7 Key Considerations for Investing in Self-Storage Properties

Are you considering diversifying your investment portfolio? Look no further than the booming self-storage industry. With an estimated market value of $48 billion and growing, self-storage properties offer a unique opportunity for investors seeking stable cash flow and recession-resistant assets. Whether you’re interested in a tenants in common investment, a 1031 TIC exchange, or direct ownership, understanding the key factors that drive success in this sector is crucial.

In this comprehensive guide, we’ll explore seven essential considerations for investing in self-storage properties. From market dynamics to operational strategies, we’ll provide you with the knowledge you need to make informed decisions and maximize your returns.

1. Understanding the Self-Storage Market

Before diving into any investment, it’s crucial to have a solid grasp of the market landscape. The self-storage industry has been experiencing steady growth, driven by various factors such as urbanization, downsizing trends, and the need for additional space in both residential and commercial sectors.

Market Size and Growth

As mentioned earlier, the self-storage industry is currently valued at an impressive $48 billion. This substantial market size indicates a mature industry with proven demand and potential for further expansion. The sector’s growth is fueled by several factors, including:

• Increasing urbanization and population mobility
• Rising consumer goods ownership
• Growing small businesses requiring storage space
• Life transitions such as divorce, downsizing, or relocation

Types of Self-Storage Facilities

Understanding the different classes of self-storage facilities is crucial for making informed investment decisions. There are three main categories:

1. Class A Facilities: These are the cream of the crop, typically constructed within the last 10-15 years. They boast modern amenities like climate control, 24/7 on-site management, and high-tech security systems. Class A facilities often command premium rents and have low vacancy rates. Many also offer additional services such as U-Haul rentals or UPS stores, providing diversified income streams.
2. Class B Facilities: These properties are usually over 15 years old but still well-maintained. While they may lack some of the cutting-edge features of Class A facilities, they often offer a good balance between quality and affordability. Class B facilities typically have average to low rent rates and are located near main roads, though not necessarily in prime locations.
3. Class C Facilities: Representing the budget end of the spectrum, Class C facilities are older properties in less desirable locations. They often have minimal amenities, limited security features, and the lowest rent rates. While these properties may require significant improvements, they can also present opportunities for value-add investors willing to put in the work.

Market Trends and Demand

The self-storage market is experiencing increasing demand, particularly in high-growth areas. For instance, the Washington, D.C. metro area has seen a surge in demand due to net in-migration, leading to low vacancy rates in self-storage facilities.

Current trends in the industry include:

• Growing demand for climate-controlled units
• Increasing popularity of multi-story facilities in urban areas
• Rising consumer expectations for security features and convenient access

Understanding these market dynamics is crucial for identifying promising investment opportunities and tailoring your strategy to meet local demand.

2. Weighing the Pros and Cons of Self-Storage Investments

Like any investment, self-storage properties come with their own set of advantages and challenges. Let’s explore the key pros and cons to help you make an informed decision.

Pros

1. Low Maintenance Requirements: Compared to other real estate investments, self-storage facilities require relatively little upkeep. With minimal common areas and simple unit structures, maintenance costs are generally lower than those of residential or office properties.
2. Stable Cash Flow Potential: Self-storage investments often provide consistent cash flow due to their short-term lease structures. This allows for quick adjustments to rental rates in response to market conditions. Additionally, income can be supplemented through administrative fees, late fees, and retail sales of packing supplies.
3. Diversified Income Streams: The demand for self-storage is driven by various economic scenarios, making it a relatively recession-resistant asset class. Whether the economy is booming or facing challenges, there’s usually a need for storage space.
4. Competitive Financing Options: Self-storage properties often benefit from attractive financing terms. These may include low loan-to-value ratios, non-recourse loans, and SBA loans with substantial interest-only periods, enhancing potential returns for investors.

