The Ins And Outs Of Joint Ventures
Our technology-driven world has had far-reaching implications on real estate investments. Amazon and other online merchants have changed the landscape for retailers, and office space is facing challenges due to an increase in home and mobile offices. With these two types of commercial real estate becoming less favorable investments, self-storage was thrown into the lime light.
Self-storage’s recession-resistant nature, along with unprecedented performance, captivated institutional investors to the point where most industry professionals acknowledge that there’s more capital waiting to be placed than there are deals to be done.
In fact, according to Shawn Hill, a principal at Chicago-based The BSC Group, there is a massive demand for exposure to self-storage. However, oftentimes the capital that wants to enter the industry lacks the necessary operational expertise to effectively manage the properties in which they invest.
That’s where joint ventures come into play.
Enter The Joint Venture
Although the details vary, a rudimentary definition of a joint venture is two or more unrelated entities joining forces to complete a deal. As Aaron Swerdlin, vice chairman of NKF Capital Markets in Houston, says, the parties involved in a joint venture bring their specific expertise to the table to accomplish more than they could do on an individual basis.
Basically, capital sources that want to place money in the self-storage industry have access to capital and financial expertise and are seeking savvy self-storage operators as partners for joint ventures. Some capital partners have explicit interests and desire to strictly stick with one aspect of real estate, such as new development or certificate of occupancy deals; others may dabble in all kinds of property investments.
While self-storage operators may be open to forming a partnership, Swerdlin notes that the capital sources looking to form joint ventures are very institutional and are “so serious about finding self-storage companies that the right companies are being approached” by the investors directly.
Ken Nitzberg, chairman and CEO at Devon Self Storage, echoes that statement. He states that there are placement agencies and firms that can help storage operators locate capital sources, but most joint venture relationships are already established as there are only so many self-storage companies well-structured and large enough to entice investors. Nitzberg, who attends various investment conferences, remarks that investors actually approach operators after the sessions wrap up. “I’ve been mobbed for business cards,” he says, adding that he receives at least one call every 10 days from someone who wants to get into the industry.
What’s more, these capital sources are looking make large investment deals. According to Arlen Nordhagen, chairman and CEO of National Storage Affiliates (NSA), as a general rule of thumb, the institutional investors want to invest $100 million or more at a clip. For instance, in the last quarter of 2016, NSA formed a joint venture with a major state pension fund to complete the acquisition of the iStorage portfolio for approximately $630 million. The 66-property portfolio consisted of approximately 4.5 million rentable square feet of storage space within 12 states. In this transaction, NSA put forth one-fourth of the capital as a 25-percent partner and the pension partner invested the remaining 75 percent.
While deals of that size don’t come around every day, Mike Burnam, CEO at TKG-Storagemart Partners, L.P., states that most public REITs and the majority of the industry’s top 20 operators have done, or are currently doing, joint ventures.
Benefits Of Joint Ventures
As Nitzberg notes, access to capital enables self-storage operators to grow bigger, faster, and sooner. He also mentions that joint ventures can produce nicer facilities with more high-tech features and security systems.
“You can take advantage of opportunities that you may otherwise have to pass on,” Nitzberg says. “It’s more capital to grow and prosper.”
For public companies with shareholders to please, growth is especially important. Hill mentions that, due in part to declining stock prices, REITs have been finding creative ways to utilize the capital. He says they are opting to find cheap capital and co-invest as minority investors. While they may not have a majority position, they are still able to expand their portfolios.
In fact, Hill reports that one REIT has carved out a portfolio of assets and will be selling its majority position, taking a minority position and retaining management of the assets. The capital raised will be used to fund 2018 acquisitions and continue to grow the portfolio. “The REIT is being very strategic by pruning their portfolio to book a profit and raise capital while retaining the management and associated scale,” says Hill, who adds that the company may ultimately choose to buy back the majority position later when the investor is ready to exit in the future. “It’s strategic recapitalization.”
