The self storage asset class has enjoyed a ten-year run of success. From 2009 to today, self storage properties have sold for higher prices per square foot, year after year. As for capitalization rates, we have seen continued compression over the past ten years. The following paragraphs will discuss the different ways appraisers select capitalization rates. Appraisers are charged with deriving cap rates as part of the Income Capitalization Approach analysis. Cap rates can be determined using several sources and methods. The following four techniques are the most common:
- Recent Comparable Sales
- Investor Surveys
- Market Participant Interviews
- Band of Investment Technique
In analyzing existing sales, it is common to select more current sales outside the market than older sales within the market area. Capitalization rates for self storage facilities have stabilized over the previous three years. Capitalization rates typically range between 4.75% - 7.00%, depending on market location, demand, and quality. Buyers will look at current in-place income and expenses, as this is how lenders are underwriting properties. In recent years, increased tax levies after sales have played a large factor, as many appraisal districts have become more aggressive with their assessment of self storage assets.
The potential investor pool for a self storage asset includes national, regional and local investors. While all of these groups place emphasis on local cap rates, regional, and national investors would also strongly consider national cap rate trends from investor surveys due to the potential to invest in other regions that are offering competitive rates of return.
Within this industry there are a handful of brokers that “truly” specialize and have significant experience and understanding within this property type. They are spread throughout the country and provide a great perspective of what is taking place or incurring in the storage market. When determining cap rates, it is necessary to find out what is available on the market. Brokers will usually share with appraisers if they have received any offers (not necessarily how much), if the seller is firm, how long the property has been on the market, and strengths and weaknesses of the property. Brokers can provide additional insight into a buyer’s motivations and cap rate expectations due to the feedback they have throughout the market. A broker who truly understands the nuances of the self storage asset class is invaluable to buyers, sellers, and appraisers alike.
Band of Investment Technique
Because most properties are purchased with debt and equity capital, the overall capitalization rate must satisfy the market return requirements of both investment positions. Lenders must anticipate receiving a competitive interest rate commensurate with the perceived risk of the investment or they will not make funds available. Lenders also require that the principal amount of the loan be repaid through periodic amortization payments. Similarly, equity investors must anticipate receiving a competitive equity cash return commensurate with the perceived risk or they will invest their funds elsewhere. The following tables provide an example of the how this technique is calculated.
Another trend with financing that we are seeing is a lot of capital chasing very few deals. As such, investors are willing to take less return on equity. This puts downward pressure on cap rates and raises values. Investors with the opportunity to sell or purchase a portfolio are seeing cap rates 50 to 100 basis points lower than the rates stated in the chart above. These premiums are often being paid for properties on a ‘Pro Forma’ basis, for newer facilities that have yet to stabilize. The opportunity to take down a critical mass of space or facilities is highly desirable for a potential buyer.
In summary, deriving cap rates is more art than science. Appraisers strive to research all facets of the commercial real estate industry. We interview buyers, sellers, brokers, and lenders as well as study trends in financing to pick the right cap rate for the property being analyzed. When asked the question, “What are current capitalization rates for self storage facilities?” I would respond, “It depends.”