The Long Run
First, though, let’s talk about self-storage as an investment and examine the right approach to that investment. Self-storage facilities are intermediate or long-term investments, not trading commodities. Any prudent investor will share this perspective. It is a business that demands good management, either directly by the owner or by a professional management firm. As such, it is much more cumbersome to buy and sell a self-storage facility than it is to sell 100 shares of listed stock–which results in market values fluctuating over a longer period of time than those of the stock market.
Thus, if you are looking for something to make a “killing” on in the short term, self-storage is not it. Yet, self storage is a great long-term investment. From a long-term investment perspective, it is highly likely that overall demand will continue to grow for self-storage. Studies have shown that once people use the product, they will continue to use it in the future and that there is currently a very small penetration into the market. Only about 3 percent of the households in the United States currently use self-storage, indicating a huge market yet to be tapped. While overall demand is quite positive, local conditions may be quite different, due to overbuilding or regional economic conditions.
Let’s take a look at why self-storage is and has been such a good investment. The first concern that an investor should have is the return on his investment. Typically, in the past, the returns (unleveraged, i.e., no loan) on the selling price have been between 9.5 percent and 12.5 percent, with the vast majority of returns falling between 10.5 percent and 11.5 percent. (See “Cap Rates and Sales Prices,” October 1997.) Interestingly, these returns have not fallen significantly as the market has dramatically improved.
The most important reason to be a buyer today may not be related to our continuing positive view of the self-storage market, but rather to current interest rates. At the time of this writing, interest rates were at 15-year lows (about 8 percent on a 25-year amortization) and funds were widely available for the purchase of self-storage facilities. Given these rates, it is possible to achieve positive leverage on a self-storage project.
For example, let’s say you bought a $1 million property with an unleveraged return of 11 percent (i.e., a net operating income of $110,000), using an 8 percent loan in the amount $750,000 with annual debt-service payments of $69,500. When you look at the return on your investment of $250,000 ($1 million purchase price minus $750,000 loan = $250,000 investment), the return has climbed dramatically over a cash-on-cash basis ( $110,000 minus $69,500 = $40,500 divided by $250,000 equals a “cash-on-cash” return of more than 16 percent). This return does not include any build-up principle that occurs through amortization of the loan, which would average another 1.25 percent over the life of the loan. When you add up the cash-on-cash returns, the loan amortization and the potential for rental increases, acquiring self-storage facilities makes as much sense today as ever.
Thus, it appears that today’s investor is paying the same amount for almost the same investment of several years ago. Another reason why self-storage is still a good investment is because an owner can look to increase the rental rates over a period of time, which will increase the total return on the investment. Since the operating costs are relatively fixed, most of the benefits of the increased rental rates fall directly to the owner.