I heard you laugh. Don’t try to hide it.
The first time I heard the term “add value” applied to self-storage, I almost laughed out loud too. It didn’t charge me. Like many of you, I have worked in single-family and multi-family real estate for many years. Value-add meant something clear to me: changes or upgrades to a home that increase the value. For rental housing, these changes increase the income to get there.
For those in the single-family or multi-family arena, typical added value may include new countertops and cabinets, or fresh paint and lighting, or new floors and toilets.
In self-storage, a domain made up of four pieces of sheet metal, a floor, and a door (plus a few rivets), it was initially difficult for me to think of any added value. But I was so wrong, as you’ll see.
The power of a dollar
Amazon founder Jeff Bezos famously removed the light bulbs from the company’s vending machines in buildings across the country. Why would he do this? Because he understands the power of a dollar.
The electricity, the lamp, and the service technician’s time to replace it was a waste of dollars for the company. And a dollar means a lot at Amazon.
A dollar saved or earned monthly equates to $12 a year straight to the bottom line. Amazon’s stock is trading today at a price-to-earnings ratio of about 60, but it has average about 131 over the past five years.
This means that $12 in additional income translates into a share value of approximately $720. That’s the power of a single dollar saved at Amazon!
Commercial real estate works according to a similar formula. That’s why I believe that the Forbes 400, the richest Americans, almost all invest in commercial real estate.
The value formula for commercial real estate is:
Value = Net Operating Income (NOI) Cap Rate
A higher income (the numerator) leads to a proportionally higher asset value. And a higher cap rate (the denominator) directly leads to a lower asset value.
Self-storage and other commercial real estate operators try to increase income, the variable they have the most control over, to increase the value of the assets. And since most use some leverage, the return on equity for investors is multiplied even further.
For example, a 25% increase in income translates into a 25% increase in asset value (assuming a constant maximum percentage). Now suppose there is 66.6% loan-to-value (LTV) leverage on the asset. This 25% increase in asset value translates into a 75% increase in equity value. Here’s the math:
Value = 1.25 x NOI Cap Rate -> 1.25x Value (a 25% increase in value)
25% increase in value divided by (1 – LTV) = increase in equity
So 25% ÷ (1 – 0.667) = 25% ÷ 0.333 = 75% increase in the value of equity
The bankers do not share in this advantage! Of course, investors should realize that the downside can be equally devastating when income falls. And the cap rate also plays an important role.
The power of a dollar in self-storage investing
We’ve identified the powerful dollar multiplication effect in the commercial real estate field. And I’ve hinted that added value in self-storage can get you there. Let’s take a look at 10 common self-storage value-adds and translate them into the expected increase in asset value. I will first introduce the physical change and then explain the math that leads to the change in the projected value.
Over the past decade, self-storage cap rates have compressed dramatically (read: higher asset value), and I’ve seen many deals sell for cap rates below 5%. I will use a more conservative cap rate of 6% (0.06 in our formula) for this exercise.
Lease 40 empty storage units
The yield of this should fall to the bottom. Assume a lease rate of $125 per unit.
40 units x $125 x 12 months = $60,000 increase in NOI
$60,000 NOI ÷ 6% cap rate (0.06) = $1,000,000 increase in asset value
Before we go any further, consider how this could affect your wealth. It’s comparable to the impact of Jeff Bezos’ light bulbs!
Increase rental unit by 10%
Increase the rent of your apartment tenants by 10% and they can leave. Increase the rent of storage space by 10% and renters probably won’t spend a weekend and rent a U-Haul to move their stuff down the street to save $12.50. Especially if they have a monthly lease and to expect to leave soon. Suppose the initial rent is $125 per unit, and your facility has 500 units.
10% of $125 = $12.50
$12.50 x 500 units x 12 months = $75,000 NOI increase
$75,000 NOI ÷ 6% cap rate = $1,250,000 increase in asset value
Add truck leasing
This is a classic example of added value without upfront investment. And leasing trucks often leads to more storage space rental and side sales. Assume that the commissions from leasing U-Hauls total $2,000 per month.
$2,000 x 12 months = $24,000 NOI increase
$24,000 ÷ 6% cap rate = $400,000 increase in asset value
Retail side sales
Professional operators usually sell retail items through a showroom/leasing office: locks, boxes, tape, scissors, and more. Assume $1,000 per month.
$1,000 x 12 months = $12,000 NOI increase
$12,000 ÷ 6% cap rate = $200,000 increase in asset value
You may be able to put up a billboard or lease it to an operator. Assume $1,500 in monthly income.
$1,500 x 12 months = $18,000 NOI increase
$18,000 ÷ 6% cap rate = $300,000 increase in asset value
Add tenant insurance
Insurance companies offer revenue-sharing partnerships with self-storage operators. It can really add up, as you’ll see here. Set 500 units for $5 per month.
500 units x $5 x 12 months = $30,000 NOI increase
$30,000 ÷ 6% cap rate = $500,000 increase in asset value
Many mom and dad owners don’t enforce a payment policy, leading to late payments. Buy this facility, enforce the policy and charge late fees when violated. Set 25 delinquent tenants at $15 per month.
25 renters x $15 x 12 months = $4,500 NOI increase
$4,500 ÷ 6% cap rate = $75,000 increase in asset value
Boat and motorhome parking
Many storage facilities come with extra land not used by the previous owner. There is currently significant demand for storage for boats and RVs, and top operators often grind or pave set-aside land incrementally for this purpose. For our example, assume $5,000 in monthly income.
$5,000 x 12 months = $60,000 NOI increase
$60,000 ÷ 6% cap rate = $1,000,000 increase in asset value
Lease propane, ATM or transmission tower
There are probably other lease options, but I’ve seen these three in different scenarios. Let’s go with $3,000 a month here.
$3,000 x 12 months = $36,000 NOI increase
$36,000 ÷ 6% cap rate = $600,000 increase in asset value
Add climate controlled units
There is an increasing demand for air-conditioned units. Facility owners own the land, have marketing in place and know the demand. Adding a beautiful new building can increase the appeal of the entire facility and provide a significant revenue stream. Costs will vary, of course, but they will likely be a small part of the increase in value. Let’s assume we add 200 units generating $150 per month.
200 units x $150 x 12 months = $360,000 NOI increase
$360,000 ÷ 6% cap rate = $6,000,000 increase in asset value
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A dollar of more income at once
I just showed you how to add over $10 million in value in the self-storage arena. A dollar of more income at once. Readers can poke holes in the numbers and fanciful summations, but the logic makes sense. Self-storage facility owners have these types of opportunities and more to generate income, increase asset value, and provide significant returns to investors.
I no longer laugh at the prospect of value-added self-storage. I’ve even written a book on the subject and BiggerPockets Publishing is releasing it this month. If you want to learn more about the nuts and bolts of operating or investing in self-storage, get your copy here.