My Self-Storage Investment
In a previous post, we looked at self-storage facilities, a subclass of commercial real estate as an investment. The majority of self-storage facilities are owned and run by small mom and pop operators. As a result there are inefficiencies in the market that can be remedied by more experienced operators for higher returns. Self-storage can be considered a relatively recession resistant asset class. During economic downturns, families and businesses downsize but still need a place to store their stuff. This results in increased demand for self-storage units. Self-storage customers are also “sticky” and not as price sensitive to rental rate increases, as compared with tenants in other real estate asset classes. And finally, short monthly leases allow managers to quickly increase rent and remove problem tenants without a lengthy eviction process.
One of my real estate investments is a self-storage deal sourced through an investment group. This deal was not listed on a crowdfunding platform. We’ll call this investment SS-Alpha. It is a common equity position in a syndication project for accredited investors. Due to confidentiality and non-disclosure agreements, I cannot publish the name and financial details of this project.
The sponsor is a specialist in self-storage, and is an affiliate with a couple of well known storage brands. Formed in 2009, they are one of the top self-storage operators in the country with operations mostly in the Southeast. The two main principals have over 50 years of aggregate experience in self-storage. The sponsor has developed or acquired over $300 million in self-storage projects involving in excess of several million square feet of storage space. They own over 40 self-storage properties and have a proven track record of multiple successfully exited deals in multiple states. Their equity partners include institutional quality investors, family offices, investor groups, and high net worth individuals.
Track record: The currently owned facilities are cash flowing well with high single to low double digit returns after year 2. Several exited deals yielded low 20s IRR.
The property is a 700+ unit class A self-storage facility which sits on 5 acres in the Southeast U.S. The facility was built in mid 2000 with both climate and non-climate controlled units. In early 2017, an additional 240+ climate controlled units were constructed on the property to add approximately 50% more sq ft of rental space. The preconstruction occupancy rate was 90%. The proforma assumes occupancy of 88%. Competition analysis showed that the immediate 5 mile area was undersupplied and had only 4 other competitors. Currently the facility does not generate any ancillary income. CAP rate is low because the newly constructed units have not been leased up yet so it doesn’t mean much. The previous owner had instituted only one rental increase in the past 10+ years. This means the rental rates are significantly below market rate.
This is a straight common equity/debt deal. The sponsor secured a senior loan with an LTV of 60%. The loan term is 3 yr interest only at 5.75% fixed with a permanent 10 year loan option afterwards no higher than 6.5%. The sponsor has relatively low co-investment at around 2% of common equity.
Waterfall distribution structure:
8% preferred return of cash flow and profit from sale, then 70/30 split.
The project is a 3-5 year hold.
Targeted net to investor IRR is 22% with disposition in year 6.
The plan is to lease up the newly constructed units to fill vacancy and also to simultaneously increase rental rates. The combination will increase overall revenue and NOI. The sponsor will implement marketing outreach programs to attract new customers. There are also plans to add ancillary income through in-house merchandise sales, tenant insurance, and on-site U-haul truck rental business. Late fees will be enforced and customer promotions and discounts will be phased out. The sponsor also plans to spend around $100+K to improve the property.
First off, the sponsor is experienced and quite reputable. Their track record is good and performance is in line with pro forma. Several members of my investment group have participated in previous deals and recommend the sponsor. The fact that their equity partners include family offices and institutions, speaks to their strength and ability to execute value-add projects. These other professional partners conduct high-level due diligence and stress test each deal, giving me additional confidence in the sponsor. Communication and investor relations are above average. The sponsor puts out a quarterly report summarizing the financial results and comparing them with the proforma. There is also a progress report describing institution of the value-add plan.
This is an off-market value-add deal. Feasibility study suggests that the local market is undersupplied in a 5 mile radius. So demand for self-storage should remain strong under current market conditions. The newly constructed units will add significant capacity, so profitability is contingent on sponsor skill and efficiency in lease-up.
Loan terms are favorable with a 10 year option at a fixed cap. This reduces the risk of the sponsor being forced to sell during a downturn. I like 10 year terms on loans in general because it gives the sponsor options. They can wait out a recession until prices come back up.
The only downside of this deal is the low sponsor equity. At around 2%, this is lower than the 10% minimum equity skin in the game I like to see. However, this is something I have accepted to invest with this high-quality sponsor and therefore, is not a deal-killer for me.
I invested $25K into this deal in the common equity portion of the capital stack. Almost one year in, the investment is performing well, slightly above proforma and I am quite happy with the results so far.
Would I invest with this sponsor again? The answer is a resounding yes for the reasons above. I’ve added this investment to the Real Estate Portfolio menu tab and will provide periodic updates throughout the hold period.
The reason for this post is not to show off my holdings or make myself appear smarter than anyone else (believe me, I truly am not), but to educate and inform any reader interested in commercial real estate investing. Many investors only know of “conventional”, “retail” investments such as stocks, bonds, and mutual funds. And some investors think any alternative investment is automatically a scam. But this thinking could not be further from the truth. High net worth individuals and institutions routinely invest in these so called “alternative” investments. Sure there are bad operators and fraudulent schemes but these are rare and are seen in any kind of investment. For accredited investors who have an interest and desire to participate in alternative investments, there is a whole universe of opportunities that are not available to the general public. These kind of investments can be a small part of a well diversified portfolio. I recognize my posts are not for everyone- once, I tried to bring up alternative investments with my friends and colleagues, and I was met with laughter and ridicule. Not one showed an interest or desire to learn more. Since they’d never heard of it, it was either ultra-risky or a scam. Crowdfunding? Scam. Multifamily? Scam. Self-storage? Scam. Hotels? Scam. Self-directed IRA/401K? Double scam. It didn’t take long for me to stop bringing up the topic.
Most high net worth individuals who invest in these asset classes are not blogging about them or divulging their holdings to the public (at least I have not found too many in the PF blogosphere), so I hope you find this site somewhat useful. The point is, I’m not out to convince anyone to invest in commercial real estate or any alternatives for that matter. But if you want to, and are open-minded and willing to learn about it, you can. And I am just one person that’s doing it.
Thank you for reading,
What do you think? Is this an investment worth considering? Is this post useful? Please comment below.
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