The self-storage industry has come a long way in recent years. Not long ago, as recently as the 1980s, self-storage developers would purchase former military outbuildings or decrepit warehouses that they would simply subdivide into storage units. These facilities often had dirt floors, little security, and a tiny front office that was only occasionally staffed. Self-storage amenities were virtually unheard of.
Fast-forward to today. Self-storage looks significantly different. These state-of-the-art facilities have been optimized based on actual use patterns. Units are well lit, highly secured and many are climate controlled to better protect users' belongings.
The transformation of the self-storage industry has made it attractive to investors and today, represents a valuable market niche for real estate investors willing to understand the sector's nuances.
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Top 20 Mistakes that Self-Storage Developers Make
Self-storage facilities are designed and operated much differently than other real estate product types. Anyone who is considering investing in self-storage will want to learn from the mistakes of those before them. Here are the top 20 mistakes that self-storage developers make that investors should be careful to avoid.
1. Not understanding the utilities available and needed to operate the property
Many self-storage developers wrongly assume that these facilities can be run on limited utility capacity. And in some cases, that might be true. But that does not mean utilities are unnecessary. Even the most basic self-storage facilities need access to electric, water and sewer infrastructure.
When self-storage developers are looking at prospective opportunities, they should evaluate the utility capacity in the area as part of their due diligence process. Bringing these services to a site where they do not yet exist can be a time consuming and expensive process that involves significant coordination with utility providers and often, other property owners and the local municipality.
Related Link: The Worst Deal Reliant Has Ever Done
2. Overlooking environmental conditions
Another critical step in the due diligence process is to evaluate the site's environmental conditions. Prior to building, a self-storage developer may want to consider doing a Phase I assessment, which will look at the property's historical uses and gauge the likelihood of potential environmental contamination based on those prior uses.
For example, a developer may go to build a self-storage facility only to find an abandoned underground oil storage tank. If that tank corroded and leaked, there could be oil or other pollutants seeping into the soils and/or groundwater below.
In situations like these, the developer will often need to notify the U.S. Environmental Protection Agency who will then require additional testing and potentially, remediation. Mitigating environmental contamination can be a costly endeavor.
3. Choosing a wrong location
Regardless of product type, there's an old adage in real estate that everyone has heard before: location, location, location! Self-storage is no different. Location is critically important. It used to be that self-storage facilities had to be located alongside major highways for ease of access and visibility.
Today, locational considerations are more nuanced. People are more likely to use their cell phones to identify and then find self-storage facilities; location off a major thoroughfare is less important.
Location is still important though, but for other reasons.
For example, you would not want to acquire a storage facility located immediately adjacent to a major municipal infrastructure project that will result in an obstacle for anyone trying to reach for your site for the next 2- to 3-years. This will dramatically impact your retail sales.
Choose your location carefully based on what you know about existing and planned infrastructure. If you are unsure, consult with local and state planning officials who may be more attuned to infrastructure improvement projects.
4. Not understanding market conditions
Some self-storage developers purchase or build facilities based on current market conditions. But that only provides a snapshot in time. Self-storage developers should take time to understand what is driving the local economy, including why people would want or need self-storage in that area.
Many developers have been burned by overlooking a major shift in market conditions that was otherwise known and on the horizon (e.g., a major employer was getting ready to shut down), that wound up crippling their self-storage business - if not right away, then over time.
5. Overlooking market competition
Related to the point above, be sure you understand local competition. Self-storage is a numbers game. Revenue is based on how many heads live in the area divided by how many square feet of self-storage is available within a certain radius.
If there is additional competition coming online, you need to be aware of that before investing in another self-storage facility. Contact the local planning department to ascertain what other self-storage projects may be in the pipeline or under construction in that area.
Consider calling the same people in adjacent towns, as well, to get a better handle on regional competition. Even if you are able to fill up your self-storage facility, increased supply may hinder your ability to raise rents over time.
6. Putting too much faith in "planned" housing
Self-storage developers will often go into an area and see signs indicating that an area is expecting "5,000 housing units, coming soon!" Unfortunately, there is no guarantee that those housing units ever materialize.
Any change in the economy (see: 2007-2008) can dramatically halt new construction and those units, even if permitted, may never actually be constructed.
