With U.S. treasury yields (interest rates) rising and concern from the Federal Reserve that inflation is starting to increase, it is important that self storage business owners understand that their facility operations are a critical component of value. The risk that self storage owners face is not only whether their net operating income goes up or down, but that cap rates may go up at a faster rate than their net operating income can compensate for the loss of value. This is directly related to the interest rate that a buyer or lender may be able to use when buying or financing a self storage property.
With investors looking to maximize their rate of return and limit the amount of risk, it is only logical to think that controlling operating expenses and thus increasing net operating income will protect the property’s value. As the market starts to turn and values start to soften, let us understand the magnitude of what each dollar of net operating income means to the value of the facility.
For example, a self storage facility with annual revenue of $600,000 and annual expenses of $250,000. This facility will have a net operating income of $350,000 which will be capitalized at a rate of return acceptable to an investor to arrive at the value. With cap rates being in the range of 7% to 9%, this facility’s value would be in the range of $3,800,000 - $5,000,000. Reducing the operating expenses by 8% or $20,000 a year would increase the value by $220,000 - $285,000. This means that for every dollar you add to the net operating income, you would receive $11 to $14 in value.
With the majority of self storage expenses being in the three major categories of real estate taxes, payroll and advertising, it is understandable how yearly escalations in service contracts, payroll raises and property taxes can deteriorate the value. Interestingly enough, you do not have to sell your facility to get an immediate gain out of this capitalization of saved operating expenses; the value will be reflected in the amount you can borrow on the property. Generally speaking, you can borrow 75% of the increase in value when you refinance. Essentially, you can have your cake and eat it too!