Self-Storage Deal Structure Advice. Land Lease? Buy?

Question

Hi All!

I am a commercial general contractor in the Southern New Jersey Region. We primarily construct commercial, medical, and industrial buildings with a strong history in pre-engineered metal buildings. My goal is to build a two-phase self-storage project for my investment portfolio. My focus at the moment is Phase 1. Phase 1 is a 45,280 SF/235 unit project.

I have done some preliminary site planning and cost analysis on constructing the facility on a property that is owned by a client I work for. The client is a real estate investor by profession and we have a strong relationship.

The property Owner had prior approvals for a retail project that never took off back in 2008 and the site (7 ACRES) and has been vacant since. In order to minimize the hard costs up-front I would like to propose to the Owner a land lease agreement with an option to buy in the future. To encourage a partnership I am considering offering him an equity position in the self-storage business. Possibly the monthly land lease could be a percentage lease in that he receives a portion of the total rental income based on occupancy. The land value is approximately $600,000. He has had it listed for years with no real takers.

Acting as the developer, I would pay for and secure the approvals and complete the architecture & engineering.  My construction firm would build the project. I have two equity investors lined up to capitalize 35% of the total construction costs.

I am looking for some opinions on how to structure the lease (deal) OR should I secure the capital to buy now and take him out of the equation? To me, it seems if he would be OK with coming along as a partner and positioning his land as equity in the deal it limits my upfront costs.

I am open to hearing your thoughts! I thank you for your consideration and opinions.

Henry Clark · Answer

Zoning.

No Partners.  Otherwise, you can hand me $1mm cash now just for the fun of it.

Random thoughts and notes:

1.  Self Storage is in hot demand as an investment.  As soon as you open your location, you will appraise $1.5mm higher than your cost.  $2mm higher when your about 75% full.

2.  Equity always costs more than debt.  Plus, more messy.  Let's say this is a $3mm project thru Phase 1, might be $4mm depending on your building source.    Would you rather pay 6.5% interest only during construction phase?  $3,000,000 x 6.5%= $195,000 per year for a full year and for the full amount.  Since you're the contractor you control build up time and thus interest expense.  Rent up phase should be about 18 months to get to 65% which should get you to Cash Flow breakeven.  Let's say 2 1/2 years from start to rent up 65%.  The full $3,000,000 won't be out all that time and you will also be getting Rent during the 18 months' rent up phase. So, say you pay $280,000 of interest.  Add that to your $3,000,000 budget.  Would you rather pay $280,000 of interest or give up say 3/4 of the potential $2mm appraised value increase after 2 1/2 years, with you doing all of the work?

3.  Can you finance the deal yourself?  If you can't, I would use these folks to finance for 3 years through debt and not equity.  Pay them 8%, with ability to pay off at anytime.  Once up and renting, would then do a SBA refinance loan.  This is if you plan to keep in your portfolio for at least 5 years.  SBA penalties if you cancel the loan before 5 years.  Self Storage is a "Finance" product, thus you want to lock up your debt as long as you can.

4.  The $600,000 for 7 acres in your area and for Self Storage is easily doable.  Just paid $800,000 for 5 acres for a future location.  You have 2 times higher rental rates than us, thus you can afford higher land costs.

5.  Never do a lease on Self Storage.  If you did that with me.  I would squeeze you at the end, at some point, because you can't move your building and business.  Longterm asset, you want long-term financing except during Construction phase and Rent up Phase, you want interest only loan.

6.  45,280 SF/235 units.  This must be Enclosed. Otherwise, you should have at least 350 to 400 units of drive up.

7.  You have enough land to just do drive up.  You might plan to do mix enclosed and drive up.  Run the numbers and look at your competition.

8.  Enclosed/multi level utilizes land better, but you add elevator, hallway, and fire extinguisher costs.  Drive up is 100% building utilization as rentable space, but you give up more driveways.  Run the numbers.  But also, I would do a mix of both, for competitiveness and price point differences.