A self-storage developer will want to make sure that their numbers work based on existing demand (smart developers will then discount that number by upwards of 20 percent as insulation from tepid demand); any future demand should be considered icing on the cake in the event those units never come online.
7. Going in without an operational plan
Many first-time self-storage developers assume that the relative simplicity of these facilities means they will be relatively simple to operate, as well. In turn, they go into the development process without having a strong business plan in place.
In order to be successful in this industry, you must have a keen understanding of market conditions, operational costs and pricing (including when and how to raise prices). The business plan should also include the preferred and alternative exit strategies.
Both the lender and potential investors will want to understand the developer's business plan before making a loan to construct a self-storage property.
8. Not being conservative enough with your pro forma
A common mistake that self-storage developers make is padding their pro forma too much. They:
- Overshoot revenue projections
- Underestimate expenses
- Overestimating occupancy growth
- Overlook potential tax increases
One miscalculation might not cripple a self-storage operator, but several miscalculations can destroy a developer's business plan. Self-storage developers should err on the side of being overly conservative with their expenses, rents, occupancy, and revenue growth projections.
9. Not differentiating between "economic occupancy" and "physical occupancy"
Economic occupancy is the actual amount of money generated each month or each year by the facility. Physical occupancy is an indication of how many units are currently rented. Many self-storage operators offer various promotions, such as one month rent free, to get tenants in the door or to retain them over time.
These promotions can inflate numbers and make a facility look like it is performing better than it actually is. A facility may have excellent physical occupancy, but if 20 percent of those renters are not actually paying rent, this will impact the facility's economic occupancy.
Any prospective self-storage operator looking to buy an existing facility will want to see at least three years of trailing financials. This is because an operator may have, for example, just increased rents by 15 percent prior to listing the property for sale.
You, as a prospective buyer, need to know that because it means that you may not be able to raise rents further for the foreseeable future.
Likewise, if the physical occupancy does not jive with the economic occupancy, it means that too many tenants are there based on promotions and may leave once the promotional period ends.
10. Not understanding the accounts receivable
Any prospective self-storage buyer will want to be sure that the accounts receivable is not too high. A good accounts receivable is around three percent or less. It is a red flag when accounts receivable is at 10 percent or more, as this could be an indication that the operator is filling the facility with people who can't pay for the sake of inflating their physical occupancy.
Also, look for operators that accept credit cards, which allows you to charge those cards automatically on a monthly basis. This makes collections easier. Look for operators that charge late fees, as this boosts revenues.
It is one thing to have people who pay late, but it is a different story when people do not pay altogether. Most self-storage operators want to avoid having to evict tenants and worse, having to sell their goods. This is why proof of strong collections over a 1- to 3-year period is so important.
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11. Padding revenue numbers with smaller units
In order to enhance their revenue projections, many self-storage developers will anticipate building more but smaller units. These smaller units rent for more per square foot than the larger units, but they often do not lease up as well as the larger units.
Having too many small units can ultimately have an adverse impact on a self-storage developer's bottom line. Instead, consider the unit mix to take on the shape of a bell curve where there are some small units, some extra-large units, but the majority of units sit somewhere in between before trailing off in either direction.
12. Overlooking tax increases
Self-storage investors often run their numbers based on existing taxes when in fact, taxes often increase (often dramatically) upon sale of the property. It may take a year for the tax assessor to re-assess the property, but when that time comes, property taxes may skyrocket.
This is particularly true if the new owner makes any substantial improvements to the property. Self-storage developers should foresee this tax increase and build a healthy cushion into their pro forma for when this time inevitably comes.
13. Not using a land use (permitting) attorney
There is an old saying: "the old folks know where the tigers are," and a good land use attorney will know where all the tigers are. In other words, an experienced land use attorney will understand how to avoid potential landmines and get through the permitting process with ease.
They will have personal relationships with local decision makers, such as city councilors and planning board members, and will be able to guide you (and your project) through the entitlement process more easily than if you were to try and go at it alone.
14. Putting too much faith in what local planners say
Many well-intentioned city officials will tell a developer that, "Sure, you can build a self-storage facility in a certain location. Sure, this is allowed by-right. And yes, we'll help you get the approvals you need on a certain timeline."
