With both individual and institutional investors now privy to the returns that self-storage investments can bring, it seems as if almost everyone is eager to invest in self-storage.
Privately Owned Self-Storage Properties
If you are looking to expand your storage empire, there are many important factors to consider before buying an independently owned self-storage property.
Look at community socioeconomic data: It is valuable to conduct a feasibility study, whereby you use census data to identify the projected growth of the area, the current population, and the average income of residents. You should analyze everything within a five mile radius.
Consider the type of homes in the area: If there are many multi-family rentals in the area, there will be a higher demand for smaller units, which in turn usually provides a higher return on investment.
Municipal and township requirements: It’s important to confirm that zoning requirements are not going to change. Additionally, don’t assume that you can relocate or replace a sign. Many municipalities have specific requirements on signage.
Land value: Look at the current value of the land, as well as the trajectory of land valuations in the area.
Location and visibility: All things being equal, a storage facility in a dense, urban area is much better than one on a freeway. Be sure to consider how visible the facility is from the road.
Consider market saturation and do an analysis of your competitors: You should plot all the current competitors on a map. Pay attention to the distance from your facility, as well as the competitors’ rental rates, occupancy levels and unit mix. Be sure to physically walk into all of your competitors’ facilities to see what you are up against.
Look closely at the current management’s financials: How are the current occupancy levels? What are cost and operating expenses? How much are they paying in taxes? In regard to taxes, there are consultancies that offer estate planning strategies and tax-deferral exchanges that can help you reduce your overall tax liability.
According to the National Association of REITs, self-storage REITs have had the strongest returns out of all publicly traded REITs over the past two years. In 2011, self-storage REITs had a 35.4% return, whereas the overall REIT market realized 8% returns. Generally speaking, REITs are relatively low risk, as 90% of all profits must be returned to shareholders.
Moreover, the 2013 fiscal climate looks promising for the real estate sector, as many financial analysts expect interest rates to remain exceptionally low. Interest rates are particularly relevant, because REITs use a lot of leverage and operate with considerable debt.
There are four publicly traded self-storage investment trusts on the New York Stock Exchange:
- CubeSmart (CUBE)
- Sovran Self Storage (SSS; doing business as Uncle Bob’s Self Storage)
- Extra Space (EXR)
- Public Storage (PSA)
Which, if any, of these companies look undervalued and ripe for purchase?
Use a market cap/FFO multiple rather than a price/earnings multiple: When looking at these REITs’ financials, a potential investor cannot only rely on traditional metrics like earnings per share (EPS) and price to earnings (P/E) ratios. In addition to looking at stock price, net income, P/E and EPS, it’s prudent to examine a self-storage company’s funds from operations (FFO).
This is because real estate is intrinsically different. While most businesses have depreciating assets, a real estate company’s business assets, or properties, often appreciate in value depending on market conditions.
In order to really assess the value of Uncle Bob’s assets, we need to add back depreciation and amortization to net income. This will provide us with their FFO. FFO is essentially net income, but with depreciation added back (and any gains from the sale of depreciable properties subtracted).
Although not accepted by Generally Accepted Accounting Principles (GAAP), these four publicly traded real estate companies will all include their FFO on their Annual and Quarterly Reports.
Uncle Bob’s market capitalization (the stock price multiplied by number of shares outstanding) was 1.90 billion.
Market cap / FFO = 1,900,000,000 / $67,407,000
Market cap / FFO = 28.19 x
Adjusted FFO multiple is even more accurate: As an important note, an “Adjusted FFO multiple” is an even more accurate predictor of a REIT’s residual cash flow and their ability to pay shareholders a higher dividend. In order to find a REIT’s “adjusted funds from operations,” you need to deduct the capital expenditures that the REIT uses to maintain their portfolio.
AFFO = FFO – capital expenditures
In 2011, Uncle Bob’s spent $14,600,000 for recurring capital expenditures, such as painting, paving, roofing and renovating offices. According to their 10-K, they plan on spending a similar amount in 2012.
AFFO = $67,407,000 – $14,600,000
AFFO = $52,807,000
Market cap/AFFO = 1,900,000,000 / $52,807,000
Market cap/AFFO = 35.98 x
Compare the market cap/FFO and market cap/AFFO multiples to industry peers: By comparing these multiples to the same multiples for CubeSmart, ExtraSpace and Public Storage, we can see if Uncle Bob’s Self Storage is potentially undervalued, hence worth investing in. As with all stocks, we want a multiple that is low.
Other important factors to consider: One multiple only tells a small part of the story, so it is important to consider other factors such as a company’s growth potential, exposure to foreign markets, dividend yield, the amount of debt on the company’s books, and the history of their stock price.
Images courtesy of info.reoptimizer.com and UncleBobs.com