9.  Do you know if this is a good location or market?

a.  Do the following.  Let's use Vineland, NJ since that what shows for you.  Google:  Sparefoot, Vineland, NJ.  In the upper left there is a map button hit it.  Doesn't look like anyone in Vineland is using Sparefoot or they have turned it off since they are fully rented.  Make a list of prices near you.  Go back to the first page.  Select the following sizes and keep redoing.  10/15/20.  Select Enclosed, then drive up for each size.  You should end up with 6 numbers if you understand me.  Go back to the map each time and pick the closest places to you and make and average price.  Throw out any outliers.  For Example:  Enclosed 10- $180 to $200; 15- $200 to $250; 20- $250 to $300.  Do the same for Drive up.  Use these for your financial planning plus call your major local storage locations and meld their rates into your figures.  Actually, at these rates, your appraised valuations will probably $2 to $3mm above cost without a single renter yet. Higher once you get to 60 to 80% occupancy.  Do you want to give that to the other investors or take on debt and keep? Your building costs, concrete costs and construction costs should be similar to mine in Iowa.  Maybe a little higher.  But your rental rates are 2 times higher than mine.  Your profit and thus your Cap rates will be through the roof.  This creates the valuation extremes I'm mentioning.  Check your property tax though.

b.  Do the same thing as above.  But now do with Google, Self Storage Vineland, NJ.  Call these folks and get their rates for Drive up and enclosed for 10/15/20.  Find out how full they are.  They should be near 100% occupancy since no one is on Sparefoot.

c.  Now if your spot a good location?  Vineland population, not counting the county, is 60,000 which means a market of 3,600 units.  You need to drive around and take and inventory of existing units.  Okay if there is close to 3,600; 3,000; 2,500 etc.  You plan to do around 400 over two phases.

d.  Is your spot a good location?  Look at your front road, is it two way traffic?  Is there a cross turn lane into the property?  What is the vehicle count, is it around 10,000 or higher?

e.  Is your spot a good location?  Look at the Google search map, for Self Storage Vineland NJ.  To the South and East side of Vineland are fewer people and more nature preserves.  Are you on 55 to the North side of town heading towards Wilmington or Philadelphia?  This is better.  Are you near Landis or Garden and 55?  Great intersections, easy to find, great traffic flow.  Where are your competitors? Will you cut them off.  If I come to town and build can I cut your location off?

f.  With 7 acres you won't build all out for a while.  Would do temporary parking storage.  Your close to a lot of rec areas and the ocean.  I would rather store my boat off the ocean front due to weather and also cheaper at your spot versus say Atlantic City or Ocean City. Or coming out of Phili.

Key to the above is to think strategically.  Just because your land is okay, is there better land, even it if is a little more expensive.

10.  If you ever plan to sell to the big REITS try for 300 units or higher once filled out.  7 acres can easily accommodate that, especially with enclosed.

Start small and Make Your Big Mistakes Early.  Thats what I normally tell people.  But now I would tell them to build.  Plus, you have already experienced most of the issues being a Contractor.  The only mistake you might make is Market analysis and location.  Or giving money away.

Henry Clark · Answer

If enclosed, go for smaller unit size mix to maximize per sqft income.  Keep your 20's down low and not a lot of them.  Or keep them closer to the elevator or front door.  Go more toward 10x15; 10 x10; 5 x 10.   Most 20 sizes the people would rather rent at a drive up.

Climate control- normally two approaches, a.  Temperature, b.  Humidity.  Your insulation will be key.  Also look at Solar.  If humidity, then you want to gear towards De Humidifiers versus A/C. This will also help with Condensation during the Winter.

If temperature, recommend you go with floor heating system versus air ducts.  Heating will be your big issue versus cooling. Example:  Say average high of 88 and average low of 35.  If you want to keep the temperature at 65.  88 - 65= 23 degrees.  88 - 35= 53 degrees to compensate for.  You will be more concerned about heating than cooling.  On the high temperature side, recommend the De Humidifier.  Even though temperature is still 88, it will feel cooler with less humidity.  Roof construction, make sure there are spacers between the roof and the frame to reduce heat transfer.Elevator placement is key.  Later when full you will want to charge more for Premium spots.  Closer to elevator is better.  Want you elevator or door entrances closer to more units versus in a far corner.