The year was 2016, and I was a newly minted Director of Acquisitions tasked with acquiring multifamily properties. It was a rough year. I underwrote deal after deal, but I couldn’t make the numbers work to match our investment strategy. After some internal discussion, we decided to focus our attention on a different asset class: self-storage. At the time, I knew nothing about self-storage. However, after underwriting multiple deals and closing on five within nine months, I realized self-storage is one of the best real estate investments an investor can make. Based on my experience, I want to share the pros and cons of self-storage to help you make informed investing decisions.

THE PROS

Fragmented Ownership

Approximately 75% of self-storage owners own only one or two facilities. These mom-and-pop owners don’t utilize industry best-practices like management software, online rentals, and internet advertising. What does this mean for self-storage investors? It presents an opportunity to acquire facilities and improve operations through online marketing, better collections, and adding ancillary income like tenant insurance. The result is higher Net Operating Income and an increase in value. The facility can then be refinanced or sold and the process repeated.

Lower Expense Ratio

The expense ratio for a self-storage facility is roughly 35%. This means for every dollar of revenue about $0.35 is used to pay expenses. The remaining $0.65 is the Net Operating Income. This ratio is considerably lower than other types of real estate. Why is this? There are no leaky toilets, broken fitness machines, or troublesome tenants. The Capex list is short and an owner can reasonably anticipate when Capex items will need to be replaced, like roofs and doors. In other words, self-storage has fewer unexpected expenses resulting in stable cashflows for the owner.

Fair Housing Laws Do Not Apply

First, what are Fair Housing Laws? They are laws created by the Federal Government to protect people from housing discrimination based on race, sex (gender), disability, color, religion, race, familial status (children), and national origin. These laws apply to every owner involved in the sale or rental of housing, not just real estate brokers or property management companies. Penalties for violating Fair Housing laws can total into the thousands of dollars. These laws don’t apply to self-storage because self-storage doesn’t offer housing for sale or rent. There are no eviction moratoriums because self-storage owners don’t evict tenants for past due rent. More on this later. The result is an owner who doesn’t have to fear the complaints of tenants, and the freedom to operate a business as it was intended.

Month-To-Month

When someone rents a unit, they sign a month-to-month rental agreement, not a long-term lease. If rents are increasing in your market, you can raise rents to capture that potential revenue. Tenants are typically sticky, meaning they most likely won’t move out due to a nominal increase in rent.  In other words, a tenant isn’t likely to get so upset about a $5 dollar a month rent increase, that they rent a truck and call their friends to help them pack their unit. Where would they go? Down the road where another facility is charging the same amount? That’s unlikely.

No Evictions

An eviction can be a lengthy and costly process, and often includes a heartbreaking story about job loss, a family breaking up, or unexpected medical bills. No one wants to be the big, bad landlord who kicks people out on the street when they can’t afford to pay. Self-storage operators don’t foreclose or evict customers. They auction stuff, and that stuff is usually unwanted.

SBA Lending

Self-storage is the only real estate asset class that the Small Business Administration (SBA) will lend on. Like an FHA loan where a homebuyer can put as little as 3.5% down, an SBA loan only requires a 10% down payment. In contrast, most other types of self-storage loans may require a buyer to put 25 to 30% down. The SBA will provide funds to cover renovation or Capex costs, helping small investors with the upfront capital needed for repairs. There are some trade-offs with SBA loans, so it’s advisable to look at all financing options before deciding. The result is the ability to invest in real estate as an operating business and have the help of the SBA to get started.

THE CONS

There are more reasons to choose self-storage as an investment, but those are the big ones. Now for the cons.

Popularity

A couple of years ago, my car was in the shop for repairs. Naturally, I took an Uber from my office to pick it up. During the drive, the topic of self-storage came up. My driver turned to me and asked, “Do we need any more storage?” An incredibly appropriate question! Although construction has slowed from 2019 to 2020 due to overbuilding and the pandemic, self-storage construction spending tripled from 2008 to 2019, reaching nearly $5 billion! You’ve probably seen it pop up around your city. What’s the downside of this popularity Investor demand is surging, causing storage facility prices to trend higher, which results in lower returns. Even Bill Gates (yes, THAT Bill Gates) got in the self-storage business in 2020 buying a stake in a private storage business through his investment company.  Self-storage popularity means it’s a seller’s market, and prices are high.

Rental Rate Decreases

Just as the month-to-month nature of storage allows for rental rate increases, the opposite is also true. If rents are declining, then a facility is susceptible to those price shifts. It’s not uncommon to see advertisements for one month, two months, and sometimes three months of free rent for new customers. Deep concessions can hurt investor returns and tamp expectations for profits.

Lower Actual NOI

Let’s say a self-storage unit rents for $100 per month. After applying a 40% expense ratio, the Net Operating Income for that unit is $60. Compare that dollar amount ($60 dollars) to an apartment unit that rents for $1,000 per month. After a 50% expense ratio, which is typical for apartments, the NOI is $500 dollars! That is a drastic difference compared to the NOI of a self-storage unit! The returns for both asset classes can be similar, but the dollar amounts can be vastly different. Most investors don’t consider this difference when jumping into self-storage.

Poor Record Keeping

As I mentioned in the Fragmented Ownership section, most self-storage facilities are owned by mom-and-pops, which I reasoned was a “pro.” However, it’s also a con because mom-and-pops keep bad records! Once when I was performing due diligence on a facility, the owner told me, “Now those are my bank statements, but when someone pays cash, that goes in my pocket!” I’ve found many mom-and-pop owners don’t record cash payments and don’t use accounting software, which makes it difficult to understand the previous 12 months of operations and trickier to obtain an acquisition loan.

Conclusion

With lower operating costs, opportunities to buy underperforming facilities, and SBA financing options, I have no doubt investor demand for self-storage will continue. However, investors would be wise to consider the trade-offs of self-storage and how to mitigate the risks. If you are considering adding self-storage to your portfolio, I hope you’ve found these points helpful as you weigh your options.

We hope you gained valuable knowledge from reading Kris Bennett’s guest post!

Be sure to get your free copy of my book and audiobook, “Next-Level Income” here.

– Chris