Cons

1. Short-term Leases: While the ability to adjust rents quickly is an advantage, it also means that occupancy can fluctuate more rapidly than with long-term leases. This can introduce an element of uncertainty, especially if local economic conditions change unexpectedly.
2. Management Requirements: Although less hands-on than many other real estate investments, self-storage facilities still require some level of management and oversight. This can be handled directly by the investor or outsourced to professional property management companies, but it’s an ongoing responsibility to consider.

3. Site Selection and Development Strategies

The success of a self-storage investment often hinges on its location and development strategy. Here are key factors to consider:

Critical Factors for Site Selection

1. Visibility: Choose a location with high visibility from major roads or highways. This serves as free advertising and attracts potential customers.
2. Accessibility: Ensure the site is easily accessible, with good ingress and egress. Convenient access is a major factor for customers choosing a storage facility.
3. Growth Area: Look for locations in high-growth areas with increasing population and business activity. These areas are more likely to have sustained demand for storage services.
4. Minimal Competition: Assess the existing and planned self-storage facilities in the area. While some competition is normal, oversaturated markets can lead to price wars and lower occupancy rates.

Development Considerations

1. Utilities: Confirm that the site has access to necessary utilities such as water, sewer, and electricity. This is crucial for both construction and ongoing operations.
2. Unit Mix: Determine the optimal mix of unit sizes based on local demographics and demand. Higher-income areas may require more climate-controlled units and enhanced security features.
3. Zoning and Permits: Investigate local zoning laws and the process for obtaining necessary permits. Some areas may have restrictions on self-storage developments or require special approvals.

4. Financial Planning and Budgeting

Investing in self-storage properties requires careful financial planning and budgeting. Here are key aspects to consider:

Initial Costs and Funding Sources

Developing or acquiring a self-storage facility often involves substantial upfront costs. These may include:

• Land acquisition
• Construction or renovation expenses
• Equipment and technology investments
• Marketing and pre-opening costs

To fund these expenses, investors can explore various options:

1. Traditional Loans: Banks and financial institutions often provide loans for self-storage investments, given the industry’s stable performance.
2. SBA Loans: Small Business Administration loans can offer favorable terms for qualifying investors.
3. Partnerships: Joining forces with other investors can help spread the financial burden and risk.
4. Crowdfunding: Online platforms now allow for crowdfunding of real estate investments, including self-storage properties.
5. 1031 TIC Exchanges: For those already invested in real estate, understanding 1031 TIC exchange benefits can be a tax-efficient way to invest in self-storage while deferring capital gains taxes.

Financial Planning and Analysis

Before committing to an investment, conduct thorough financial planning and analysis. This should include:

• Detailed market research to understand local demand and competition
• Feasibility analysis to project potential returns and break-even points
• Comprehensive budgeting for both development and operational phases
• Stress testing of financial projections under various scenarios

5. Operational and Management Strategies

Efficient operation and management are crucial for maximizing the returns on your self-storage investment. Consider the following strategies:

Efficient Management Practices

1. Blend of Hands-on and Technology: Implement a management approach that combines personal oversight with technological solutions. This can include on-site managers for customer service and security, alongside automated systems for payments and access control.
2. Management Software: Invest in robust management software to streamline operations, track occupancy, manage payments, and provide valuable business insights.
3. Security Systems: Implement comprehensive security measures, including surveillance cameras, access control systems, and adequate lighting. This not only protects your investment but also attracts security-conscious customers.

Marketing and Customer Service

1. Digital Marketing: Develop a strong online presence through a professional website, search engine optimization (SEO), and targeted online advertising.
2. Local Outreach: Engage with the local community through partnerships, sponsorships, and participation in local events to build brand awareness.
3. Customer Service Excellence: Train staff to provide exceptional customer service. Positive experiences can lead to customer retention and referrals.
4. Value-Added Services: Consider offering additional services such as packing supplies sales, truck rentals, or package acceptance to enhance customer convenience and generate additional revenue streams.

6. Investment Strategies and Vehicles

When investing in self-storage, selecting the right strategy or investment vehicle is crucial to aligning your goals, risk tolerance, and involvement level. Each option offers unique advantages, risk profiles, and degrees of hands-on management. At 1031 Exchange Place, we guide investors through these options to help you find the best fit.

