Buying a self storage facility is no small task. A self storage transaction, just like many commercial real estate transactions, involves hundreds of thousands or even millions of dollars, as well as the concerted effort of several professional organizations. In the final installment of our eight part series on Preparing to Purchase a Self Storage Facility, let’s review the pitfalls that can arise, and the lessons we’ve learned over the years that can directly benefit you.
This leads into the first pitfall of buying a self storage facility – not starting conversations with lenders early enough. The reason this is one of the most important parts of the purchase is that having a term sheet from a lender ahead of making an offer on a storage property helps separate your offer from the rest. Then on top of that, not having the loan secured in time for closing can cost you tens or hundreds of thousands of dollars.
Another pitfall from a lack of preparation includes not having your entire team ready during the transaction process. There are several parties who need to be involved, including: an attorney, a title company, an environmental company, as well as financial analysts and someone on the ground to be present at the property, such as your self storage broker. The days of due diligence are limited and in most cases the escrow deposit becomes completely non-refundable at the end of that period. One of the potential pitfalls is not having the title work or environmental work done in time for the expiration of due diligence. If there is a potential issue with a phase I environmental and a phase II is required, for example, that’s an issue that’s best addressed early in the due diligence process. Otherwise you may not have time to get the phase II study completed before due diligence ends; which can require an extension for the transaction.
Additionally, a potential pitfall is not knowing which items you need for due diligence. It’s important to get enough financial materials (and the correct ones) for your lending institution to fully underwrite the property. Getting multiple years of financials paints a picture of a decline or an improvement that one year of financials will not be able to. Sometimes, the numbers on the tax return will not match the stated revenue, so you have to use other documents to validate the revenue. (Download due diligence checklist.)
There are also several pitfalls during the transition of the facility from seller to buyer post diligence and during closing that can pop up. Upon the transition, all previous contracts have either had to be assumed by the buyer or cancelled by the seller. Sometimes an overlap in service might be in the best interest of both parties and your customers, so there is no interruption of service; such as with phone and internet service. You also need to follow a specific time frame for sending out a new ownership letter to all tenants, as well as updating the signage and branding on the facility if you’re not keeping the same name. Not doing so in a timely manner can cause confusion on behalf of your storage tenants. Even more costly than confusion is the mistake of not switching over the payments to a new account; because it becomes a headache to sort out the financials post settlement when not done correctly.
There are several lessons to learn from going through the sales process as well. For example, while using one lender is serviceable, it is much better to pit several lending institutions against each other to get the best interest rate and terms. And don’t forget about private lending as a viable option.
The financials of the property can teach many lessons as well. In most cases, the facility is marketed by a self storage broker via an offering memorandum. This is where the broker gets a chance to present “pro-forma” expenses and/or revenue in addition to presenting the actuals. The lesson in many cases is to take the broker’s numbers with a grain of salt. Not all brokers are created equal when it comes to knowing reasonable expenses associated with running a self storage facility. Take time to review the broker’s pro forma revenue and expenses to ensure they’re reasonable and not inflated beyond what might be reasonable. For example: using a higher revenue than what actually exists by extrapolating forward a few years that assumes a constant growth. In addition to that, look out for significant cuts to expenses. While it’s absolutely possible to decrease the expenses of operations, some cost cuts are more pie in the sky numbers that are not actually possible to achieve. Sometimes, both of these factors come together to create a picture that is too rosy and would make the returns not worth it from a buying perspective. That is why we recommend our clients work directly with a self storage broker, who has direct experience with buying and selling, or even operating, a self storage facility.
Let’s review a quick list of the potential pitfalls when purchasing a self storage facility:
- Not starting conversations with lenders early enough:
- Institutions need time and the right documents to fully underwrite a deal
- If you’re a new commercial real estate buyer, a term sheet helps greatly
- Not having your entire team ready:
- Walk through on site
- Physical lock check on site
- Title company
- Environmental company
- Survey company
- Self storage broker representing your best interest
- Knowing what due diligence items are needed:
- For your lender
- Multiple year financials
- Request a list of all necessary items from your self storage broker with the deadline you need to supply them to the correct parties
- Handing over of operations:
- Switching of payments for utilities, third-party vendors, etc.
- Sending out letter to all tenants
- New branding and signage
- Managing all previous contracts and services
- Enough escrow money available
Let’s also review the lessons learned, so you can be better prepared:
- Talk with several competing lenders, and get terms from each
- Return requirements and proper valuation of the self storage facility
- Know how to read and understand the Offering Memorandum
- Check the broker’s work; ask for a self storage broker with experience in the industry
As we wrap up this eight-part series on preparing to purchase a self storage facility, our goal was to better inform you of the steps and processes along the path of the transaction so you are not surprised. If you follow these guidelines and work with a reputable self storage broker, the purchase of your first or fiftieth storage property should run smoothly.
If you would like to review the process in more depth with Yevgeni, you can call him directly at 703-223-6387 or email him. Yev is a self storage broker in the states of Maryland, Virginia, West Virginia and Washington, D.C. You can also request more information directly through our website.