Self-storage, once an alternative real estate category, has been an investor favorite for years, growing rapidly over the past decade. Today, it remains a valuable niche property type because it performs well even in a recessionary environment. Indeed, self-storage is known to perform well in good times and bad.
But, like any deal, investments in self-storage require a thorough due diligence process. A complete due diligence checklist could well cover more than 700 points, with no deal moving forward until every box has been checked. In the interest of transparency, that checklist should be shared with investors to give them insight into the process.
If you’re thinking about investing in a self-storage deal, the research you do now could determine the fate of your investment. Before you put money down, here are five common pitfalls to avoid.
Poor positioning: Like other real estate property types, self-storage relies on its geographic location to thrive. If the facility is poorly located — or is built in an oversaturated market — it is unlikely to generate strong returns. Look for facilities in high-traffic areas with solid population growth and steady local demand for storage.
Incorrect zoning: Local zoning ordinances dictate what can be built where. Without the correct zoning for an existing or planned self-storage facility, your operator will face an uphill battle. As such, if verifying zoning is not at the top of their property due diligence checklist, they are probably not the right partner for you.
Unrealistic projections: Don’t be distracted by the lure of high returns. Instead, focus on how your operator reached its projection. Interest hikes are likely to push capitalization rates up. Does its model account for this? Are its rent projections realistic in the current market? Does the operator allow for rising insurance prices as weather patterns change?
Survey and title defects: As with any real estate class, errors in public record or unpaid liens can be expensive to resolve. If the operator is purchasing new facilities, ensure you understand how they survey the property and verify the seller is legally positioned to enter into the transaction. The process should include receiving a copy of the most recent property survey — or requesting a new one — reviewing a title commitment and title insurance policy, securing an owner’s affidavit and checking for unpaid liens.
Bad operators: What are the qualities of a good operator? Strong communication, transparency with investors and the right resources to steward a deal, to name just a few. While your operator is responsible for property due diligence, it is up to you as an investor to take the time to vet your sponsor and ensure you are comfortable working with the parties involved. Ask questions that get to the heart of the sponsor’s investment philosophy and values. Talk to past investors and ask for an honest assessment of their experience. Review the operator’s past communications and see how (and how frequently) they update investors on progress.
Recognize the red flags: There’s a reason why investors are vying for self-storage; it frequently outperforms other commercial real estate property types. Continued market volatility creates opportunities to purchase facilities at competitive prices. Even if you’re working with a solid asset class, it is essential to recognize the red flags — and know when to walk away.
For operators and investors, exacting due diligence is the secret weapon behind every successful deal. Likewise, almost every investing horror story starts with a flimsy vetting process.
Everything your sponsor does should be focused on mitigating risk, and to seek out investors who take the same approach. Any good due diligence process should be designed to assess and offset potential liabilities well ahead of time so there are no surprises down the line.
At times, that may mean lengthy and time-consuming checks, but the process pays off — for sponsors, operators and investors.
Ryan Gibson (email@example.com) is CIO of Colorado-based Spartan Investment Group.