GDPF & Radius+ "Six Days of Feasibility:" Don't Make Business Risky: Why a Feasibility Study?
This post is the first in a series of articles entitled: “Six Days of Feasibility” designed to educate the reader on the world of Feasibility Studies. Over the next 6 days Jay Garlick of GDP Feasibility will address the following:
Day 5: Get You in the Game: What Do You Do with a Full Feasibility Study?
Day 6: Deal Makers, not Deal Breakers: Do You Have Someone to Walk the Path with You?
Day 2: Don’t Make Business Risky: Why a Feasibility Study?
I am going to state this plainly right up front. Storage is truly an amazing, high performing asset class! Without a doubt the fundamentals of asset class and its performance are virtually unmatched. However there is one issue that raises a challenge in storage, it's the lease-up period. Storage facilities have hundreds of units and in some cases thousands. The time it takes to lease up can take 12-48 months with a target of 24-36 months. That is a long time to see the interest clock tick for a bank or time to pass without a return to an investor. So how does one do what all good developers should do and minimize risk?
Before we get into that, let’s look at exactly why self-storage is so attractive for developers and investors.
As compared to other real estate sectors, such as retail, office, or industrial, the self-storage sector offers a number of advantages. GDP Feasibility has identified the following characteristics which, in its opinion, differentiate self-storage as an investment asset from other real estate sectors:
Diverse Tenant Base -Self-storage serves a large and diverse tenant base, so no single tenant should generally have a material adverse impact on a property.
Recession Resistant –Storage is a “need-based” product. Life forces that drive demand for storage, such as death, divorce, business expansion or contraction, moving, migration, changes in employment, and other life events create need-based demand in both up and down economic cycles. Therefore, storage benefits from needs-based events that tend to mitigate the severity of down economic cycles felt in other real estate sectors, like retail or office.
Inflation Defensive –Storage contracts are month to month. In inflationary environments, storage rates can rise faster and more broadly than other real estate types that have yearly or even long multi-year contracts. The ability to strategically raise rates monthly across the board can act as a dynamic defense against inflation.
Easy Exit –Self-storage is highly fragmented as an industry. The large industry owners, mostly. REITs only own about 20% of the facilities in the nation. As the major players jockey for position and market share, they are aggressive in pursuit of quality targets to purchase. The post COVID stall in development and fewer properties on the market has transactions at an all-time high and cap-rate compression at an all-time low. If a property positions itself well as an institutional-grade facility, it has a near-built-in exit to a REIT at top dollar.
Higher Operating Margins -With no tenant improvement requirements, lower energy costs, property taxes that don't rise with inflation, and labor is not unionized. Typically, with some fluctuation, storage costs are about 1/3 of revenue making for gross margins of 60-70% on average. Those numbers far exceed that of other types of investment real estate.
Lower Cost of Tenant Rollover -Tenant rollover for most real estate sectors requires making changes to the tenant improvements and incurring costs associated with brokerage commissions, thus requiring longer lead times and expense to replace tenants, whereas self-storage usually requires a simple cleaning of the unit.
Very Favorable Cost to Rent Ratio.
With such a well-performing asset in self-storage, where is the risk to a self-storage developer? Certainly, there is plenty of incentive to have an asset that hedges against inflation, has a higher rent-to-cost ratio, is deflation-defensive, and is nearly recession-proof. The numbers below show a comparison between the cost of a hypothetical, but plausible storage project, and an equally plausible apartment project in some markets. The gap between the rent to cost ratio in both is staggering and it illustrates the value that a well-vetted storage project creates both in cash flow and in sale margin after the market cap rate has been applied.
But, again, there is a catch. Storage has the longest lease-up period of all the major asset classes. Storage lease-up to stabilization can take 12-48 months. The longer the lease-up to 90% the more risk to the project. It would not be a stretch at all to say that the whole storage project hinges on the feasibility study. It's in feasibility studies that you establish the actual risks to developing the project.
Moving forward on a project without knowing the risks can be catastrophic:
Questions that a developer should have solid answers for before they move forward or even purchase ground should include but not be limited to:
1. Where will a project fit in its market and its trade area?
2. What will be the strengths, opportunities, threats, and potential weaknesses of a proposed facility?
3. What will the projected lease-up be?
4. Is the trade area ready for more supply and how much?
5. What do the existing competitors look like (how old? how big? product mix?)
6. How much will the market bear for rents?
7. What are the demographic fundamentals that will either support or take down a project?
8. Do the numbers work? Does it all pencil out?
Establishing the feasibility of a project helps to know where you stand in project risk. You would not take a trip without a plan, build a house without a budget, or purchase a car without a test drive, right?
NO PROJECT SHOULD MOVE FORWARD WITHOUT A QUALITY FEASIBILITY STUDY!
Up Next: Day 3: Self-Storage = Cash Cow: How a Feasibility Study Makes You Money?
Who is Jay Garlick?
A self-storage developer himself, Jay Garlick is the Principal at GDP Feasibility and Partner/CEO of Greenscape Development Partners which specializes in self-storage development nationwide. Garlick began doing feasibility studies in 2004. Since then he has done studies on over 400 sites in the United States. Jay has a Masters Degree in Real Estate Development (MRED) and will soon finish a second in Masters in City and Metropolitan Planning (MCMP). Jay has also been a principal in a self-storage focused architecture firm, and a construction company. Garlick has developed and or entitled his own projects coast to coast in UT, WA, MO, KS, and VA. Garlick can be reached at firstname.lastname@example.org. For more information please visit www.gdpfeasibility.com.