Why Invest in Self-Storage

What is the big deal with self storage and why should investors think about it as part of their overall portfolio?

Uh, because I think there's a lot in that, but I personally believe Without any doubt that any accredited investor should have an allocation to real estate within their portfolio directly into real estate not You know owning real estate related stocks or that type of thing, but self storage in particular has been a tremendously popular asset class over the last 10 years and predominantly because it's extraordinarily resilient If you look at all the data, self storage has outperformed every other

type of real estate from office to, um, multi family to retail, uh, in more difficult economic periods. It's, it's simply a product that, uh, is a consumer based product. It's not an extraordinarily expensive proposition for people to store, uh, their things and, and their, the demand for storage holds consistent throughout more difficult economic environment. So I would say that's probably the first and biggest reason, uh, to consider self storage as a part of your portfolio.

Secondly, it's an asset class that generates above average cash flows and cash on cash returns. Um, and is a very simple business. Um, the expense structure in most self storage, well run self storage facilities is roughly 30 to 34 percent of gross revenue. Um, and so it has an extraordinarily simple model. The two biggest expenses are real estate, property taxes, and insurance. Um, and beyond that, there's not a lot of moving parts on the operating side in self storage. Uh, facility.

So it's a very efficient, um, economic model that produces very good cash flows and is counter cyclical in terms of its performance in more difficult economic times.

Uh, there are five publicly traded REITs. Uh, that have an insatiable appetite for, for, for property and that's driven some of that, that lower cap rate environment for self storage. There's also a tremendous amount of private equity outside the, the publicly traded REITs, um, that has been attracted to self storage because of the overall returns.

And so that demand on the property product side has, has made, um, the, the, the, the, valuation of self storage properties not look tremendously different than multifamily. However, the difference is a good multifamily project either cost or cost to construct somewhere in the 200 to 250 a square foot range where self storage can be built for around 100 to 110 a foot and can often be acquired For, for something less than, you know, well under 200 a square foot.

So, um, it's, it, those dynamics kind of create a very interesting environment. Um, as, as you know, others listening to this podcast may not know, we are a developer of self storage. We tend to focus on the development, the ground up development of new projects, and then the management and stabilization of those projects over time. One of the fundamental differences in self storage versus any other, segment in the real estate industry is the yield on cost. that the product provides.

And, um, again, that's a subject maybe for a whole different conversation, but very quickly yield on cost is the cash on cash return that's proforma when a property stabilized versus its actual cost to construct. Um, in the self storage world, we see a yield on cost in the nine and a half percent range is typically what we look for on a project.

And if you look at every other segment in the real estate industry, A developer of multifamily retail office is really pleased if they can get a yield on cost in the seven and a quarter to seven and a half range. That's a pretty big difference in terms of the yield that a project costs or produces based on its cost to construct. And when you combine that with development spread, which is the difference between cap rates in the market, and the yield on cost that a project can generate.

What you see is there's about a three point spread between today's cap rates and yield on cost in our projects. And that 3 spread is what creates the immediate value that's realized when you develop a project from the ground up and get it stabilized. So that is another sort of economic efficiency dynamic.

Um, and some metrics that we look at very carefully as we're looking at projects and, and we think are a great reason to not only invest in self storage, but invest, invest in the development of self storage properties from the ground up.

Something that makes you guys distinctive is that kind of vertically integrated model that you have part of what you just described that you develop the properties as well. But another one in this fund in particular is that that cash. when a lot of people think about self storage investing, they think about kind of a cashflow type business where they're receiving, you know, cash based on rents and things like that.

But you guys actually lock up that cash for a period of time and then distribute that the, the proceeds at the end, uh, which is a little bit unique. Can you talk a little bit why you do that as, as part of a model? Is it, is it helpful to get, um, you know, more value than more of a cashflow model or, or how do you, how do you guys think about that when you're structuring the fund?

Maybe it needs some capex, maybe it has the opportunity for expansion. Um, And then the third or fourth class would be ground up development, which is really what we're focused on. Um, as a ground up developer. The investors that, that invest with us are looking not for necessarily cash flow on a quarterly basis. We don't send out dividend checks, uh, from the fund, uh, although I can unpack that. We certainly, there are circumstances where we may, but that's generally not our plan.

What we're about is providing investors with the opportunity to, um, get significant growth in their equity capital. Our track record over 30 years and 90 days. Full cycle deals is we've returned on average across those 90 deals a little bit more than 3 times the equity that the investors gave us to start with. Um, and we've done that over an average three and a half to four year period, which equates to an internal rate of return of about 19% on average across the 90 projects.

So we are fo the metrics we're focused on, start with yield, on cost that we talked about a minute ago. 'cause that drives the value creation and development process. process and time valued rates of return. Um, as everybody knows, a dollar you get today is more valuable than you get a dollar you get 10 years from now.

And so we're focused on essentially being a merchant developer where we're going to go in, we're going to develop a property, we're going to get it stabilized, um, and when it's stabilized, we can get full value for it in the marketplace and we're going to sell the property and distribute those proceeds back to our investors. Um, you talked about vertical integration. It's a critical. component of what we do, um, but I'll go all the way back to the beginning.

