This post originally appeared on tBL member blog SVN Southland Commercial Blog and is republished with permission. Find out how to syndicate your content with theBrokerList.
I recently had the opportunity to participate in one of our monthly National Self Storage Team calls. These calls are a great opportunity for the SVN advisors, specializing in self storage real estate, to come together and discuss relevant news, trends, pricing and deal opportunities. On our most recent call, I had the pleasure of listening to and reviewing an interesting scenario outlined by Jeff Ottmar, a Self Storage Specialist, with Sperry Van Ness/Cornerstone. He posed a hypothetical scenario that I found very interesting and worth sharing here on our blog.
I am sure everyone has been keeping up with the discussion around whether or not the Federal Reserve was going to increase interest rates. As it happened, the rates were left unchanged with the speculation that a rate hike will be forthcoming in the near future.
The following scenario depicts how a 100 or 200 basis point rise in Borrowing Rates would affect self storage sales prices. This same scenario could be applied to most any income producing property such as triple net retail properties.
The paralleling of interest rates (in this case denoted on the below graph using the floating 10-yr treasuries rate which, has a similar relationship) and capitalization rates in the commercial real estate industry is well known. It stands to reason that the lower your cost of funds as an investor, the lower return on investment threshold you’ll consider. The graph below, shown in the The Real Estate Report, 2013, 42:3 by the Real Estate Research Corporation, shows a fairly good representation of that relationship, except during periods of extreme market volatility.
So let’s say you have a client that owns a self storage facility with 12-month trailing NOI (Net Operating Income) of $195,000. If that facility was worthy of a 6.5% CAP rate, you’d expect that facility to be valued at $3,000,000. ($195,000 divided by .065 equals $3,000,000)
What happens then if interest rates and ultimately capitalization rates increase 100 basis points and our fictional facility is only worthy of a 7.5 CAP?
- Trailing 12 Months
- NOI = $195,000
- CAP = 7.5
- New Value = $2,600,000
That is $400,000 of lost equity for the owner which was completely beyond their control. Guess how long it will take for an owner to recoup that lost value using an industry standard 5% year-over-year NOI gains? To get back to a $3,000,000 value, NOI has to increase to $225,000.
- 1 NOI. $195,000 x 1.05 = $204,750 Year
- 2 NOI – $204,750 x 1.05 = $214,988 Year
- 3 NOI – $214,988 x 1.05 = $225,736 or Almost 3 full years!!!!!
What if interest rates rise another 100 basis points during the time the owner is trying to recoup his lost value? What if 300,000 sf of new storage is built in the trade area?
Capitalization rates are at historic lows. Interest rates are at historic lows. Everyone knows there is nowhere to go but up. The only question is when? If you are self storage owner, now is a great time to contact an advisor within the Self Storage Specialty Practice Group, to have that person market your facility for sale.
As always, if you have any self storage questions, or anything else I can help you with, just let me know. You can find my contact info in the bio below. Thanks for reading, and please share the following tweet for me!
About Carlton Dean – Carlton is a SIOR and a CCIM, two of the most respected designations in the CRE industry. He has nearly 20 years of experience in the commercial real estate industry. Carlton is the Managing Director for SVN| SouthLand Commercial and is based out of the Tallahassee, Florida office but serves clients throughout the entire Southeastern US. Click here to view his full profile and listings, or if you would like to contact him, you can call him at 850-877-6000 ext. 101, or email him at [email protected] You can also follow him on Twitter at @CarltonDeanCRE.
Great Outlook for Hotel Investors in 2015
How to Get Top Dollar When Selling Your Income-Producing Property
Importance of a Commercial Property Inspection