How to underwrite a self storage property? How to look at an OM? Kathryn East has several years experience in the self storage space, she is the Founder of Sopapta Consulting, Management & Auditing, and shares her knowledge.

Tell us a little bit about you
I’m an Asset Management / Operations Specialist in the self storage space. What that means is, from A to Z, starting with the broker programs, underwriting, and going all the way through how a facility is actually going to be operated, and even the auditing side. I’ve been doing this for 16 years, and held several different positions from State Association, Executive Director to Asset Management for Kingdom Storage Holdings, to also being the owner and operator of my own consulting firm.

In your very first self storage job, you made that owner about a million dollars in that first year. Is that correct?
I did. I was an onsite facility manager and after six weeks working in their one office, they asked if I could corporate manage their entire portfolio, which was seven facilities. They were bigger facilities, they weren’t necessarily the under 200 model, they were more like 300 to 700 units. 

I was able to really start developing the systems of operations that needed to be put in place. A lot of people call those SOPs, but the fact of the matter is that companies still use those models today, in order to generate the income production that’s needed to sustain a portfolio.

We are going to underwrite a deal together, and see where Kathryn's mind is at when she gets an OM, I will let you take it from here.
Deals are made. In order to create the cap rates and the profit analysis that’s needed for specific clients, I have to underwrite these very carefully. I love OM's, because they generally have 95% of the information that I need. The first thing I’m doing is looking at pictures, it sounds very elementary, but I need to see the property from their eyes. Those pictures are designed to make the property look better than what it is, so there could be some filtering applied. The purpose of that is to see what the general condition of the property is, because I have to know how much Capex I’m going to have to put into this property, and that’s directly going to affect my evaluation. 

The next step is to enter the numbers exactly as they’re stated on the offering memorandum, into an evaluator. The reason is because I need to see, from the numbers that they provide, how accurate is it to get that price point that they’re looking for. Most of the time, brokers are cap rate driven, so if I’m looking at a property that says that they want 1.2 million at a 6.5 cap rate, I need to determine whether or not that’s realistic, based on the information they’ve provided in their current analysis column. We all know that as interest rates go up, cap rates go up, things fluctuate, it’s a cycle. 

When I’m looking at the numbers, I’m trying to determine whether or not it’s a fair asking price. A lot of times we’ll find some small issues on the underwriting on the offering memorandum and that leads to questions for the broker, so we're able not only to decipher whether or not they’re necessarily a self storage broker, and believe me, I love self storage brokers, because their underwriting is quite impeccable, but they often underwrite price for pro forma.

What do you think when you see a broker put a projected cap rate for year one or two and not the existing cap rate?
First of all, don’t buy off of a cap rate, but you can determine what the value is on your exit strategies on cap rates. If I buy this property at a six and a half cap, I’m estimating to sell it at a 6.5 cap in my exit strategies, which are three to five years, generally. We have seen a lot of inventory come across that has been selling in a year or 18 months, that was a year ago, that’s the past. Now we’re back onto our holding pattern. It’s always a cycle, so we are back to the three to five years. When they say “I want $2.4 million based on the exit strategy I’m projecting in five years of an eight cap", I’m asking “Where did you come up with that information, because our current column is more like two and a half?”.

A lot of brokers are dictated the pricing by the seller themselves, so they have to ask their clients how much are you wanting for this property? They throw out $2.4 million, the broker runs the analysis on the current numbers and says “That’s at a four cap, interest rates are at a six and a half, you’re probably not going to get that”. Then the client says “Well, you are going to get it for me anyway”. Which is why underwriting as-is is so important, that is what will give you your actual asking price. 

Whatever their GPRI states, which we often find a few minor errors in that, where they might come up with 240,000 for a GPRI and we come up with 220,000. We’ve seen that happen several times, we’re all human and humans make errors, that is why it’s good to be able to use a tool like an evaluator to decipher what those issues could be. Another thing that’s very important when underwriting those numbers, is what is their expense ratio? What are they spending right now, to currently run this property the way that they’re running it?

