storage customer and pharmaceutical rep Michelle Meehan, of St. Louis, Missouri, said that many of her colleagues use self-storage facilities to keep their supplies, promotional materials, literature, and drug samples. “It is a common practice for a pharmaceutical rep to use storage facilities… [However] the reps have strict FDA (Food and Drug Administration) regulations that they have to follow.”

Behrens said that each tenant group has its attractive points. For example, commercial tenants, as a rule, tend to stay longer, and pay their rent on time, so they’re very desirable. Tenants range from pharmaceutical sales reps, to small business owners, such as painters, dry wall contractors, plumbers and more. The biggest bonus of commercial tenants – especially those that are solid members of the community - is that many will commit to a long-term rental, saving you the time, money, and effort of filling that unit every month. For this reason, many self-storage facilities have become exclusively commercial storage facilities.

“A lot of areas are seeing an increase in a commercial tenant base from the home-based business or Internet-based business standpoint. [These people usually start by] putting their goods in their back bedroom, but as they get more successful, they need a place to keep those things. And we’re actually getting a lot of places that use storage for their eBay or other online businesses.”

The Build Versus Buy Proposition

RK Kliebenstein, co-author, with Scott Duffy, of How to Invest in Self-Storage, has spent more than 20 years in the self-storage industry. He is also the founder and owner of Coast-to-Coast Storage, which he says is the leading provider of consulting services for the self-storage industry.

According to Kliebenstein, for new investors wanting in on the self-storage game, the first thing they need to decide is whether or not they will be a buyer of an existing property, or a builder-developer of new property.

Someone buying a property needs to begin by addressing the construction basics – from finding the right piece of property with the right zoning, to finding the right contractor and developers. There are many development experts in the self-storage industry, and a poor plan could be the death of your project before it even gets off the ground, so work with a builder who knows the industry. After choosing your team, you’ll work with them to determine the type of facility, the construction materials and infrastructure, landscaping, lighting, and building codes. Your general contractor can help you create a budget, based upon estimated costs plus his markup.
Kliebenstein offered his in-a-nutshell analysis of the pros and cons of building your own facility. “Under the development side of it, [there] are the higher risks and a greater amount of capital; [plus] difficulty in zoning, and site location.”

But on the plus side of the development approach, he noted, there are higher rewards. “[A self-storage facility] is easy to construct. It’s not too difficult [of a] development process. Once you get past the zoning, it’s pretty easy from there on. There are a lot of providers who can help you get across the finish line.”

The other option, Kliebenstein said, is the lower-return, lower-risk “buy” consideration. The challenge with this option is finding available properties to purchase. The positive aspects of buying, in addition to the low risk factor, are typically strong cash flows, and a proven location.

According to Barry Feinman, a self-storage investor for the past 20 years, and co-owner of four Safe Storage facilities in and around Albany, New York, if an investor finds a facility for sale, the most important thing to consider is the location.

“[Location is essential] because you can always improve a facility, but if the facility doesn’t have the right location, I think that’s where you’re going to run into problems, either today, or in the future,” said Feinman. “And I think that, from our standpoint, as well as, I believe, [the standpoint] of the industry, you have to look at self-storage as being a retail business.”

How Do Self-Storage Facilities Measure Up?

In theory, the operating expenses of a self-storage facility seem far less than the expenses for other types of property investments, such as residential or other commercial properties. However, to be successful with a self-storage investment – as with any investment – it is essential that you step back for a realistic look at the numbers.

Let’s start by comparing rents and total development expenses for self-storage versus those of office, retail, and multi-family properties. According to American Steel Buildings, Inc., which produces self-storage buildings for investors, self-storage facilities most often have rents that are slightly less than that of other properties on a square foot basis. More to the point, though, is the fact that self-storage property development costs are between one-third to one-half the development costs of multi-family, office, or retail properties. Bottom line? Less money upfront, yet comparable rents to other property investments.

According to the 2005 Self-Storage Expense Guidebook, the average nationwide operating expenses for a self-storage facility is $3.47 per square foot; or, as a percentage of collected income, 44.3 percent. These numbers vary by region, with the Western U.S., being the most expensive at an average $4.36 per square foot, and the South Central region of the U.S. having the lowest expenses, at $2.63 per square foot. The other regions are as follows: Southeast Region: $3.47/sq.ft.; North Central Region: $3.37/sq.ft.; and Northeast Region: $3.17/sq.ft.

Self-storage investors will want to keep a close eye on the following three expenses as they can add up quickly: taxes, advertising, and management. The 2005 Self-Storage Expense Guidebook breaks down the national average of operating expenses as follows: on-site management: 20%; taxes: 15%; off-site management: 12%; administration: 11%; repairs and maintenance: 7%; utilities: 6%; advertising: 6%; insurance: 5%; and miscellaneous: 18%.

Another advantage of self-storage compared to office, retail, and multi-family developments is what happens in a bad economy. During an economic downswing, multi-family development occupancies might drop as much as 25 percent, and office and retail occupancies as much as 30 percent. Not only are the vacancy rates for self-storage properties impacted less, but because of their smaller operating budgets and lower occupancy needs, they can better withstand slow periods.

