Self Storage- COC, Cap rate, Cash Flow evaluation; which is best?

Question

Was on another post and the question was asked, "What is a good COC for B and C self storage."  The following discussion relates just to drive up B/C self storage locations.  More than 80% of these are owned by Mom/Pop.

Realized, I didn't have a clue, since I don't use COC or cap rate to evaluate my deals.  So I thought lets educate myself, so sorry for the basics.  Keeping the examples, simple.

COC- Cash on Cash ratio:

Formula- Annual Cash flow divided by original Cash investment.  Pre-tax.

Example: (Cash flow= NOI $60,000 less debt payment $50,000=  $10,000) / (Original cash investment (example:$100,000 infusion with a $900,000 loan))= 10%.

Note:  Net "Operating" income does not include depreciation.

Cap Rate:

Formula- Net Operating Income divided by current market value

Example- using the example above:  NOI $60,000 divided by $1,000,000=  6%.

Note:  NOI does not include depreciation and does not exclude debt payments.

Whatever I am about to say, the above two metrics are the best to use, since they are common metrics and definitions used in the Real Estate world.

We use the "comparison" of Pay back in years versus Loan Amortization period.

Our target for Pay back is 8 to 12 years.  Our Loan Amortization we want is 20 to 25 years.

Our primary focus is on cash flow first; Returns are an inherent part of the Payback calculation.

Remember the discussion started off with a metric to evaluate B/C self Storage properties.  I'm going to avoid picking a winner.  Just use what suits you best.  The key point relative to all three of the approaches, as they relate to Self Storage, especially B/C locations are use them as a starting point, but for Self Storage do a look beyond the numbers.  Disregard which ratio of the above you use:

A.  Is extra land available or is parking rentals included?  The next units you build on this property, subject to the market need, greatly swing all three ratios.  Our first Phase is always built around a 65% occupancy level that pays for everything.  All Land, All fence, All engineering, P/I, insurance, property tax, electric,etc.  The next phase only takes a 35 to 45% occupancy for Cash breakeven (includes P/I).

B.  Increase your rent $10 per unit.  Doesn't sound like much but your NOI goes through the roof.  Evaluate your market to see the potential.  Example:  Using your metric, two potential properties have a "ratio" of 8%.  All things being equal "financially" which one is worth more?  The one in the underserved market.  You can raise the price $10 per unit with Occupancy staying the same.  $10 per unit on a $60 10 x20 is 16% gain.  $10 on say the same unit but NOI, lets say NOI $25 is 40% gain.

C.  Market strength.  Again both have the same "ratio" of 8%.  All things being equal "financially" which one is worth more? Market A "needs" 2,000 units; has 1,500 units with a shortage of 500 units.  Market B "needs" 4,000 units; has 4,100 units with an oversupply of (100) units.  The "quality" of your "A" investment is better than your "B" investment, all things being financially equal.

D.  Occupancy level.  If the occupancy level is low, the sellers will think in terms of Cost to build, versus revenue stream/NOI.  This will have a "Poor" ratio due to the low revenue/cash stream.  Gets back to "C" above.  Which market A/B are you in.  Emphasizing their Net operating Income which will be low.  They will be stuck on their price at Cost to build.  If your in market "B" above, walk away.  Its not worth working with them on the price.  If your in market "A" above, work with them.  Possibly get them to do zero interest finance for a portion of the investment for 5 years balloon.

The question was on B/C self storage properties, which are primarily owned by Mom/Pop.  A.  Extra land and parking is valued at that "use" value and not with a what if, built out., B.  They don't raise prices as fast as REITS or regional firms, if at all.,  C.  They don't care about "Market", "theirs" is the only property in town.  Their Sales Price is not based on any of the discussions above.  They don't think that way and most will not go through a broker.

Look beyond the ratio's, especially for B/C Mom/Pop self storage.

Start small and make your Big mistakes early.

Henry Clark · Answer

When analyzing these smaller towns and B/C locations your obviously looking for a “financial” deal but look beyond that.

1. Look for land to expand.  Phase 2 always makes more money than phase 1.

2. Try to get to 60 to 70% of the market  Then you can do the $10 per unit increase.  This will get you more cash flow and profit than the “financial” deal

3.  If you accumulate enough of these properties they become more valuable as a group than individually in total. A future owner would rather buy a package than one single small location.  More effective on your management cost

Henry Clark · Answer

@seth. The above was an example.  Like I say on most of my post.  Start small and make your big mistakes early.   Recommend you stick to towns 30,000 or less.  Stay away from both large cities and climate controlled for the next 5 years the large REITS and regional firms will pummel each other.  You will need about 50% equity  to survive.

