Self Storage- What is best Appreciation or Cash flow, forget them for a second.

[Henry Clark]

Taking a break from the last round of snow and ice.  Wasn't too bad.  Around 2 to 4 inches for two back-to-back storms.  I'm on Week 3 of my right hip replacement so I had our neighbor plow the snow, versus renting a skidsteer and climbing around on the ice.  Hip is doing great.  Walking on my own after about the first 5 steps to loosen up.

Little marriage advice before I get into the post.  Always ask your future spouse if they will help you out.  My wife out helping salt and chip frozen ice.  Had a kick about how large some of our icicles got.  

Okay.  People are always asking about which is better Cash Flow or Appreciation as NOI as an investment model.  I'm not going to discuss those.  

While salting and chipping ice got to thinking about the returns on Self Storage.  Just taking a break and writing a post right now.

Rarely discussed are the Non-sexy returns of Self Storage.  Interest expense as a deductible, Depreciation expense as a deductible and Principal paydown as a piggy bank.  I'm not going to get super mathematical, just going to discuss these aspects in general.

1.  Interest Expense- when you do monthly "P/I" payments there is a portion for interest expense and principal paydown.  The ratio of each starts higher with interest expense in the first month and then higher with principal in the last month.  To keep this simple, let's go with the two extremes.  Let's say in year one, all interest expense and no principal paydown.  Say Income tax rate is 25%.  Interest expense of say $50,000.  That is a $12,500 cash back to you.

2.  Principal paydown- Same scenario as 1 above.  But let's say 100% principal paydown of the same $50,000. No impact to the tax return. Just you put $50,000 into your piggy bank if/when you sell the location. The good thing about Self Storage there is very little Capex R&M, so this $50,000 is truly yours to reap. Or this equity can be used as collateralization for another deal.

3.  Depreciation Expense- As noted in 2 above, there is very little Capex R&M in Self Storage. Let's use $100,000 as depreciation each year, again at 25%. Thats $25,000 cash per year. Yes, you will have to pay taxes back for the depreciation amounts should you sell in the future. And for Self-Storage you will definitely beat Inflation, and your building and property will sell for more than it originally cost.

Forgot one:

Inflation-  Got to love inflation.  If you already own.  Inflation is great. Realize its relative. But for Self-storage it is beneficial in two ways.  A.  Our rentals are on a Month-to-Month basis.  So, we can increase the rent as needed., B.  Principal Paydown- If your loan term is say 20 years.  Inflation is 5% per year.  Your paydown in the later years is virtually free.  $1 of debt in year one, will only be worth say $.10 in year 20; someone can do the actual amort table.  Who doesn't love Inflation?

Yes, deal Cashflow and Appreciation are great.  But the meat and potatoes of Interest expense and Depreciation tax impact, Principal paydown and Inflation truly make the deal.  When we do our deal analysis, we normally build so that at 65% occupancy on our 1st phase we are cash neutral, which includes P/I paydown.  Thus at 65% occupancy we are still making good money.

Start small and Make Your Big Mistakes Early.  Plus ask your future spouse if they will help out.