How does SSSE underwrite properties?

SSSE is committed to downside mitigation. Our underwriting process is our first step in minimizing risk. From the very first phone call or email we receive with an opportunity, there are at least 3 levels of underwriting that a deal must make it through prior to any consideration of investment.

The first is our “back of the napkin” underwriting. Our acquisition team is fielding constant responses to our marketing efforts day in, day out. In order to be efficient and effective, they must collect a minimum threshold of information from a lead in order for it to be even considered an opportunity and continue to move through our process. That minimum information includes the contact information of the seller, broker, or wholesaler; the name and address of the property; size and/or acreage of the facility; current occupancy or zoning of the property; and current annual gross operating income.

With this information, we are able to identify an as-is financial valuation and replacement cost valuation for existing facilities. For development opportunities, we have standard build types that are possible based on the size of the lot and from that a range of value we can assign to the land with comparison to market value of similar listed and sold land. The purpose of the “back of the napkin” underwriting is to be able to provide an offer range as quickly as possible to the seller, broker, or wholesaler that will be fine tuned in later levels of underwriting.

If the lead passes our “back of the napkin” underwriting and becomes a potential opportunity, we perform our “underwriting lite”. This involves collecting readily available due diligence items and remaining information. Unit mix, pricing, expenses, recent capital improvements, needed capital improvements, management structure, build types, security components, insurance information, and more.

In our “underwriting lite”, we perform the “chicken pox test” on Google Maps, searching for storage in the nearby area to see how many red dots show in order to get a general sense of supply. We virtually drive the market using Google Street View to compare the subject facility to competitor facilities. We pull up census data to get a general understanding of population, trends, and demographics. We compare the subject facility’s unit prices to the 3 nearest competitor’s prices to see what sort of soft value add is available. We call the city building and zoning department to see if there are any active or applied permits for self storage development. Once we have completed underwriting lite, we should be able to solidify value and viability for the subject property. Beyond that, we have our full underwriting and analysis.

SSSE’s full underwriting and analysis takes all of the previous steps of our initial acquisition activities, formalizes them, and expands upon them. We have a full due diligence document checklist that the seller is required to submit prior to the due diligence period starting. We take all of the due diligence documents and audit them by recreating them within our standardized underwriting and analysis template. By auditing and recreating their rent roll, we are then able to create an accurate unit mix with each unit size’s range of rates accounted for.

In our full underwrite and analysis, we conduct an extensive competition study where we compare the supply index number, the competitors’ historic and current occupancy, and the subject facility’s historic and current occupancy in order to get an accurate assessment of the market’s supply and demand. The supply index number is determined by using satellite imagery and secret shopping to measure the size of each of the competitors and the type of storage the competitors provide. Using ArcGIS Esri Business Analyst we are able to map 1, 3 and 5 mile radii in addition to 5 minute, 10 minute, and 15 minute drive times, to establish our potential market and customer base. We analyze our potential market to determine population, income, housing and other metrics within the various radii. Dividing the population by the storage supply within our market radii provides us our supply index numbers which we compare against the state statistics provided by the latest Self Storage Almanac. Our competitor’s historic and current occupancy along with their unit rates is established through secret shopping. This underwriting triumvirate of supply index, subject facility occupancy, and competitor facility occupancy gives us as accurate of a market supply and demand study as possible. We are able to use the market supply and demand results along with the competitor unit rates matrix to determine what the market rates are and update the unit mix with the potential rental rates for each unit size.

By updating the seller’s unit mix with market rental rates gleaned from our competition study, we achieve a projection of gross potential income that can inform development and expansion plans. It allows us to project future years profit and loss in comparison to current income and expenses with downside mitigation factored in through stress tests, applying a range of decreases to income and an increases to expenses. We explore the various debt and equity structures available and the effects on cash after debt service and internal rate of return. Beyond the quantitative analysis, we collect qualitative information: physical appearances, amenities, opportunity zone qualifications, property insurance qualifications, FEMA flood map reference, police reports, and more. We order a Phase I Environmental Site Assessment, a Property Condition Assessment, drone photography, and a site walkthrough. In the scenario of an expansion, adaptive re-use, or ground up development, we order a third party feasibility study to verify our work and further mitigate downside risk for us and our investors.

