This article formed part of the SSAA Insider magazine October – November 2012. The initial comments are made by Rennie Schafer, CEO of the SSAA. Malcolm’s commentary follows Rennie’s…
There have been very few sales of mature self storage businesses in Australasia over the last couple of years and those that have been sold, have mostly been part of distressed sales or had other complications. So without this sale data how do you know how much your business is worth and how are valuers valuing our businesses without recent historical sales?
Up until 2008 there were an ever increasing number of self storage businesses being sold. While not all sale data is publically available, there was still good data on what the market was like in terms of the value of the businesses sold. Most of those sold were solid going concern operations and there were lots of active buyers in the market including various property trusts like Abacus and APN. Since the economic downturn hit, the property trusts have certainly lowered their activity in the industry and there has been a significant drop in the number of self storage businesses being sold, particularly without other financial incumbencies on them.
Many banks have also changed their financing models, increasing the level of equity they require to finance the business and most property values generally have dropped to some degree. Even if you are not considering selling you need to know the value of your business, particularly if you need to refinance or are considering borrowing additional funds for an expansion.
Most valuers now would suggest that in simple terms the capitalisation (cap) rate for a self storage business is somewhere around the 10% mark, possibly down to 9% for a good self storage business. This simple equation is determined by the net profit of the business divided by the value. So if the cap rate was 10% on a business making $100,000 a year, you would value it at a $1M. So the lower the cap rate, the more your business is worth, relatively speaking.
This is a very simple example but the reality is a lot of different factors influence cap rates, such as potential expansion opportunities, current and potential occupancy and pricing influences into the future. Nevertheless, the value of self storage businesses appears to have dropped since the economic downturn when most businesses sold had single digit cap rates and some were below 9%.
But given the limited sales data, which is really the only measure to provide an accurate picture of what people are willing to pay for self storage businesses, are the current valuations a realistic indication of what people will pay for a solid, well managed self storage business?
Current Sales History
In the last 18 months there has only been half a dozen or so significant self storage businesses, having at least 200 units, sold in Australia or NZ. Given that there would be around 1,100 of these sized businesses across the region and self storage is such a localised business, this is not a particularly large sample size. The data is further distorted by
the fact that almost every one of these businesses sold has been under some degree of financial distress, usually as the owner was over geared on the business or a larger property portfolio.
Financially distressed sales attract bargain hunters, buyers know the vendor is almost forced to sell, there is some degree of risk in taking the business on, and data would suggest that not just in self storage, but in most property groups these types of sales generate a lower than average sale price.
So current sales would hardly be an accurate reflection on the value of the industry as a whole.
While there is no doubt that the self storage industry is not as strong as it was 3 years ago and it is continuing to struggle to increase profits, it has not drifted backwards to any large degree. Data such as the Urbis Blackwell Storage Indices show that over the last 3 years the revenue for self storage business has increased by just under 10%.
This is a good result when you consider so many other industries, particularly in the retail sector are all showing decreases in revenue over this period. So while the industry is facing some challenges, it is pulling through a lot better than many other investment opportunities. Surely this should make them a more attractive investment to potential
buyers? An industry that is holding its own through this economic downturn and has a solid property investment behind it.
Are valuers being conservative?
It is often said that valuers by their nature, tend to be on the conservative side with their valuations. This is not necessarily the truth, it is the valuers job to find the line between vendors perceptions and buyers realities.
If a valuer was consistently conservative in their work then this would impact their own business. In the current market, the sales data available is limited so valuers need to rely more on their experience, understanding of the industry and the business, to develop a valuation. If a valuer does not understand the self storage market then they are more likely to come in on the conservative side as they may not understand the positives within the industry.
Are Banks being more conservative?
In the current economic conditions, banks are being more risk adverse in their lending’s. Certainly the opportunity to borrow against blue sky aspirations has long gone. The financial institutions will take your valuation and then add a “risk factor” against it, essentially reducing it again, regardless of who completed the valuation. The level of the reduction will vary depending on a range of factors but it is unusual for a bank or other institution to accept a value as provided and not reduce it to some degree. So if you are valuing your business to get additional finance, then you need to take this into consideration.
Why sell now?
Given the drop in value of businesses generally, the state of the investment market, the reduced activity by institutional investors in the market and the fact that self stoarge as an industry is still performing better than many other investment options, it is little wonder that people are not selling their self storage businesses. Combine this with some very aggressive purchasing leading up to 2007 and arguably an over-valued self storage market where many owners decided to sell up while the offers were good.
