Is Self Storage Investing Right for You? Here’s How to Succeed

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For those relying on real estate investments as a core part of their financial planning, the debate between different types of properties is an important one. Each asset class uses resources differently and some have greater cash flow than others. Multifamily homes tend to yield profits quickly for buyers, but they also have a high rate of failure. The same goes for office and retail space—landowners can negotiate a longer-term lease, but the business behind it may fail. Comparatively, self storage investing is a safer bet, with a failure rate of only 8%. That is a great number for any type of investment.

Self-storage facilities can be found in most cities and are often buildings divided into multiple units that customers can rent to store their possessions. Sometimes clients need to rent the storage space only for a month while others need it for the long term, which could be years at a time. Hidden in these self-storage facilities is a potential gold mine for investors looking to diversify their portfolio.

What makes self-storage so successful within the greater real estate investment arena? It comes down to a few factors, especially flexibility and low overhead. Together with increasingly mobile lifestyles, the market is perfectly calibrated for a growing self-storage sector.

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Flexibility: the key to self storage investing

Though the phrase self-storage tends to conjure up a singular image of a garage or closet-like spaces—and many do look like this—part of what makes this market so profitable is that it can shift to meet the needs of the local community. Flexibility is a virtue and easy to achieve in the self-storage world.

Many storage facilities offer boat or RV parking, for example, so that owners do not have to keep these large vehicles at their homes. However, these types of offerings are contingent on location. There isn’t much water in Phoenix, Arizona, so it doesn’t make sense to offer boat storage in this area. Rather, there are standard storage spaces in many sizes in those locations, but facilities near large bodies of water or along the coast often include boat storage.

One word of warning about storing cars, boats, and RVs: Investors should be conscious of liability. Unlike most other items kept in self-storage units, these items need to be insured, and proof of ownership must be provided.

Increase revenues by upgrading infrastructure

In general, overhead costs for self-storage units are much lower than those for residences or even for offices and commercial spaces. They just do not need the same level of architectural finesse as spaces that people inhabit. There are no windows to buy or special siding to choose from. Many storage facilities are even built from inexpensive, recycled shipping containers.

Since infrastructure costs are fairly low to begin with, there is no reason not to upgrade a self-storage site to make it more appealing. For example, while almost every self-storage site uses a gate code to monitor who comes in and out of the site, that cannot prevent theft by unit owners. Consider upgrading the units to install door alarms that are coded to individual users, rather than just using locks that someone else can cut.

Move with the market

Based on the community, some storage companies provide storage calibrated to wine collectors. Others emphasize climate-controlled spaces that can be a boon to antique collectors who want to protect their finds. These varied offerings emphasize the importance of listening to customers. When a customer is looking for a particular kind of storage, it is worth noting the request and seeing where it might fit in a business’s overall strategy.

Requests like these typically come more from affluent neighborhoods where it is possible to charge higher rents, but it may also be necessary to improve the appeal of the property. In some areas, investors have changed the appearance of their storage units to better fit in, making them look like modern, commercial buildings while maintaining a utilitarian manner inside.

Ultimately, these types of requests require infrastructural changes. Therefore, it will be necessary to assess the facility to determine if the improvement is viable, how much it will cost, and what kind of profit it will yield.

The pros of self-storage investing

Let’s dive into the ways that self-storage can be a great addition to your investing portfolio.

Performs great during good or bad economic times

During good times, people are buying lots of stuff and need a place to store it. And during downturns, people are downsizing their homes, so again, they need storage space.

Garners sticky tenants

People in this asset class are willing to put up with more rent increases than tenants in other asset classes. Let’s say an owner increases rent by 6%. Self-storage customers paying $100/month are not going to take a Saturday to rent a moving truck, get friends together to help them carry heavy things things, and relocate all their belongings elsewhere to save $6/month. But apartment dwellers paying $1,000/month might be motivated to move to save 6%.

A huge industry

The size of the self-storage industry is on par with Starbucks, McDonald’s, and Subway combined. But the way in which things are optimally run within the industry is shifting. The strategy now is to buy mom-and-pop-owned facilities, upgrade them, increase the income, increase the value, then refinance or resell it to an institutional investor or real estate investment trust (REIT).

Simple, inexpensive value-adds

For example, adding truck rental can increase income by a few thousand dollars on a self-storage facility. Late fees, admin fees, raising rent, selling moving supplies, and putting in a showroom are other options.

Makes money when buying, operating, and selling

In other areas of real estate, it is said that one can only make money when they buy. But the self-storage value formula is to buy from a mom and pop, upgrade to an institutional standard, then refinance or sell to a REIT—and money is being made the whole time.

Business value not limited by comps

For residential owners and investors, value is limited by comparable properties in the area. This isn’t the case in commercial real estate. The value is calculated by dividing the net operating income by the rate of return (or cap rate). So, if the numerator is increased and the denominator compressed, it can dramatically increase the value of an investor’s assets.

The cons of self-storage investing

But remember: with every pro list, there’s a list of cons.

Needs to be located in high-traffic area, but away from competitors

This is ultimately what will drive profitability. The best storage units operate at a 90% capacity most months, have high visibility at their location (a minimum of 20,000–30,000 cars driving by daily), and offer something of value to the community.

Must meet the demands of the surrounding community

It is also important to offer the right mix of units (drive-up vs. interior) and amenities (conditioned, high security, 24/7 access, etc.) to meet the needs of the local community. Market research will clue owners with what they should offer based on the needs of the surrounding community.

Finding good help

It can be difficult to find good help in this industry, and most self-storage facilities are run by one trustworthy person. Many owners tend to manage their self-storage businesses personally because bad management can tank a company quickly.

Varying customer demographics

Your customer base could have very different needs, and people using storage facilities may be experiencing stressful circumstances (death of a loved one, job relocation, etc.). Dramatic interactions with tenants should be expected and managers need to be able to keep their cool and still provide excellent customer service.

Fluctuation of yearly occupancy rate

Most storage unit companies are encouraged to shoot for a 90% occupancy rate as a way to measure their annual income. But that number is not always easy to come by in this industry.

Protecting items

It is hard to protect the items in each storage unit 100% of the time. A facility needs several different security features to keep personal or commercial property safe: locks on the doors, security cameras, and other safeguards. Costly upgrades might be needed to sway customers to use the facility and help your business grow.

Financing self-storage investments

Self-storage financing usually comes in the form of a commercial real estate loan that funds the purchase, renovation, or construction of self-storage units and commercial real estate buildings. These loans typically have repayment terms spanning 10–25 years.

Lenders generally review a business’s financial performance, the value of the real estate, the surrounding market, and the business owner’s credit profile. Most lenders consider a self-storage loan to be a low-risk business loan.

The typical qualification requirements for self-storage financing include:

• Time in business: At least two years
• Minimum credit score: 680
• Minimum down payment: 10%
• Debt service coverage ratio (DSCR): 1.25x or greater
• Credit history: No recent foreclosures, bankruptcies, or tax liens

Those interested in purchasing an established self-storage business often seek a loan to cover the acquisition costs. Acquisition loans are needed when purchasing an existing self-storage facility. A lot of merger and acquisition activity in the self-storage industry is conducted by large investment companies and (REITs). It’s less common for independent storage facilities to buy others, but there are plenty of financing options to purchase an existing facility. The best option for prime borrowers is almost always going to be a conventional bank loan or a Small Business Administration (SBA) loan.

When it comes to self-storage investing it is about knowing—and moving with—the market. The flexibility to do that is what makes self-storage such a profitable investment in the first place.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.