When everything is said and done, we can identify if there are any changes needed to the purchase price, projections, or structure of each deal.

How much does a ground up development cost to build?

The cost to build a multi-story, temperature controlled, self storage facility is going to be one of the most expensive ways to build self storage. Self storage is primarily made of steel and concrete, with steel being a highly traded commodity susceptible to supply chain disruptions, geopolitical factors, and economic events. As a result, the cost to build any type of self storage can vary greatly from location to location, month to month. As of the time of this writing, we have seen the cost of building a class-A, multi-story, temperature controlled self storage facility range from $75 to $125 per square foot. Decisions like how many stories, how many elevators, smart locks, etc. will increase prices. There are ways to reduce costs like prefabricated components that are flat shipped and assembled on site. Involving your general contractor in the equity stack and incentivizing price reductions through a profit share structure can help ensure the best price and timely performance. We believe in getting multiple bids on every job.

How much does an adaptive reuse/conversion project cost to build?

The cost to do an adaptive reuse or conversion of a building into self storage is often less than the cost of building ground up. By using an already existing shell or “envelope”, you can reduce expenses dramatically depending on the condition of the shell. Self storage is primarily made of steel and concrete, with steel being a highly traded commodity susceptible to supply chain disruptions, geopolitical factors, and economic events. As a result, the cost to build any type of self storage can vary greatly from location to location, month to month. However, with an adaptive reuse or conversion project, you are not as exposed to the price of concrete and steel because not as much is needed with the exterior shell already existing. As opposed to structural components, the steel will be used for framing out units. As of the time of this writing, we have seen the cost of adaptive reuse or conversion projects of turning a building like a former big box store into self storage fall in the range of $45 to $85 per square foot. The condition of the shell- the roof, walls, foundation, electrical, HVAC, and fire suppression system- will greatly effect the project cost. If the shell is not in good condition, there becomes a break even point of using the existing shell vs. building a new shell from the ground up. Some pre-existing buildings will have enough ceiling height to consider building a mezzanine second level which will effect not only the price of the build-out but also the potential revenue the footprint of a given building can generate.

What cap rates do self storage facilities sell for in 2023?

The subject of self storage facility cap rates is one that does not age well. The bottom line is that self storage is a commercial real estate asset that has performed the best out of all real estate asset classes through recessionary periods so while other cap rates may be negatively impacted in the upcoming years, we believe that self storage will fair the best. We approach self storage cap rates from a 9 category matrix. There are 3 types of markets and 3 grades of self storage. Primary markets, secondary markets, and tertiary markets. Primary markets are major cities with high population density. We categorize that as populations of 250,000 or greater within a 10 minute drive time. Secondary markets we categorize as populations of 75,000 people to 250,000 within a 10 minute drive time. Tertiary markets are anything below that and because of the smaller populations, the density is usually less and it causes the trade area to increase sometimes to a greater than 10 minute drive time.

Class A self storage is mostly found in primary markets but we are seeing it more and more in secondary markets as the REITs and other institutional players expand out of the saturated primary markets into secondary markets. Class A is going to be newer, more expensive build types, multi-story, and temperature controlled. Class B is going to be slightly older, a mix of multi-story and single story drive up, with amenities like paved aisles, automatic gates, and potentially temperature control. Class C is going to be pretty much everything else: older drive-up units, possibly unpaved with gravel, compacted substrate or hopefully not just mud and grass. It is not an exact science and there is the largest range of quality facility within Class C which prompts some groups to use additional letters.

As you can imagine, a Class A facility in a primary market is going to trade at the lowest cap rate meaning that it is valued the highest, with the highest premium paid by buyers. A Class A facility in a primary market is going to trade at a lower cap rate than a Class A facility in a secondary market because of the security that a greater population and hopefully corresponding demand provides. So the Class C facility in a tertiary market is going to trade for the highest cap rate, or the lowest premium, because it is not as pretty of an asset, with potentially more risk.