Direct Property Ownership

Direct ownership involves purchasing and managing your own self-storage facility. This option provides the highest potential returns since you retain complete control over all decisions, including property improvements, marketing, and tenant relationships.

Advantages of Direct Ownership

• Complete Control: Investors have full autonomy to make decisions related to pricing, improvements, and expansion, allowing for strategic changes to maximize profitability.
• Higher Returns: Direct ownership usually offers higher returns compared to passive investments like REITs or TICs. You can influence rent prices, make upgrades, and reposition the asset for appreciation.
• Tax Benefits: Property owners benefit from tax advantages such as depreciation, interest deductions, and the opportunity to leverage 1031 exchanges for tax deferral.

Challenges

• Hands-on Management: Managing a self-storage property requires time and effort, whether it’s dealing with tenants, overseeing maintenance, or handling marketing.
• Financial Risk: Investors bear the full financial burden, from the initial capital outlay to ongoing operational costs, and any downturns in market demand directly impact returns.

Real Estate Investment Trusts (REITs)

For investors who prefer a more passive approach, self-storage REITs offer exposure to the sector without the complexities of day-to-day management. Self-storage REITs, such as Public Storage (PSA), Extra Space Storage (EXR), and CubeSmart (CUBE), are companies that own and manage self-storage properties and distribute earnings to shareholders.

Advantages of REITs

• Liquidity: REIT shares are publicly traded, providing liquidity that’s uncommon in most real estate investments. Investors can buy or sell shares without the lengthy process of selling physical property.
• Professional Management: REITs are managed by experienced professionals, ensuring optimized operations and investment strategies without requiring direct involvement.
• Diversification: By investing in a REIT, you gain exposure to a diversified portfolio of self-storage properties spread across different regions, reducing location-specific risk.

Challenges

• Lower Returns: While REITs offer steady dividends, the returns may be lower compared to direct ownership, especially when accounting for management fees.
• Limited Control: As a shareholder, you won’t have a say in how properties are managed or which assets are acquired or sold.

Tenants in Common (TIC) Investments

A 1031 TIC investment (Tenants in Common) allows multiple investors to own a fractional interest in a larger self-storage property. This is an excellent strategy for investors who want to own higher-quality, larger assets but do not wish to manage the property themselves. Through a 1031 exchange, you can reinvest proceeds from the sale of another property into a TIC investment and defer capital gains taxes.

Advantages of TIC Investments

• Tax Deferral: One of the biggest advantages of a 1031 TIC investment is the ability to defer capital gains taxes through a 1031 exchange.
• Professional Management: Most TIC investments are managed by professional property managers, freeing investors from the operational responsibilities.
• Access to Premium Assets: By pooling resources with other investors, you can gain access to high-value properties that might otherwise be out of reach as a solo investor.

Challenges

• Shared Control: In a TIC structure, investors share decision-making power. Major decisions typically require consensus, which can slow down processes or create disagreements.
• Liquidity: TIC investments are generally less liquid than other investment vehicles. Selling your interest in the property may take time, depending on market conditions.

Crowdfunding Platforms

For investors looking for a modern, tech-driven way to enter the self-storage market, online crowdfunding platforms offer a user-friendly option. These platforms allow investors to pool resources to buy fractional shares of properties, similar to a REIT or TIC structure but often with lower minimum investment thresholds. Platforms like CrowdStreet or Fundrise have made it easier to participate in real estate with minimal capital.

Advantages of Crowdfunding

• Low Capital Requirement: Crowdfunding platforms often have low entry points, making them accessible to a wide range of investors.
• Diversification: With lower capital requirements, investors can diversify their portfolios across multiple properties or asset types.
• Passive Income: These investments are typically hands-off, with the platform or sponsor managing the properties.

Challenges

• Platform Risk: The success of your investment can depend on the platform’s management and financial health, adding an extra layer of risk.
• Lower Control: Like REITs or TICs, investors have little control over how the properties are managed or sold.

