Building Value in a Tight Property Market

[Lauren Brychell]

It is a challenging time to find profitable deals on existing self-storage facilities. Interest rates are steep, and banks are backing away from financing, making it harder to secure loans. Meanwhile, because storage is still recognized as a strong asset class, property values have remained high, leading to compressed capitalization rates.

Fewer deals are coming to market, and for those that are, it is becoming increasingly difficult to negotiate terms that leave both the buyer and the seller satisfied.

However, while acquisitions may be slowing, the market is ripe for opportunistic ventures like ground-up development. To understand why, we need to take a deeper look at one of the metrics we use to assess a project: the yield-to-cost rate.

Unpacking Yield-to-Cost

The yield-to-cost rate is essentially an operational cap rate. It measures the expected return on investment by weighing the estimated income from a completed project against the initial cost basis. Whereas cap rates have stayed relatively low, the yield-to-cost rate on ground-up development is trending upward.

That means that, at the moment, it can be more profitable to build than to buy. We're currently seeing ground-up projects averaging a yield-to-cost rate of 9-11%.

There are several reasons for this. Fully-developed storage facilities are expensive, but there are opportunities to purchase affordable, well-positioned land in regions with elevated rents and substantial population and wage growth. Although property values are climbing, construction costs have remained stable.

Lastly, when developing or expanding a facility, the operator has more control over the outcome. This enables operators to focus on amenities and features that attract tenants and drive up rates — leading to enhanced profits once the location is open for business.

Economies of Scale

A high yield-to-cost rate is not the only advantage when it comes to ground-up development. Consider having an in-house construction team that is licensed in multiple states, which helps provide all the benefits of a national builder combined with deep, local knowledge of the markets you serve. This would allow you to retain complete oversight of construction, helping control the value chain and mitigate risk.

Multiple Exit Strategies

Ground-up projects also provide several exit strategies. You can buy and entitle a property and flip it, or build a facility, obtain a certificate of occupancy, and sell it empty. Or finally, you can lease up and stabilize the asset.

Every location is different, and the optionality of having multiple exit strategies allows you to adapt to the market, remain agile and achieve the maximum return on investment for every deal.

Even when conditions are favorable, prioritize a proactive approach to due diligence and mitigate risk by structuring the purchase agreements so you only close with full entitlement approval. That means money only changes hands once you're certain that planned development can move forward.

I hope this article provided some insight into building value during uncertain economic times. Thanks for reading!