Self Storage- What's the best Metric- COC, Cap Rate, Payback
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.
Comments (3)
@Ashley Zhang
When you first build a location you want to both build enough units to cover all of your costs, not just the building and enough so you don't have to turn around and build more.
Buildings- Build enough to cover Principal and Interest, property tax, insurance, lawn, all other expenses.
All other costs $Fixed for discussion purposes
Revenue- 100 units at $100 per month = $10,000 per month.
Let's say your Principal and interest payment at 100 units is $7,000 including all assets.
On top of Principal and interest, you have property tax, insurance, lawn, income tax less depr., etc. Let's say those costs are an additional $3,000 per month.
Thus your total cash flow is $10,000 per month. But at 100 units, you're bringing in $10,000. Thus you have achieved break even from a cash flow standpoint.
Now we have Circular logic or chicken and egg thinking. Its easier when you have a spreadsheet, you just keep changing figures till you hit 65%. Since we don't have a spreadsheet just go with the $10,000 total cost stays the same, even though you know it will go up as you add units.
$10,000/.65= $15,400 revenue / $100= 154 units to achieve breakeven at 65% of total units. You would never build a location if your goal was just too breakeven, that is why I use 65% as a starter.
Even though your calculation says 154, you might build 150 or 190 depending on the lengths of your driveways and the contour of you land.
You want your spreadsheet to update both Cost and Revenue at the same time, as you adjust the number and sizes of your units.
Now that you have covered all costs on your first Phase. Your second phase will need a smaller occupancy percentage around 35% to 40% for breakeven since you already covered most of your upfront costs.
Henry Clark, over 2 years ago
@henry
@Henry Clark HI Henry, when you say build 65% occupancy, can you use simple numbers to explain how it works ? Than you!
Ashley Zhang, over 2 years ago
@Henry Clark
Great comment on raising rents. I didn't realize it would have such a huge impact. It also seems that raising rents from $60 to $70 likely won't make anyone move their stuff, but it'll have a big impact on your bottom line. Win-win!
James Rodenberg, almost 3 years ago