7. Performance Metrics and Evaluation

To ensure the success of your self-storage investment, monitoring key performance indicators (KPIs) is crucial. These metrics help you assess how well your property is performing and guide decisions to improve efficiency, profitability, and long-term returns.

Occupancy Rate

The occupancy rate is one of the most fundamental metrics for self-storage properties. It represents the percentage of rented units relative to the total number of available units. A high occupancy rate indicates strong demand and effective marketing. However, 100% occupancy may also suggest that rental rates are too low, so finding the right balance is critical.

Formula

Occupancy Rate = (Rented Units / Total Units) × 100

Revenue Per Square Foot

This metric evaluates how efficiently your facility is monetizing its rentable space. It is calculated by dividing your total revenue by the total square footage available for rent. Monitoring this helps to assess whether your pricing strategy is effective.

Formula

Revenue Per Square Foot = Total Revenue / Rentable Square Footage​

Net Operating Income (NOI)

NOI measures the profitability of your property after deducting all operating expenses (such as maintenance, insurance, and property management fees) but before accounting for debt payments and taxes. It is a critical metric for evaluating the core financial health of your investment.

Formula

NOI = Total Revenue − Operating Expenses

A rising NOI over time indicates that your property is becoming more profitable, while a declining NOI suggests that costs may be rising or revenues may be falling.

EBITDA Margin

Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) is another critical profitability metric that removes non-operational factors. A strong EBITDA margin indicates efficient management, often achieved through minimizing expenses while maximizing revenues.

Formula

EBITDA Margin = (EBITDA / Total Revenue) × 100

Well-managed self-storage properties can achieve EBITDA margins of 70% or higher, reflecting their relatively low maintenance and operational costs.

Cash Flow from Operating Activities

Cash flow is the lifeblood of any investment, and tracking the actual cash generated from day-to-day operations is essential. This metric evaluates your property’s ability to cover operational expenses, debt service, and provide returns to investors. Strong cash flow ensures that you can meet financial obligations and reinvest in property improvements or expansions.

Break-Even Occupancy Rate

The break-even occupancy rate tells you the minimum occupancy needed to cover all operating expenses and debt payments. It’s a key metric for understanding your risk profile, especially in a new or developing market.

Formula

Break-Even Occupancy = Operating Expenses + Debt Service / Gross Potential Revenue × 100

Tenant Turnover Rate

Although self-storage typically experiences lower turnover than other real estate sectors, keeping track of how frequently units turn over is important. High turnover can increase marketing costs and lead to periods of vacancy. Implementing strategies to improve customer retention, such as offering discounts for long-term rentals, can mitigate high turnover.

Understanding the diverse investment strategies and key performance metrics is essential for success in self-storage investing. At 1031 Exchange Place, we help you navigate the intricacies of direct ownership, TIC structures, REITs, and crowdfunding, ensuring you choose the right vehicle to meet your investment goals. Additionally, by closely monitoring performance metrics like occupancy rate, NOI, and cash flow, you’ll be well-positioned to optimize your investments for long-term growth.

Navigating Your Self-Storage Investment Journey

Investing in self-storage properties can be a lucrative addition to your investment portfolio, offering stable cash flows and potential for long-term appreciation. By carefully considering the seven key factors outlined in this guide – understanding the market, weighing pros and cons, strategic site selection, financial planning, operational excellence, choosing the right investment vehicle, and monitoring performance metrics – you’ll be well-equipped to navigate the self-storage investment landscape.

Remember, whether you’re considering a direct property purchase, a 1031 TIC exchange, or investing in REITs, thorough due diligence and ongoing management are crucial for success. The self-storage industry’s resilience and growth potential make it an attractive option for investors seeking to diversify their real estate holdings and tap into a sector driven by evolving consumer needs and urbanization trends.

As with any investment, it’s advisable to consult with financial and real estate professionals to tailor your strategy to your specific goals and risk tolerance. With the right approach and careful execution, self-storage investments can provide a solid foundation for long-term wealth creation and portfolio diversification.