This was particularly opportune for those people approaching retirement and looking for an exit strategy. Those left in the industry are likely to hold onto their business, hopefully manage it well, maintain profits and wait for the market to turn before looking to sell. After all, what else would they do with their money?
The gap between buyers and sellers
It appears that the owners of self storage businesses in many cases have a higher opinion of the value of their business than potential buyers. This is evident not just in the lack of businesses being sold but the number that are placed on the market and not sold.
In some cases even businesses that were offered as distressed sales have been retained by the administrators as they felt they were better off managing the business until the market improved and better offers became available. Sellers are likely thinking back to the pre ‘07 boom and what they could have got for their business then and looking at how well their business has performed during the downturn.
Buyers are looking at the data on those properties that have been sold, considering we are in an economic downturn and are also under more pressure from lenders in terms of leverage available. Expectations on both sides are going to need to come closer together before we can expect any surge in self storage properties sold.
So what is my business worth?
It is likely that most self storage businesses are somewhat undervalued on their true worth given the current economic conditions. But ultimately any business is only worth what someone is willing to pay for it, and in the current market buyers are not offering the prices sellers are expecting. It would be interesting to see if a number of well managed mature sites with no financial incumbencies on them were offered for sale, if this situation would change, but this is unlikely to occur any time soon so all we can do is speculate.
One fact remains is that a self storage business that is well managed, in a good location and is maintaining its pricing and profitability will be worth more in any market. So concentrate on making your business as profitable as it can be and when you are ready to sell you will get the best possible result in the market at that time.
What the Valuers have to say!
(Collins & Associates)
This article provides a good overview of the market dynamics affecting self storage as an asset class post-GFC. In my view it is worth noting the following however:
There has always been a lack of market-based sales of going concern self storage facilities that can be used as direct evidence. Generally, good quality, well run facilities which produce stable cashflow only sell when owners have a particular reason (and are not pushed by insolvency or receivership) e.g. retirement, and “the price is right”.
The days of offers “too good to refuse” have long since passed. Vendor and purchaser expectations remain apart, and individual facility performances are much more affected by competitive pressures that the whole industry is noticing.
Reference to storage business sales must be made carefully and on a consistent basis, looking beyond the “headline” reported price. A valuer should understand the property itself and its particular market. Interpretation of such sales and their application to comparable properties being valued must be done in a considered manner.
Bank credit departments are once again imposing more stringent lending and loan book criteria on their line managers, affecting all trading facilities, good or bad. The appetite for risk has cooled appreciably in the last six months, fuelled in part by the Big 4 banks review of the loan books and credit profiles of banks they’ve bought. The general commercial and industrial market will take some time to recover post-GFC and in the shadow of China’s slowdown in my view, and as such, capitalisation rates will not sharpen until fundamental value returns to property across the board.
No sector of the economy can avoid the contraction in market-based sales, business sentiment and economic outlook. Hence cap rates applicable to self storage, which is a property and business asset, will always be higher than “blue chip” commercial property.
I have always believed that informed valuers are realistic, not conservative. People must remember that we value a property as at a specific date, for a specific reason, and we must rely upon sales evidence available, experience and our industry knowledge.
Valuers should have these traits and must interpret evidence available – which is usually dated by the time it becomes public knowledge – often lacking particular parts of the puzzle regarding purchase details, financial and other information. Experience, market knowledge and industry or agency contacts then make the difference.
All of these issues place constraints on valuers and when viewed from the perspective that valuers must interpret a market, not create one, it is easy to see why valuers are labelled “conservative”. I believe the words realistic and prudent, are much more to the point to describe how a good valuer acts.
Valuers attempt to rationalise the process leading up to a purchase or sale price, and value a property based upon a “market value” definition.
Given that any genuine vendor in this post-GFC market is potentially seen as a distressed vendor, and no purchaser I have encountered in the last 12 to 18 months is in any way desperate to “do a deal”, it is no wonder that a well run, strong cashflow producing self storage facility remains an asset worth keeping to an incumbent owner, who’s usually spent years building up a business and is not about to sell it cheaply.
Having said that, a genuine vendor will still find a genuine purchaser if the property fundamentals stack up. Otherwise, hold on to your facility, look after your clients, manage your costs, grow your income and wait for the next upturn in the property cycle to occur.
It will happen. The $64,000 question, as always, is when.