Self Storage Real Estate A Land of Opportunity and Land Mines Michael L. McCune, President – Argus...

Self Storage Real Self Storage Real EstateEstate

A Land of A Land of OpportunityOpportunity

and Land Minesand Land MinesMichael L. McCune, President – Argus Self Storage

Sales Network

Table of Contents:

I. What Creates Value?

II. Cap Rates

III. Interest Rates

IV. Overbuilding

I. What Creates Value?

Measuring Value Extracting Value What does a Market Look Like? What’s New in the Market?

What Creates Value?

Commercial Real Estate 90% of value is cash flow! Intangible increments to Value

Good maintenance Appearance Attitude of Seller “Nice City”

Impairments to Value Lack of Future Flexibility Zoning Restrictions Land Leases Sometimes Existing Financing

Measuring Value

Value is essentially the present value of all future estimated cash flow

The Three $64 questions! How much cash will there be? When will it come? What is the “right” discount on future cash?

The Answer is only in the Market - Cap Rates!

Extracting Value

Sales of Real Estate occur when buyers and sellers agree on all three estimates of value! Perhaps not explicitly – but they must agree.

In large measure the “right discount rate” on future cash is set by the market!

What Does a Market Look Like? This is a Market Impacts in Today’s Self

Storage Market Investment Advisors Pension Funds Foundations 1031 Purchasers (TIC’s) REIT’s Pilgrims from Other Real

Estate

Per SF Cap Rate

$57/SF 10.5%

$66/SF 9.0%

$81/SF 7.5%

100/SF 6.0%

$133/SF 4.5%

Buyers

Sellers

Equilibrium

Where deals are done

II. Cap Rates

What are they? How to and not to calculate Cap Rates The Component parts of a Cap Rate How do they change over time?

Cap Rates – What are they? A Cap Rate is the rate of return on projected

income that investors are willing to accept from a project that:

1) Is competitive in the market and

2) Compensates them for inherent risks and deficiencies in the property or location

Stabilized NOI is often MORE important than the Cap Rate

How to, and not to, Calculate ValueWhen is a higher Cap Rate Better?Base Case Alternative 1 Alternative 2

Stabilized Market Stabilized Occupancy (in 1000s)

Stabilized Market

Below Market Occupancy

Stabilized Market

Potential Rent $333 $333 $333

Vacancy 10% ($33) 20% ($67) 10% ($33)

Collected Rents $300 $266 $200

Expenses 33% $100 $100 $100

NOI $200 $166 $200

Cap Rate 7.5% 7.5% 8.25%

Value $2,666 $2,213 $2,424

Thus, a higher Cap Rate on adjusted NOI may be better than a lower Cap Rate. Raising the Cap Rate to adjust for the increased risk of vacant space or low rates may be better.

Cap Rate Components and the Change Over Time

These are the lowest spreads and interest rates in 40 years.

Some Spreads I have seen:

250 BPs to 300 BPs - Late 80’s

300 BPs to 400 BPs – Mid 90’s

As a general rule all spreads increase as interest rates increase and money tightens.

CR BPs

7.8% Spread of Cap Rates Over Loan Rates

150

6.3% Spread of loan over 10 years T Notes

130

5.0% 10 year US Treasury Note

Current Cap Rate Components

What a DifferenceCap Rates Make!

Back to our example:

3/1/03 3/1/05 3/1/08NOI $200,000 $200,000 YourCap Rate 9.45% 7.5% Guess?Value $2,116,000 $2,660,000

• Increase in value solely because of change in Cap Rate (26% increase)

• Increase in equity: 100%+ % increase

• Loan to Value Ratio Change: 75%, now 59%

Source: Self Storage Data Services, Inc. – Pasadena, CA Copyrighted

III. Interest Rates

A very short history of Interest Rates Impact of increasing Interest Rates on Cash

Flow Impact of Increasing Interest Rates on Cap

Rates

A Short History of Interest Rates

Interest RatesPerspective: How extraordinary are these times?

• Current rates are among the lowest in 40 years.• The Rates in the 1960s were a function of the Treasury

setting artificially low rates.• Average rate over the last 40 years is 7.4%, or 2.5%

greater than current rates.• Over the last 40 years rates were 3.5 times as likely to

be in the 6% to 8% range as where they are today! Rates were equally likely to be in the 12% to 14% range as where they are today!

