Why Construction Costs Shouldn't Be Your Focus When Buying an REO Self-Storage Facility By Frank Rolfe

When considering the purchase of a foreclosed self-storage facility, it's crucial to focus on current income rather than construction costs. Often, potential buyers fall into the trap of using the bank’s loan amount or the facility's original construction cost as a valuation guide. However, these figures are largely irrelevant to the actual value of the property in its current state.

Key Considerations

• Income is the Core Metric
  • Self-storage facilities are income-generating properties, and the value of these facilities is determined by their profitability. For instance, if a facility generates $10,000 annually, it's worth $100,000 at a 10% capitalization rate, regardless of its initial construction cost. The focus should be on the net income, not on speculative future improvements or grand plans that sellers may present.
• Construction Costs Can Be Misleading
  • Just because a facility cost a certain amount to build doesn’t mean it’s worth that much today. Many developers overspend, leading to inflated costs that don't reflect the facility's market value. For example, a self-storage facility with luxury features like fountains and tile roofs may look impressive but can be financially unsustainable. It's important to assess whether the original investment aligns with the facility's actual performance.
• Bank Loan Amounts Aren't Reliable Indicators
  • Banks are not always experts in self-storage real estate. The fact that a bank issued a substantial loan on a property doesn’t guarantee that the property is worth that amount. Many loans were made based on optimistic projections rather than solid income data, resulting in overvaluation. Therefore, do not let the loan amount sway your valuation judgment.
• Appraisals Can Be Misleading
  • Appraisals are often a mix of various valuation methods, including income, construction cost, and comparable sales. However, appraisers may not always provide an accurate market value, especially if they are influenced by the lending bank's expectations. It’s essential to rely on your assessment of the property's income potential rather than on potentially biased appraisals.

Our Experiences with REO Properties

In 2013, we acquired several REO properties at a fraction of their note values, demonstrating that income is the primary determinant of value. For example, a property with a $5 million loan was purchased for $2 million, and another with a $1.4 million loan was bought for $700,000. These deals were based on the properties' ability to generate income, not on their initial costs or loans.

Conclusion

There are opportunities in the REO self-storage market, but it’s vital to base your decisions solely on the current income of the facility. The original construction costs may make for interesting trivia but are not indicators of present value. By focusing on income, you can avoid overpaying and make profitable investments. Use common sense, and you can capitalize on the market's misjudgments.

By Frank Rolfe

Frank Rolfe has been an active self-storage investor for around two decades, with self-storage units in many states throughout the U.S. His nuts and bolts knowledge of what makes for a successful self-storage facility has led to a three-decade career without a single failed property.