How does rolling up units into a larger portfolio effect the exit CAP Rate?

Question

I am currently in the process of looking at some self storage facilities to syndicate. One of the questions that has come to mind is as follows...

How does aggregating more units into a portfolio effect the exit cap rate when you go to sell? Can you charge more of a premium due to economies of scale or is there a threshold that becomes too large and overwhelming for prospective buyers?

Thoughts? Thank you!

Zach Quick · Answer

@Garrett Gatton there is no such thing as too many to overwhelm perspective buyers.

Immanuel Sibero · Answer

Cap rate used to value a property is determined by the market, not by the investor. It generally varies from market to market and across property classification (i.e. A, B, C etc.) Exit cap rate is the cap rate that you estimate to be the prevailing cap rate for the specific property and specific market when you go to sell. Since this rate is an estimate of what the market determines in the future, an investor needs to make a decision whether he wants to be aggressive and estimates a lower cap rate at exit than his Entry cap rate or be conservative and estimates a higher cap rate at exit than his Entry cap rate (usually by some measure of basis points).

As to your question about rolling up units: Are these units located in different market? If so, they should be underwritten separately as they operate under different circumstances and more likely have different market cap rate. As a buyer, I would underwrite different properties in a portfolio separately, especially if they're located in different market.

One thing is for sure though, the properties (i.e. their conditions,  age, whether they're rolled up in a portfolio) have no bearing on Exit cap rate. This rate is determined by the market when you go to sell (i.e. using recently sold comparables).

Cheers... Immanuel

Tiffany Colvert · Answer

Adding more storage units to a portfolio can increase the NOI, which in turn can increase the property's value and potentially lower the cap rate. I do think investors will ultimately look at specific market conditions and the demand for storage units in your market. If the vacancy is low, I'd say it makes sense and could be a viable option to bundle into a portfolio for greater returns.

Immanuel Sibero · Answer

Some more food for thought:

I invested in larger apartment syndications (350 and up), one of the investments was actually a portfolio of two properties. My observation was the bigger properties tend to trade at higher cap rate (i.e. contrary to your expectations). Everything else held constant, large number of units carry relatively higher risks which put upward pressure on cap rate. Also, in the 350 unit and up the market is not as crowded (it's harder to syndicate large number of units), so less players means less competition, less competition means lower prices)

As to the question: Can you charge more for economies of scale?

I agree that there may be economies of scale by pooling multiple properties. However, as a buyer I’m buying your most recent NOI. If you’re able to achieve economies of scale during your hold, they’re reflected in your NOI (i.e. your NOI would have increased because your expenses had come down as a result of the economies of scale). Since I’m buying NOI (based on T12), I’m already pricing in this increase in NOI. No need to pay a “premium” for it.

I'm curious what the data from Costar will show though.

Cheers... Immanuel

Garrett Gatton · Answer

Thats's fair haha.

Garrett Gatton · Answer

Immanuel these would be in the same market across 4 different locations. And the data that I wanted to find was looking at sold comps to see if the exit CAP was different for say a portfolio of 100 self storage units vs. 500 self storage units. We have CoStar so I will likely start there but didn't know if anyone has had first hand experience in that either from the buyer side when evaluating a larger portfolio or a seller seeing more demand on larger portfolios. Thank you for the insight! These are good questions to be asking.

How does rolling up units into a larger portfolio effect the exit CAP Rate?

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