The Precursor To Any New Self-Storage Build
On the popular Showtime series, “Ray Donovan,” Bunchy Donovan was presented with the “perfect, no lose” business deal when a businesswoman who looks for opportunities for the family told him about a self-storage facility that was for sale.
Bunchy responded that he didn’t know anything about the business. The woman replied something to the effect of, “Don’t worry; you just buy it and hire a couple of people to run it and sit back while the cash rolls in.”
If only it were that easy.
Anyone who has been in the business–or any business–knows this isn’t how it works. It is a good idea to investigate any existing or new business venture with plenty of research. For existing self-storage facilities, this might mean a detailed financial history of the property.
For new facilities and conversions–ones that are highly successful–this typically means a professional, detailed proforma.
“Proforma is the projection of income and expenses of future business,” says Ray McRae, vice president of Storage Solutions in Phoenix, Ariz. “Assumptions are typically made based on current market conditions and the self-storage operator or investor knowledge of the marketplace. Sometimes a proforma is used to determine a seller’s opinion of value or a buyer’s opinion of values.”
Although many consider a proforma a financial, it is much more than that. “A proforma is a perspective of five to seven years out,” says Jim DiNardo, consultant at J. DiNardo Consulting in Reading, Mass. “While a feasibility study will show you if your site is viable for self-storage, a proforma is much more detailed and gives the bank or your investors a picture of what to expect in the long term.”
The market has certainly changed how proformas are constructed in the past few years. “In 2006, we did three to five year projections and were typically set and leased up in three years,” says Ken Nitzberg, chairman/CEO of Devon Self Storage, Emeryville, Calif.
Jim Chiswell, president of Chiswell & Associates in Ashburn, Va., says that it isn’t so much that proformas have changed, or the need for them, it’s how new developers are putting them together. “Some people have started making unrealistic projections,” says Chiswell. He states that there are three ways in which some developers are “padding” their proformas:
- What they can achieve in rental rates.
- How fast they will be leased up.
- Cost of construction.
While some of your numbers may change from the time you create your proforma, doing your research and creating a comprehensive proforma is the detailed roadmap to your success as a self-storage operator.
Getting To Your Proforma
Before you even reach the proforma stage, you should have conducted a detailed feasibility study that gives the first snapshot of whether your self-storage facility will be viable. “A market feasibility study, although sometimes tedious and strenuous, is the first and most essential step in the self-storage development process,” says Ann Parham, CEO of The Parham Group in Bulverde, Texas.
According to Parham, the feasibility study, which is typically prepared by a storage industry expert, should:
- Identify market competition.
- Include the square footage of each competitor.
- Determine competitor occupancy.
- Identify your demographics.
- Include a demand analysis.
- Determine existing market supply.
- Determine the market potential demand.
- Determine the market net demand.
- Calculate a rent analysis.
Your feasibility study will help set you up for the particulars of your proforma. Your proforma will be much more detailed, says Thomas Krendl, president of SkilCheck II, Inc., in Tucson, Ariz. Many companies use professional demographic data companies, such as Nielsen Data, to gather demographic information. “The companies will do all of the legwork for you, including pulling permits for development in the area,” says Krendl. “Once you have all of this information, it creates a picture of the market.”
Other information your proforma should include is a detailed outline of the unit mix you will have in your development. “You should estimate the smaller, medium, and larger sizes,” says Krendl. “Is it a suburban drive-up market or a construction market?”
In the pricing survey, you should be able to compare apples to apples, says Krendl. For example, if you’re building a class-A facility, you should be looking at comparable facilities with similar amenities. When doing market studies, Krendl uses an average of 12 properties in the area to compare.
As an example, Krendl says that if you’re comparing a facility that is 90 percent occupied and they are charging $92, you might be able to charge $120 for that same size. Break out each size of unit and project rental income, add together, and average for your average rent per square foot.
To arrive at your gross potential income, you take your average rent per square foot and multiply it by your total leasable square foot.
Example: A facility with 500 units has an average of .80 per square foot times 60,000 square feet of total leasable square foot, which is $48,000 potential gross income at 100 percent occupancy. Obviously, you will not be at 100 percent (nor should you ever be, or you’re likely not charging enough), so you will need to project your occupancy for each month and then annually to arrive at your potential gross rental income.
Proforma: The Details
There is no one formula or spreadsheet for proformas; various companies use different formats. “If I’m looking at a good proforma, I’d like to see more detail rather than less,” says DiNardo. “It should be a minimum of five years; I like to see seven, and it should be detailed year by year.”
DiNardo emphasizes that this is more than a financial statement. “If you’re listing expenses and they are 35 percent of your gross income, I just don’t want to see the 35 percent rule; I want to see detail and projections that fall into the industry standards.” He calls a proforma the financial model to the business and does a 36-month forecast month by month and then does it annually to seven years.
DiNardo says it’s best to list how that income breaks down by each stream of income, not just by “gross income”. For example, income would be broken down by:
- Rental income: Obviously your most important source. You should also include increases by year, as well as projected occupancy rates. “A good proforma has a lot of breakdowns,” says DiNardo. “You should also include all unit sizes and pricing.” He also likes to include a rent-up chart showing how all of the units will rent year by year.
Projecting Your Lease-Up Schedule
Krendl projects a lease-up schedule on a five-year plan. He plans at least 24 to 30 months, or as many as 60 months, to stabilize the property at 88 to 92 percent occupancy. “I do a five percent average growth,” says Krendl. “Some people use seven to 7.5 percent, but I do five percent to allow for increasing expenses.”