Of course, we teach that 35% is the accepted AGI which is the estimated gross income percentage of expenses. I’m always looking at that, I want to see what they are at. If they are at 56%, I will only be underwriting it for 35, and that is directly going to affect my price point. Actually, they will get a better price point if I do it that way, not necessarily will they get what they are asking for, because in real life, when they are asking for $2.4M, we are not giving them 2.4, we are giving them less, but it helps in the underwriting process, if I’m looking at the expense ratio, to see what is going on. I'm checking out the numbers to get my price point. Once I get my price point, I move on to the market. I need to know what I can reasonably do in my first year in that market, in order to raise the gross potential rental income, and potentially the economic occupancy. Those are two big factors. Notice, I didn’t say I look at those when I’m doing the current underwriting? Because I don’t look at them until after I have got a price point. The reason for that is because if they’re operating, at say a 60% economic occupancy, I have to show the bank, and the investors that I can do better than that. I am using very specific sources to obtain the information that I need. 

Let’s start with a new StorTrack Explorer, it’s a wonderful tool. It is fairly accurate, but you do have to then research outside of StorTrack as well, which is why Google Earth is so important. I get a lot of laughs when I say go to Google Earth, but it will tell you how many facilities are on the market, just put in your address and click nearby and put it in self storage. Not only does it give you how many are in the market, but it gives you the distance from your own facility. I check that out to see what the accuracy to StorTrack is.

The other observation that I need to make is, how many of my competitors have websites? If they don't have a website, they are not really a competitor, because how do you find them if you're a consumer? I don't necessarily have to worry about them unless it comes to pricing, which again, is why I like to use StorTrack, it gives me the average for the market, for the state, and national. I can gauge if they are charging $50 for a 5x10, but if the average in this market is $75, I can raise my rates up to $75, why can't I? I am checking rates to see where I can raise not only my GPRI, but I am also looking for how I am economically going to be able to make that happen.

Then I start looking at resources like City Data USA, a great resource to determine things like average household income in a market, poverty level, housing, investments, how they have grown over the past 20 years. I personally like to see it at least double, if the market is not sustaining, or at least doubling in the housing market, then I tend to look at it a little bit differently. I need to know that not only can these people afford the rates that I am about to charge, but is this a growing market? If I have a market that's basically stagnant in population, but the housing market has grown in value, and it's a low poverty rate, then I will still look at that market, especially if I can raise rates. I want to know where I can grow, that is my add value. 

Are they implementing any type of tenant protection or other income streams? City Data USA is great for that kind of information. World Population Review is great for that information. Then there is also Data USA. All three of those combined, will give you a good sense of what that market is actually doing. If I can't find that information, I will go into the county website to find out who has pulled permits, and for what because a lot of times, what you will see are housing developments are going in, and apartment complexes, or Amazon pulled a permit for a huge building that they are about to build. If that's the case, I know that industries are growing in this market, for example, Amazon Prime buildings, they can employ up to 1,500 people, and that means people are moving to that area. So I know it's a good growth market.

When I am looking at this market, and I see that the population graph is nothing but a sharp decline, I'm out, because that means that people aren't coming to that market. Unless you can prove that there is something coming into that market that is going to significantly increase that population, where am I going to pull my tenants from? So when I go in, and I raise rates to this new rate, from $50 to $75, that is a $25 increase per month for these tenants. If they move out, how do I fill it back up? How am I ever going to get beyond the 60% economic occupancy that was stated in that OM? I research that information to determine the structure of my new GPRI, to determine the structure of my new economic occupancy which stabilized is 85%, so I underwrite to 85%. I then apply my 35% expenses, and that will give a true NOI. That NOI is then divided by the cap rate that they provided and it tells me what it really should look like, what the price point is. 

I hear a lot of mumbling and grumbling about interest rates going up, and people think that now this is a bad a deal. If it was not a deal six months ago, it is still not a deal now. It has nothing to do with the cap rate, and everything to do with what is the add value for that property. I have put that in my current numbers, I have looked at my year one, which sounds super simple, does it not? Now I have to move on to how to operate this to make sure that my expenses are within that 35% margin.