I’m building two in large metro.

Location 1.  It’s exposed and open to market pressure, but I had planned to be able to change my product offering.  Which I am doing for phase 3.

Location 2.  Identified a protected location due to zoning and availability of land suitable for storage.

Start in small towns with $250,000 up to $800,000 locations.

Looking forward to your COC calc and interpretation

@Seth Eatonundefined

Henry Clark · Answer

Traveling so I’ll do a rough call on the road.  At the end remember it’s about the three additional investment steps that bring you abnormal cash flow.  I wouldn’t try to compare a Storage facility initial investment versus a BRRR and flip

Going to do a 1mm metro area type of investment versus a population of 5,000 to 30,000.   Due to the rampant REIT and large regional/local builders your grade of investment can degrade very quickly in a large city if you have not selected a location with little chance of competition coming in.

Cash in:

SBA loan 10% down$250,000 on $2,500,000; loan of $2,250,000. Use 20 year term 5% over life.

Annual cash outlay:

Calc P/I annual or how you do versus 20 years compared to the down payment lump sum

Property tax  $50,000

Insurance $10,000

Electric  $12,000

No manager $0 or use $50,000

Maintenance   Grass snow etc  $20,000

Depreciation disregard

Income tax leave to you, leave out or put in.  If your building this or do cost segregation assume immediate writeoff of $700,000 for taxes if you do them.

Cash inflows:

Rent  430 units at $100 average at 90% occupancy, annual, past rent up phase.  $464,000 annual  if you want to get more precise with rent up period assume 30% first spring: 20% fall; 30% second spring; 10% second fall

Disregard all fees for now.  Just doing a rough calc for you

Traveling  please run the numbers and let us know how you calculated

This includes a phase 2 which I included up front

You won’t be able to do items 2 and 3 above for further value generation.

For my benefit what type of investments are you comparing against a storage location.  And how much time investment on your part from an ongoing standpoint.  Also how much are you looking for a BRR killer deal?   Storage is really boring once setup.  If everything is done right all your work is done for 20 years.   You just have to manage.  Very little entrepreneurship  after initial investment

Henry Clark · Answer

No response to coc ?   If you use coc please complete the above calc. If missing info let me know.

Curious to find out how you use the initial down payment in an annual calc.  Or do you use a Npv of revenue stream against the initial down payment. Thanks.

Seth Eaton · Answer

Thank you for shedding more light on my original question, Henry. We need to know how much of a return on our investment (COC) to expect, under varying conditions, for this capital intensive business. The huge capital investment (higher risk) and of time necessary to acquire and stabilize a self storage business, may not be worthwhile, for example, to only earn a 10% return.

Bjorik Mutize · Answer

Good intel. Thanks for sharing @Henry Clark

Henry Clark · Answer

Since we manage ourself we only look in markets within 40 miles.

With that said we approach the owners directly. There are roughly 40 storage facilities within that realm that are B/C facilities and that are mom/pop.  Most of these people will be in their late 60’s or older.  Subject to age, health and kids not wanting the business a good percentage of these will be for sale.  At the same time we are building.  All of the facilities we have purchased or passed on the owners came to us.  Two purchased.  Three passed on.

Because it takes us a year to build a location or to digest an acquisition we really haven’t tapped our market. Or pushed contacting people.

See our post on “will they come”.  We rate the different cities and decide which is the best to invest in based on potential market and unit inventory.

This is truly the best time to ever get into storage.  Baby boomers will be leaving the market.  They are not interested in expanding this territory is left open to grow into.  Don’t compete with “A” properties, REITS and climate controlled.  Both their financing and SEO power are better than you can ever be.

Taylor L. · Answer

"If the occupancy level is low, the sellers will think in terms of Cost to build, versus revenue stream/NOI. This will have a "Poor" ratio due to the low revenue/cash stream."

One of many fantastic insights in your post, thank you for sharing. Are you typically able to source these types of deals through brokers or are you finding it more effective to go direct to the seller?

Self Storage- COC, Cap rate, Cash Flow evaluation; which is best?

Start small and make your Big mistakes early.

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