If you're familiar with self storage, um, today there are really two types of self storage. There's the, um, drive up self storage that have been around forever, and then there's what we call the big box, multi story, usually brick buildings that are all climate controlled. We have remained focused on drive up self storage. And we stay focused on that because we can build it because of our vertical integration for about 105 a square foot.

Um, the big boxes that you see, some of the big brand names doing and even regional players that are multiple stories, all climate control, um, 180 to 200 210 a square foot to build because they include elevators and sprinklers and brick exteriors and and that costs money. Um, but the interesting thing is if you look at those big boxes, they may get a small rent premium over our facilities.

We offer both climate control and non climate control, but because it's a little fancier building, they may get a small rent premium over our facility. Let's say the neighborhood of 20 to 25 percent.

But their costs are 2x our cost and so their yield on cost and therefore the value creation that that they have the ability to create for their investors is significantly less than what we can create for our investors and Part of that is the product that we stay focused on and the strategy that we have and part of it is the fact that We're totally vertically integrated particularly in the state of Texas Um, we control all the resources, um, from the acquisition of a property to the final

construction and CO, um, both the vertical and horizontal construction process. Outside the state of Texas, we do use, uh, third party contractors, but it doesn't affect our costs tremendously. It's a little bit more expensive to build outside Texas. We also have our own vertically integrated property management team. Uh, we manage all of our properties. Today, we have a portfolio of about 25 existing facilities that we manage.

Um, and all the new product that we develop that comes online, um, is taken over by the property management team. David Lutz, our VP of property management, has 20, almost 25 years in the industry with AAA Storage. He's probably one of the best lease up, uh, property strategy guys in the country, um, which is an important part of the process once you get it built.

Um, so we feel really confident that with our vertical integration, the product that we focus on and our focus on yield on cost, we can drive above average time value returns for our investors. That's a lot. Sorry. I just kind of dumped the whole dump truck on you there,

And you guys being so You know, experts and having so many decades doing this that you've got a great way to do it. So, yeah, so I'm glad you went into the detail. Um, but I

Our whole strategy, and I said a minute ago, I could give you an example. I'm going to give you a very quick example. Of the, um, value creation in development of self-storage which is what we're very specifically focused on. Um, if you have a property that costs 10 million to build, and has a $950,000 pro forma NOI, Um, that is a 9.5 yield on cost. If you do that math, which is about where our portfolio sits on average.

Some a tick higher, some a tick lower, but on average, that's the target we shoot for. Once that property is stabilized and it cost us 10 million to build it all in. When you put a 6 cap rate. On that $950,000 NOI, the value of that property is $16.5 million dollars. So if we've leveraged that 70/30 which is our, I mean, our typical leverage is 70% loan to cost. That means our investors had $3 million of equity in that project that we built for, for $10 million.

We sell it for 16, pay off the $7 million of debt and send our investors back $9 million. That's the power of development. The development opportunity in self storage is the ability not to just distribute income, but to create true growth in equity. Um, and, and give our investors an opportunity, um, to get, you know, in that two and a half to three and a half times, uh, their equity investment back as a return.

Of, of any development activity, buying land, getting it permitted, getting it ready for construction has some risk in it. In order to strip that risk out of what we offer investors, we land bank land and take it through a process to get it fully permitted and ready for construction before it goes into one of our investment vehicles. So our investors aren't taking that raw land risk.

There's still a tick more risk in development, uh, in theory than there is in buying an existing stream of cashflow. Um, but again, if you, you, the, the risk in self storage is generally less from a lease up standpoint than it is in the other aspects or the other segments in the real estate industry because it's a consumer based product with very broad demand, um, and, uh, and, and it historically has performed very well, so.

You know, how to how to as an investor, You know, maybe I want to start up my own, you know, kind of development practice. How do I do that? You know, just kind of walk me through the mechanics of what it looks like to get involved in this world that you're, you're painting this picture. But also, you know, what are some case studies of investors you've, you've seen in the past, how people gotten involved and what does that look like from an investor point of view?

And then I also want to talk a lot about what are future trends that you're seeing in the self storage space and the real estate market and in general, because You know, obviously we're having inflation. There's, there's bond yields, uh, are elevated right now. You know, there's a new administration coming. There's just a lot of different things that may be happening.

And I think it would be helpful for investors to understand your point of view on the world because you, you are such an expert and you have such a great team. So in future episodes, I hope listeners will stay tuned and, and, um, be focused on those kinds of things. And if you have questions, Please send them to the team. Like what, what are things that are on your mind when you're thinking about real estate investing, self storage, investing, what can the team address for you?

Check us out on social, check out our website, get in touch with the team. Like, let's have this conversation because I think you've got some real experts here. that can provide so much great information. And I, and I want this podcast to be a place for that build this kind of community where we can all help each other succeed, grow portfolios, improve land values, improve asset values, and, uh, and really make a difference.

So Paul, I'm so grateful for you and your expertise, uh, as well as the rest of the team, Andrew, Mike, John, some of the others. Um, I know you guys are doing really amazing things and I'm, I'm really grateful for your time and I'm very excited about this podcast. to be a lot of fun.