According to American Steel Buildings, the typical leveraged self-storage facility’s break-even occupancy rate ranges between 60 percent and 72 percent; while the leveraged multi-family, office, and retail properties have break-even occupancy rates between 80 percent and 90 percent. To the investor, this means that the self-storage development has more room in which to absorb market drops.

National Development Services conducted a 10-year study of the failure rates of multi-family, office, retail, and self-storage developments in Texas, Oklahoma, New Mexico, Colorado, and Louisiana. The study found the failure rates of each property type were as follows:

• Multi-family: Failure rate of 58%
• Office: Failure rate of 63%
• Retail: Failure rate of 53%
• Self-storage: Failure rate of 8%

Essentials of Self-Storage Investing

To assess the self-storage needs in your community, start by checking out the yellow pages to see what’s out there. Use a resource like Mapquest to determine where the various existing facilities are located, then visit them, posing as a potential customer.

When sizing up the competition, and determining whether there is room for another storage facility in your area, remember to consider the following important aspects of a self-storage facility, regardless of whether you decide to buy an existing structure, or develop a new one. (Each facility will have its own specific issues that will affect its success, but these topics are universal to almost any development.)

Size: While the majority of self-storage facilities are comprised of ground-level units, there are those that have built up, instead of just “out.” In such a case, the owner must install service elevators that are convenient for those carrying larger items from their vehicle to the elevator.

Kliebenstein advises that investors building their first project stick with “institutional-grade criteria,” which translates into the following requirements:

• The facility must have a minimum of 55,000 square feet net rentable;
• The facility should be located in a population center of at least 750,000 people;
• For a single-story facility, the size should be three to five acres.

Why does Kliebenstein advise investors to follow these standards?

“If this is your first project, [we recommend] that you build this project so that the natural buyers of self-storage – like large self-storage companies – will want to buy your property. So, if you decide that you don’t like the business for one reason or another, then [at least] your exit strategy is easier,” he said.

Security: Security is one of the top requirements for most consumers and businesses, so an investor should not skimp on this. Most investors hire security guards, and put many or all of the following measures in place: restricted access that requires all members to sign in and out during each visit to the property, no admittance of non-members onto the site unless they are accompanied by a staff member or security guard, 24-hour closed-circuit TV with or without on-site monitoring, motion detectors and other alarms, and a key code or swipe card needed to enter the entire facility and/or one’s specific unit. Remember that even the most basic security measures should include general alarm systems – including fire and smoke detectors – electric or non-electric perimeter fencing, or the newest break-in deterrent – concrete walls (which also keep potential thieves from seeing into the facility and being able to plan a burglary).

Flexibility: Flexibility includes everything from your hours to the ease at which a customer can drop off and pick up belongings from his unit. Some self-storage facilities today offer a premium service – at a premium cost – to accommodate the customer’s needs: they’ll drop off a storage unit at the customer’s home, where either the storage provider or the customer will pack it, and the self-storage employee will deliver it to the facility. This is a trend that is growing in popularity, so investors might want to consider implementing this service. However, keep in mind that this added service means buying or leasing vehicles, paying vehicle/moving insurance, getting bonded and insured drivers, and a host of other considerations.

Services: Service “extras” – which may be offered as fee-based or free, value-added incentives to the customers – can include dollies, loading trolleys, even workers, to help customers load and unload storage items. Some self-storage facilities (usually the larger ones) now offer amenities fit for a king – or, at least for a businessperson – including such perks as mailboxes, administrative services, meeting rooms, and more.

Location, Location, Location: The self-storage market area is the three- to five-mile radius around your facility, according to Behrens. “So many times, we’ll see new people coming into the industry that just think, ‘Oh, here’s a great piece of land,’ and they [get] it cheap and they don’t do their homework in terms of feasibility studies and all of the analysis that they need to do… they end up not only damaging the performance of their store.”

Insurance: Keep in mind that, with regard to tenant property, most self-storage facilities include a waiver of responsibility, along with a statement that the tenant must hold his own insurance for his stored possessions, within their rental agreement. Many facilities also offer their tenants the option of purchasing insurance to protect the contents of their storage units.

As a self-storage owner, you should be aware of the many types of insurance you need to consider purchasing, including property, business interruption, general liability, limited pollution removal, workers’ comp, and umbrella policies.

The Opportunity is There

In his book, Kliebenstein notes that despite the success of self-storage facilities, the industry remains “relatively unsophisticated and highly fragmented.”

“Today, roughly 75 percent of self-storage facilities are owned by small independent ‘mom and pop’ operators,” said Kliebenstein. While consolidation is occurring in the self-storage industry, it is still not a common occurrence, simply because most self-storage facility owners find that self-storage is such a great, high cash-flow business, that they don’t want to sell.

It’s hard to believe that this is the same niche that many investors used to consider the “ugly duckling” of real estate investing.