While access to investing capital is the usual motive for forming a joint venture, Burnam says that self-storage operators may pursue a joint venture to spread risk or possibly enjoy lower costs of capital.
Zachary Dickens, senior vice president of real estate at Extra Space Storage, suggests that joint ventures promote an exchange of expertise and a focus on core competencies. He also says that they allow more good developments to transpire. While some fear the flood of cheap capital will lead (or has already led, in some cases) to oversupply, Dickens views Extra Space’s joint venture involvement as a way to guide where new developments crop up.
Another benefit of joint ventures is scale, which Extra Space creates through its third-party management partnerships (or joint ventures). Of the REIT’s 1,483 self-storage facilities, 422 (or 28.5 percent) are management properties. These partners also serve as a pipeline for potential acquisitions should the storage owners want to exit the industry at some point.
The Right Mix
Despite the benefits, joint ventures can be deemed a double-edged sword as capital comes at a price. In most cases, it means forfeiting some control of the asset(s) to the JV partner(s). “The difficulty is in finding good alignment,” says Swerdlin. “Like tug-of-war, both sides want control, or more control than the other is willing to give.”
Swerdlin cautions that attempting to force control can kill a deal. “Kick them off the court and the ball’s going with them,” he says. But, from his observations, it’s a lack of sophistication on the operator’s part that makes most joint ventures fall through. For this reason, he advises operators to invest in good financial controls. “There’s no better investment operators can make,” says Swerdlin, as institutional investors value astute financial recording.
Dickens says the most successful joint ventures are the ones that meet the basic needs of the partners and are drawn on their strengths. When considering a joint venture, Extra Space looks at the potential partner’s competency, character, capacity, compatibility, and experience, as well as its capital and collateral—the five Cs of credit lending and then some. “You don’t want to force an arrangement,” he adds, as you should want to enjoy doing business with them.
Nitzberg, who has done many joint ventures over the years, concurs with Dickens. He says that self-storage operators must really know the capital partner as a whole—not just your point of contact as that person’s situation can quickly change via termination, retirement, or death. “Meet a bunch of people from the CEO and down,” says Nitzberg, adding that it’s in your best interest to know the capital’s rules and procedures as well.
Of course, it’s imperative that all parties have expressed their expectations before proceeding with the partnership. Nordhagen says to make sure the agreement is clear about the objectives, selling, buyouts, return expectations, relative risks, and the magnitude of the investment. He also emphasizes that self-storage operators must recognize that equity partners will always want an exit strategy. Therefore, you face the issue of having to eventually sell the properties, which results in a loss of scale as well as personnel, unless you have a way to buy them. While you typically cannot dictate the timing of their exit, Nordhagen suggests requesting a hold period. For example, you may ask the partner to wait a minimum of four years before selling the properties. However, he says, “They usually have the final say.”
As Hill sees it, forming a joint venture is “inviting another decisionmaker to the party”. And unfortunately, whoever has the most money oftentimes has the most control, which is why he adds that self-storage operators should “know their rights, remedies, and interests” in advance.
When it comes down to it, these industry professionals agree that joint ventures can be beneficial. “They will continue to be a bigger part of the industry,” says Swerdlin, who adds that taking advantage of the capital makes sense to him.
Hill reiterates that groups tend to be stronger than an individual. “They are bringing something to the table that the other doesn’t have,” he says. “Joint ventures can open doors.”
Still, Burnam warns operators to “be very careful” and have great legal and accounting teams in place before solidifying any arrangements. “The devil’s in the details,” he says. “Know the conditions and expectations.”
And those expectations are key, as a capital partner can fire an operator for lack of performance.
“Understand that there are no guarantees,” says Nitzberg. “You can’t always bat a thousand.”
Erica Shatzer is the editor of Mini-Storage Messenger, Self-Storage Now!, and Self-Storage Canada.