Interest RatesSo What ? This is What!!

Project ExampleRevenue $300,000Expenses $100,000NOI $200,000Purchase Price @ 7.5 cap $2,666,000

Cash Flow CalculationsLoan Interest: 6% 8% 10%NOI: $200,000 $200,000 $200,000Debt Service: $154,632 $185,232 $218,000Cash Flow: $45,368 $14,768 ($18,000)Return on Equity: 6.8% 2.2% -0-

Assumptions:Loan: 75% of valueAmortization: 25 YearsEquity: $666,000Loan: $2,000,000

IV. Overbuilding

Plague on our House Self Storage Issues Anecdotes that We Have Seen A Look at the Impact on One Market

Overbuilding“Plague on our House”

Iron Rules of Real Estate• High returns generate new development• Supply of real estate is often money driven,

not demand driven• Pent up demand is about gone – growth is

based on more users not their new uses.

OverbuildingSelf Storage Issues

• The “Learning Curve Demand” is about over• “Build it and they will come” is over• Information on Supply is poor• Understanding of Demand is poor• Prediction of markets is difficult• The fastest growing MSA in the US

(population) was growing 3.9%/year – the average was 1.3%/year.

OverbuildingAnecdotes (Some Local Conditions)•Current market is 93% occupied. Site specific projects planned equal 150% of current projects.

•Previous Market (3-mile radius) had 338,590 SF and 85% rented (290,000 sf)

New projects opened in last 12 months 221,000 SF (76% of existing demand)

•Rates on Climate Controlled 10x10 units went from $145/month to $89/month plus a free month as 9 new projects opened.

The Local MarketA Sample Market

Facilities Number SF Total SF Occp. % Actual Demand

Existing 6 40,000 240,000 88% 211,200

Facilities Number SF Total SF Occp. % Actual Demand

Existing 6 40,000 240,000 88% 211,200

New 1 60,000 60,000 0% 0

A Sample Market, cont.

Facilities Number SF Total SF Occp. % Actual Demand

Existing 6 40,000 240,000 88% 211,200

New 1 60,000 60,000 0% 0

New Total 7 300,000 70.3% 211,200

Total demand has to rise 25.1% to get back to the same market.

A Sample Market, cont.

Impact of Overbuilding

Occupancy 100% 88% 70%

Rent $300,000 $264,000 $210,000

Expenses $100,000 $100,000 $100,000

Operating Income $200,000 $164,000 $110,000

Debt Service* $111,000 $111,000 $111,000

Cash Flow $89,000 $53,000 -0-

Value** $2,222,000 $1,822,000 $1,222,000

* Value $1,822,000; 75% LTV, 6.5% INT, 25 year amort.

** Based on 9 CAP

Sample Facility Check Up Form

  8th & Main Ash & 4th Smith St. New Property Our Facility Average

Location 8 4 9 9 9  

Visibility 7 8 7 7 6  

Access 4 10 8 7 9  

Signage 5 5 7 8 5  

Traffic 10 4 8 10 8  

Appearance 9 6 8 10 8  

Total Points 43 37 47 51 45 44.6

Occupancy 83% 63% 87% N/A 91% 81%

Rates            

5x5 $28 $31 $25 N/A $30 $28.50

10x10 $66 $70 $62 N/A $67 $66.25

10x15 $75 $85 $73 N/A $80 $78.25

10x20 $95 $100 $92 N/A $97 $96.00

For a blank form, visit www.selfstorage.com/argus/toolbox/checkup.htm

A Few Thoughts about Capital Gains A History of Capital Gains Rates Is a 1031 always the best way to sell?

Will History Repeat Itself?

Second Thoughts

It’s Worth the Math Reduced tax deductions Lower rates carried over

Other Issues The right property Higher capital gain rates Negotiating disadvantage

Detailed Analysis at: www.selfstorage.com/argus/online/1031calculations.pdf

Question & Question & AnswerAnswer

For more information contact:

Michael L. McCuneArgus Self Storage Sales Network

1-800-55-STOREmccune@argus-realestate.com

www.selfstorage.com

For a copy of this presentation email:

info@argus-realestate.com

or call: 1-800-55-STORE