We love to buy existing Class C and Class B self storage facilities for value add investment where we can improve their performance or even improve their asset class categorization. We like to build Class A self storage facilities because the premium to buy is incredibly steep so we are able to build them for less than purchase, lease them up, and either refinance at stabilization or sell them to market at the premium that grade asset garners. Historically, we have seen Class A facilities in primary markets trade for as little as 3% cap rates as long as there is room for increasing the financial performance. Over the past 3 years, we have bought Class C facilities in tertiary markets for as high as 12% cap rates. The rest of facility class and market combinations fit within that range, but now cap rates are rising because of interest rates.

Cap rates typically float above interest rates because of cash flow needs. So with the drastic increases in interest rates over 2022, we are seeing cap rates for all self storage facility grades and locations slowly rise to meet the higher interest rates. There is a lag in cap rates increasing and it is not directly proportional to the interest rate hikes because self storage is such a highly desired real estate asset especially for its recession resilience. As a result, we are seeing the highest valued self storage facilities trading at above 5% cap rates at the start of 2023.

The relationship between self storage facility values and interest rates can boil down to debt service coverage ratio (DSCR). Debt service coverage ratio is the calculation of net operating income versus debt payments. If the net operating income and debt service costs are exactly the same, it would be a DSCR of 1. Lenders typically want to see a DSCR of at least 1.25 so there is a buffer between loan costs and revenue from the facility, meaning that the net operating income of a facility can more than cover the debt payments. So as the cost of real estate loans go up with interest rate increases, the value of self storage facilities and other commercial real estate can go down unless the net operating income also increases to maintain bank required debt service coverage ratios.

How does SSSE act on its commitment to “social stewardship”?

Our company on-liner is “tax-advantaged self storage with an emphasis on downside mitigation and social stewardship”.

By nature self storage mitigates downside and is tax-advantaged. In the Great Recession of 2007-2009, self storage dropped -3.8% in comparison to the S&P 500’s -22%. This was the smallest drop of any real estate asset class. From 2011-2018, self storage had the lowest default rate of any real estate asset class. When those rare few properties did default, the banks only lost an average 1.52% per default. Banks recognize the inherent downside mitigation of self storage and that’s why its one of their favorite assets to lend on.

We further emphasize downside mitigation with our rigorous underwriting and analysis. Each of our syndications and investments is required to have multiple exit strategies. With our robust pipeline of leads and opportunities, we are never in a position where we feel the need to take on a new acquisition or development because of pressure to deploy capital. We pick the best opportunities to move forward with when it makes sense to do so.

As for tax advantages, the government provides incentives for anything that creates food, jobs, or shelter. While self storage is not housing, it is real estate and has all of the great tax benefits like bonus depreciation. We consider tax benefits as part of our analysis process, and choose deals that will result in the greatest tax benefits.

Our company one-liner emphasizes social stewardship. We believe that self storage can be more than metal boxes. We are very fortunate with the opportunities that self storage affords us. One of those is the opportunity to give back to the communities our storage facilities serve and to make environmentally conscious decisions when designing our developments. Energy efficient materials, solar panels, electric vehicle chargers, green roofs, native species landscaping, and more are all considerations we take into account when planning and designing our new self storage facilities. Our primary focus in regards to social stewardship is participating and donating to local charitable causes for each of the communities our storage facilities serve. Self storage is an incredibly localized business. On average, 70% of renters come from a 3 mile radius of a self storage facility. This is an opportunity for us to really participate in our communities. Our charitable donations and participation is focused around food, shelter, and jobs. Some of our most common avenues for giving back to the areas we serve are local food banks, domestic violence shelters, and after school programs. Our renters trust us to store and protect their beloved belongings, and we want to go beyond that to protect and improve the communities that store our properties.

What is the average occupancy rate for self storage?

The average occupancy rate of self-storage facilities varies depending on location, market conditions, and other factors. Typically, the average occupancy rate for self-storage facilities is between 80-90%. However, it is not uncommon for occupancy rates to fluctuate based on seasonal changes and local economic conditions. The self-storage industry as a whole has been stable and consistently growing, with high occupancy rates reflecting the growing demand for storage space.

According to the Self Storage Almanac and Radius+, as of 2022, the national occupancy was 93.4%.