Ask Brian is a weekly column by Real Estate Expert Brian Kline. If you have questions on real estate investing, DIY, home buying/selling, or other housing inquiries please email your questions to [email protected].
Question from Skylar in AZ: Hello Brian, I’m thinking about making the leap to commercial real estate investing but I’m nervous. Before I decide to even start looking, I’d like answers to a few basic questions. Quite frankly, my biggest concern is what type of business structure to use. Rental house contracts are pretty straightforward. After I had a basic contract reviewed by an attorney, I was comfortable filling in the blanks as the tenants in my houses changed over the years. I’m comfortable that I can do the same with the storage rental contracts for customers. My bigger concern is my risks and obligations with a self-storage facility. As I understand my options, I can buy raw land to develop a facility, purchase an existing independent facility, or buy a franchise. There are probably other options but those are the ones that make sense to me. What should I be focused on as I increase my knowledge before deciding how to proceed?
Answer: Hello, Skylar. I’ll start with some differences between being a rental landlord and a self-storage business owner. You are going to be running a business as compared to being a landlord with rental houses. Many small landlords try to grow their portfolio by expanding into duplexes, triplexes, and then larger apartment complexes. That can be a good strategy, but self-storage units could be a better stepping stone. With self-storage, not only are the maintenance costs much lower but you’ll be dealing with fewer hassles from tenants. The old saying “clogged toilet in the middle of the night” comes to mind. Instead, you’ll be dealing with lost passcodes and customers that become irritate when you double-lock them out of their units for failing to pay the rent. At least those happen during normal business hours.
So Skylar, the first thing to realize is that storage units will take more of your time compared to collecting the monthly rent on a few rental houses. You’re going to have to run an office and probably hire a small office staff. That can be a compelling reason to go with a franchise because they will help you set up a mostly turnkey operation. On the other hand, buying an existing independent operation will also be mostly turnkey. Going independent avoids the always expensive franchise fees. A good businessperson would look for a struggling independent operation with an eye towards making it much more profitable. Breaking raw ground on your own is certainly the riskiest choice.
Before you look at those options, you want to consider how risky or financially rewarding the self-storage industry is. According to Self-Storage Almanac statistics, in 2019 small business owners operated 73% of all self-storage facilities in the United States. Once they got into the business, many mom-and-pop investors went on to own two or more facilities. More than 30,000 owners operate approximately 55,000 self-storage facilities nationwide, according to the Self Storage Association. It’s estimated to be a $39 billion industry and still growing.
Partially because of the pandemic, the self-storage industry has been booming. People of all walks of life have carved out extra living space for things like home offices, classrooms, and home gyms. Some young people even fled urban centers to ride out the pandemic at their retired parents’ rural homes. Occupancy rates and rents for self-storage are at record highs.
Skylar, you’ll need to perform your due diligence, but the exceptionally low operating costs are financially attractive. Compared to retail strips, hotels, and other high-expense businesses, the costs to run empty storage units with a fence around the property are nominal. Property taxes are lower because improvements on the property are minimal. Few, if any, amenities are needed, and electric/water use is spartan. One of your higher expenses will be some labor.
There are more good reasons why self-storage is appealing to small business owners:
Skylar, self-storage has tremendous upside, but you always need to conduct or hire a cash flow analysis that examines the net operating income. NOI equals the total expenses of the storage facility versus how much revenue the facility generates. Something else to keep in mind is that the large institutional self-storage operators control major metro areas. You should investigate smaller markets where storage demand is high, supply is limited, and land costs are low.
Skylar, I’m going to end with this thought. You are just making the move into commercial real estate. You should also consider other strong positive cash flow properties. Besides self-storage, these include mobile home parks, senior living, and offices. What you want is an investment with an appeal to a wide cross-section of renters.
What do you think are good first moves into commercial real estate? Please add your comments.
Our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions or inquiries to [email protected].