However, unless you have that information in writing, take it with a grain of salt. These planners generally do want to be supportive, but most do not have the zoning code memorized. What is more, the planners only have so much control over the permit granting authorities—those decisions are often made by independent city councils or planning boards.
This is why it is so important to have a land use attorney who can interpret zoning language on your behalf.
15. Overlooking specific ordinances that impact your project
Municipal regulations are constantly in flux, in some communities more so than others. Increasingly, cities and towns are adopting ordinances intended to promote sustainability, to protect trees, to enhance landscaping, and to prevent stormwater runoff.
For example, a new tree protection ordinance can turn out to be quite costly for a developer who was not aware of the ordinance and its impact. For example, a self-storage developer that is planning to clear-cut the trees on a greenfield site may end up paying tens of thousands of dollars to re-plant trees elsewhere.
The payments are often based on the size and quantity of the trees being removed. A single tree could cost $5,000 to cut down or replace. In any event, it is important to be aware of these ordinances (and any pending approval) before initiating your self-storage project. Again, a good land use attorney will advise you regarding these regulations.
16. Designing the building incorrectly
Self-storage building design is more nuanced than people might imagine. For example, an entire building does not need to be climate controlled. Instead, a 60/40 mix is usually more appropriate. The climate-controlled units command higher rents, but these do not lease up as quickly.
Having roughly 40% of units be non-climate-controlled usually means the building will lease up faster which helps to mitigate risk. This balance results in greater occupancy and more stable cash flow.
Another design mistake is including too many small units. First-time self-storage developers often assume that more but smaller units will result in higher revenue. That is because smaller units rent for more per square foot than larger units. However, demand for small units (e.g., 5' by 5' spaces) is usually relatively low. They are not as popular as mid-sized and larger units.
The good news is that a developer who makes this mistake can remove partition walls to combine units, but this will eventually have a ripple effect that impacts their pro forma - and changes to the pro forma can spook investors and lenders.
17. Overreliance on elevators
Another design flaw that self-storage developers make is designing multi-story facilities that require tenants to use elevators. Many users do not want to cart their belongings up and down elevators. They prefer to be on the first floor (second floor, tops).
This is particularly true if the local demographic is more accustomed to low-lying buildings. In an urban setting, people might be used to using elevators—but those who are not may steer clear of facilities that require them to go up four stories to reach their unit.
18. Building too big, too fast
A common mistake that self-storage developers make is building a facility that is too large for existing demand. Someone with a large plot of land will assume that, since they have the space, they might as well build a bigger building.
Instead of building a 50,000 square foot facility, they build a 100,000 square foot facility - only to have half of the building sit vacant. Carrying costs, such as utilities and property taxes, must be paid on the entire building whether it is leased up or not. This can quickly eat away at a developer's profits if they have overbuilt the facility.
Instead, developers with large land holdings are better off considering a phased approach. Build one facility now and if that leases up and performs well, and if demand remains, then either a) increase rents or b) then consider adding a second building on site.
19. Using a developer without self-storage experience
Many self-storage developers will begin by looking into the cost of steel, and once they develop a relationship with the steel contractor, will rely on their team and/or recommended contractors to design and construct the building.
This may seem like the most convenient option, but in fact, it is always best to hire your own architects, engineers and contractors. This way, you can ensure your team has robust experience in self-storage and understands the nuances of these facilities.
20. Not being business-like enough with tenants
This sounds cold-hearted, but it is the truth: a self-storage operator must maintain a business-like relationship with their tenants. This rule is most often broken at mom-and-pop storage facilities where owners can forget that the relationship between them and their tenants is not a personal one; it's business.
Running the facility like a business means increasing rents gradually over time, which may result in the loss of some tenants, but will ensure the standards you have put in place are maintained, that security remains tight, that tenants can rely on your service, and that the business remains profitable.
Knowing the Common Self-Storage Development Mistakes Leads to Better Investing
Self-storage facilities can be highly lucrative for developers who take the necessary steps in the planning, permitting and design process and then operate the facility efficiently. There are many nuances to self-storage, as described here, and some pitfalls that can be avoided by learning from others who have decades of experience in the field.
Looking for a lucrative self-storage investment opportunity? Contact Reliant to learn more about our facilities, rates, and locations.
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