Self Storage- Cap Rate and/or Value Add discussion

[Henry Clark]

Was on another post and cap rate was really being discussed heavily, in terms of how many good deals are not out there, due to Cap Rate compression. If an REI investment arena was to ever use Cap Rate it would be self storage. But we don't use it. We analyze deals based on an 8 to 12 year payback; with a loan amort period of 20 or more. This does not include value add potential since, I would be paying the current owner for improvements that I would be doing.

Can Cap Rates be used to analyze properties, I guess so.  But to me only to the following degree:  

When I want to go catch Red Snapper I look for Salt water, not fresh water.  That to me is the level of use of Cap Rates looking for a deal.  You might use at a macro standpoint, but I wouldn't even do that.  You have to look at the details as shown below.

I am using the Self Storage arena for the following discussion. There might not be as many variables or potential in the SFH and MFH world, but still the same concepts.

Same property, same market, same everything except the following:

                                                     Option 1:                Option 2:    How???????????????
Selected P/L items:

Rental deductions                             $20,000                 $5,000             ??????

Property Tax                                     $30,000                          0            ??????

Insurance                                          $10,000                         0             ???????? 

Electric                                             $12,000                         0            ????????

Auto                                                  $ 6,000                          0           ????????

Management                                      $20,000                         0           ????????

Snow/Landscaping                             $   4,000                        0           ????????

Advertising                                        $20,000                         0           ????????

Net Operating Income                        $100,000             $207,000

Property Market Value $1,500,000 $1,500,000 Yes, Market value would go up as NOI increases, left the same for discussion, you can adjust to $3,089,000 new NOI value at 6.7% cap.

CAP rate 6.7% 13.8%

All of the above tactics, positions, decisions, situations are legal and easily executed. But see the big swings in CAP rate, and in turn potential Market Value. Some of these are "timing" and others are permanent.

If you respond, please address the following:

A. Where and from whom do you get your CAP rate figures?

B. To what degree do you analyze the CAP rate figure?

C.  How would you move the above figures or how could they move without your efforts?  They could go up or down in your scenario.

Don't trust me or the Cap Rate figure.  Do your due diligence.  Because if I'm selling to you, I want your money.

There is a tool or metric for everything, make sure you're using the right tool.

[Henry Clark]

I see posts all the time talking about cap rate.  When I have looked at properties and they have communicated the cal rate either the realtor or the owner has calculated it.   Neither are accountants.  You don’t have to be an accountant to understand cap rates.  But you should be pretty good at looking at numbers.

Is the cap rate based on existing financials or projected?  If projected then your paying the owner for your future work.  
   
Self storage is a little different.  If we sold we would want asset value plus Cashflow value.  Currently costs have increased 40% to build in the last 3 to 4 years.  So asset value would need to be increased.

Keeping everything legal and proper accounting how can you move cap rate? Most owners are cash basis accountants so Net Operating Income is based on cash basis. Some ways to move NOI or cap rate are.

1.  Simply increase rents. Self storage customers are sticky and don’t like to move.

2.  Add revenue. Do Uhaul rentals or parking rent in spare ground.

3.  Property taxes are usually paid in 1/2 year installments.   Either pay ahead or don’t pay, staging your sales.

4.  Same for insurance.

5. Purchase solar panels. This is depreciation expense and is below Net Operating Income. Reduce your electric costs which are in NOI.

6.  Snow removal or ground keeping services.  Pay a year in advance or do yourself.

7.  Forgot maintenance on facilities or security systems.

8.  Writeoff bad accounts after or before year end.     

The above may sound small but they can swing your cap rate easily from a 5 to a 7.  Or 5 to a 3.   

Sounds hokey pokey doesn’t it?  I have seen $1.5mm deals with $200 property taxes.  Which will get adjusted after the purchase.  Have seen deals with $25,000 management fees paid in cash off the books.  

Start small and Make your Big Mistakes Early.

And yes you can do Self Storage offsite.   Even on the Danube River.