Self Storage - Is this a good deal?

Question

Hello everyone -I am looking at my first self-storage transaction, and I'm wondering if this is a good deal or if it's a pass. Seller is asking $1.1 million for a funky/ self-storage transaction. Property Mix 147 self-storage (mostly climate controlled)approx 20k sf office/ work-space. The office is empty, and there are 7 tenants that use the basement as work-space i.e. cabinet makers, auto hobbyists, etc cell towerSelf Storage Unit Mixbalanced mix of 10x10, 10x15, 10x20, 5x10Cash Flows (Trailing 12-Months)Self Storage (approx 80% occupied): Gross income of $123k. Expenses of $72.3k. NOI of $50.6k.Office/ Work Space (only basement is occupied. First floor is empty.): Gross Income of $35k. Expenses of $15k. NOI of $20k.Cell Tower: $24k in net incomeLocationThe property is located in a small town with an approx 11k population.The 5-mile radius also bumps into another town with 26k folks and a third town with 11k people.The property is surrounded by lots of farmland. So theoretically new entrants could build other self-storage properties to compete. Potential UpsideAnother cell phone provider may rent the cell tower, at approx 2x the current rents. However, the seller wants a 50% split of the rents if the new lease is signed within five years of closing the deal.The approx 20k sf office/ work-space could be converted into additional self storage i.e. for RVs FinancingSeller with provide owner financing at 80% of purchase price at a 4% interest rate for 20 years. 10-year prepayment penalty.Other Potential RisksThe seller does not have any leases with existing tenants. (Not sure how this is possible.)Thanks everyone in advance for your help and insight.-Andrew

Scott Meyers · Answer

Andrew, Hard to weigh in on this, as there are many considerations, but here are the main points I look at: 1. What is the Current Cap rate, or Value, that he is placing on the property, using 12 months trailing financials? Currently, on the #'s you provided, he's at an 8.5% Cap rate. Not bad, especially since there appears to be upside. 2. What does the market look like? More specifically, the supply index within a 5 mile radius of the facility - is it undersupplied, oversupplied, or at equilibrium, the quality of the competition, is it growing, stable, declining, Median Income, etc. 3. Where can you create value - Increasing occupancy, reducing expenses, increasing revenue from other sources in addition to raising rent... Those are my main criteria BEFORE you begin negotiating some of his terms. Splitting revenues on additional cell tower income is Non-Negotiable, and although I've seen sillier, that's at the top of the list. I LOVE the 4% rate for 20 years, but I don't like the 10 year prepayment, unless it's low, or fair. What is the penalty? I am skeptical about NO leases - that's rather rare - did he say he just wouldn't "share them" or does he truly NOT have them? Before Purchasing, you would need to get a lease in place for all clients - Strike that - HE NEEDS TO HAVE LEASES SIGNED for all tenants, and Self-Storage CLients prior to acquisition.

Michael Wagner · Answer

That is certainly a complicated one! Very interesting for sure. From a self storage standpoint, the income to expense ratio is not inline with industry standards. I would expect to see a 30-35% income to expense ratio rather than the 59% the owner shows. Could be that other property expenses are lumped in with the storage? If these numbers are accurate, there could be quite a bit of room for improvement/value add. Conversion of empty space is also a very cost effective way to expand. Can be 30% of the cost to build from ground up.Storage, not cell towers, is my area so take what the rest with a grain of salt. My understanding is that the value of the cell tower lease has much more to do with the other terms of the lease. Many providers are trying to renegotiate leases, or shopping any leases that expire soon. How long is left on current lease? Also, sharing the rent with the current owner is an odd arrangement....is he doing the work to get it signed. If so, then it might not be unreasonable, especially given his fair financing terms. The only term I dont like is the pre-payment penalty. Any chance of getting rid of that? Or at least making is a de-escalating penalty (5% in first two years, 4% in year 3-4, 3% in year 5-6, etc)?

Michael Johnson · Answer

The cell tower is a cool idea, is there a limit to how many carriers can rent? (idk, bandwidth or something).Are your expenses average?

Account Closed · Answer

@Andrew H. Overall the deal sounds good to me. Of course, you still have to check if the information is correct.Make sure you put the property in the name of a stand alone entity. Try to make sure there is no personal guarantee of the mortgage. That way the property can be sold without triggering an issue with the financing.

Steven Quinn · Answer

Hello Andrew,A couple important considerations with respect to the cell tower: 1) Who is the carrier (Verizon, AT&T, etc.) - this can tell you a great deal about reliability of the income for a number of reasons.2) Does the Seller own the tower (or is it a rooftop install) - if it is actually a tower and the Seller does not own it, upside from an additional carrier may not exist (all depends on the lease).There are a great deal of additional aspects to consider, but most of them require more information. With respect to the 50% upside for additional carriers (if even an option), I am not a fan, or if you do, (if it were me) I would insist that Seller refund purchase price by 1/3rd if the existing carrier goes away in the same timeframe.Good luck!

Scott Meyers · Answer

Thanks Andrew, It's complicated, but easy to determine the Supply Index.

Andrew H. · Answer

Thanks @Scott Meyers –These are great questions/ insights.I just surveyed the market for comparables, and it looks like there are eight other self-storage facilities within the 5-mile radius. However, only one of the eight properties are climate controlled, so I’m thinking this is a competitive advantage. And the new climate property will not be on-line until January or February 2017. Supply seems to be a little tight. I checked the websites of the comparables, and there was limited availability. Most properties had 4 units for lease. And one property had 8 units for lease. At your suggestion, after some more research, the five-mile radius reaches into a total of 5 small towns with a total population of 110k (average of 22k persons per town). The median income ranges from $48k to $94k, average of $67k. Is this enough population density? Not sure if this is the right analysis. But the way I’m looking at it now is there are approx 44k households (assuming 2.5 folks per household) within the 5 mile radius. These 147 climate controlled units would just need to reach 0.3% of those households.And I think further value can be created by 1) slimming down the expenses 2) creating an online presence and 3) maybe create additional self-storage on the site. The prepayment penalty currently reads as follows: 5% years 1 to 6, 4% year 7, 3% year 8, 2% year 9, 1% year 10; thereafter 0%. However, I will amend as suggested by @Michael Wagner.Thanks again, and I will definitely reach out as I hear more from the seller.-Andrew

Andrew H. · Answer

@Michael Wagner - @ Michael Wagner Thanks for your message. I agree the expenses are higher than industry average on the self storage. It does seem like some of the expenses from the office/ workspace are lumped in. However, I still think there could be some value creation from saving on some expenses. I’m also waiting on some clarification on the seller’s rationale for wanting to stay in the deal. I spoke to the broker today, and it sounds like the new carrier may be signing the lease within the next week or so. I'm going to push for an out-right purchase on the cell tower, instead of the arrangement where the seller stays in. Per the seller (I haven’t yet seen the actual leases), two of the leases expire in 2034 and the third lease expires in 2019; so the average remaining lease term is 12.7 years.That is a great suggestion on the step-downs on pre-payment penalty. I’ll go back with 5% years 1 – 2, 4% years 3 – 4, 3% years 5 – 6, 2% years 7 – 8, 1% years 9 – 10.Appreciate the insight.-Andrew

Andrew H. · Answer

Hi @Michael Johnson –Thank you for your response. I’m also just learning about cell tower leases, and it looks like there are currently three carriers on the tower. And a fourth carrier may be added shortly. I’m still getting into the due diligence on the transaction. However, it seems the cell tower leases are NNN, and the carrier pays all expenses.