- Ancillary income: Most self-storage facilities have a number of other revenue streams, which might include retail sales of locks and moving packaging, post office boxes, wine or gun storage, incubator office space, truck rentals, propane sales, and services relating to RV storage such as cleaning, wash bays, and waste dumps. These typically are added in at a five percent rate. Don’t forget to include fees such as auction and lien rates (typically two percent) and one to 1.5 percent in insurance and administrative fees.
- Detailed construction expense: “This is just not putting down $40 per square foot, but the details that go into it,” says DiNardo. “From the land, entitlement, and site work right down to the security system.”
- Estimated loan expenses: DiNardo says this should include solid, long-term financing assumptions. “Interest rates can really throw off the figures,” he says.
- Staffing: This is one of the biggest expenses for any self-storage operator. As with all the line items, this should include as much detail as possible. “Not just the number of employees but the number of employees and when they will be working. Will they be full time or part time? You really need to put a lot of thought into staffing; it’s one of the most important aspects of your business,” DiNardo says.
- Utilities: These might be the hardest to estimate, so they should always be estimated on the high side.
- Marketing: Krendl says that although marketing has become more affordable since the days of the phone book ads, you still have to build and maintain a respectable online presence, which he estimates at $1,500 to $1,800 per month.
- Management fees and insurance: Krendl says that $2,500 to $3,000 minimum per month or five to six percent of monthly gross (whichever is greater), should be estimated. “Even if you’re not using a management company, you will have to include your salary,” says Krendl. “No bank wants to see a proforma in which you don’t pay yourself, as no one works for free.”
- Project loss rate: “A lot of finance people take away a 10 percent loss,” says Krendl. “They project a 90 percent economic income; it’s very hard to predict accurately as many times we can’t predict discounts and other losses.” Krendl cites an example of one facility that was projected to open in the summer during the height of moving season. Instead, the project was delayed, and it didn’t open until the middle of the winter, which severely impacted the first-year projections. “They were averaging five rentals per month instead of the 20 that were projected,” says Krendl. “A proforma is a moving target, and it’s 50/50 science and a crystal ball. Everything has to go right in order to meet the projections.” Krendl says that’s why he likes to build in a 15 percent loss rate. “An 85 percent economic income is much more conservative and has a little fudge room,” says Krendl. “It helps when there are unforeseen circumstances such as construction delays.”
At the end, Krendl says your expenses should project two percent more per year.
Property Sale Projections And Investor Return Analysis
The property sale projections and investor return analysis on your proforma show what you put into the property vs. what you will make. “It’s the point at which people need to be conservative,” says Chiswell. “Caution is the watch word.”
Chiswell says that cap rates will surely go up and values and occupancy will go down from current rates. “Self-storage did well in the recession, but it’s not bullet proof.”
The Major Mistakes
Of course, the biggest mistake you can do is try to “pad” your proforma to make the numbers work when the project is not going to make sense. “In many cases, people are building to try to attract investors or financing,” says Chiswell. “They project they can build a four-story building and have it leased in two years as opposed to four.”
Unfortunately, there are some promoters who try to make their proformas look as good as possible, so they will attract those investors. “If you make that mistake on your proforma and it takes five years to lease 80 to 90 percent, you will run out of working capital and no one is going to be happy,” says Chiswell. “The dumbest thing to do is to try to make it come out when it just isn’t going to.”
Chiswell cites one developer who found property in a good market, but instead of paying about half what he needed to for the land, his projection included paying $8.5 million on the land. “I told him he was paying too much for the land,” says Chiswell. “You really want someone who is going to objectively tell you if your project will work out.”
Other key mistakes people make on their proformas is not including key and sometimes hefty expenses, which include:
- Taxes: Taxes are typically a commercial property’s major expense. “This is something people don’t always anticipate,” says Krendl. “You can’t look at the existing taxes, not when you invest $4 million into a property; you will need to know how it will be assessed after that investment.” Krendl says underestimating taxes could cost you a mistake on your proforma of up to $70,000 per year. When looking at taxes, make sure you include all that apply to your property, including city/township/county, state, and land use taxes.
- Repairs and maintenance: A lot of people make the mistake of thinking that maintenance contracts and warranties will cover most items for the first five to seven years. “There are always things that pop up,” warns Krendl. “You might have to start doing repairs in two to three years.”
- FFE, or furniture, fixtures, and equipment: Your manager is going to need office furniture; if you have a conference room, you’re going to have to supply a nice conference table along with other equipment. Don’t forget to line item this expense in your proforma.
What You Should Expect to Pay For A Proforma
There are many good industry experts who consult on both feasibility studies and proformas. DiNardo guesses the average of both will run between $5,000 and $10,000. Some companies, such as his, break down the project into two pieces, conducting the feasibility first and, if it makes sense, moving to the longer proforma. “There really is no sense of doing a long proforma if it didn’t make sense with the first piece,” DiNardo says.
That expense is well worth it to ensure your project is feasible and the numbers will work. It could cost you a lot more to invest in a project that isn’t viable.
Kerri Fivecoat-Campbell is a freelance journalist based in the Ozark Mountains. She is a regular contributor to MiniCo’s publications. Her business articles have also appeared in Entrepreneur, Aol.com, MSN.com, and The Kansas City Star.