How to value self storage … and why multiples can be dangerous!

The FEDESSA magazine "Unlocked" - which is aimed at operators and suppliers to the self storage industry - published this article recently. It is published here in full.

With more than 6,000?self storage properties across Europe, and with an industry that has tripled in size in the last decade, the self storage sector has become an increasing focus for investors who have seen the resilience of the sector and are attracted by the income that it generates and the ability to invest at scale.

When I started valuing self storage 25 years ago, there was only a limited amount of transactional activity. Fortunately, as the industry has developed there have been plenty of transactions to help valuers.?This is likely to get even better as the sector will soon be transacting over €1bn a year in Europe.?That is a three-fold increase from where it was in 2019!

But valuation is a mix of art and science – based on factual information about the asset, the valuer’s interpretation of the market, how buyers are pricing assets and when they buy them.???It also needs to be in the wider context of the macro economy and commercial real estate market – and importantly consider factors like the cost and availability of debt.

What is a valuation?

A valuation seeks to estimate the most likely selling price.??It has to be based on the current market realities and the factual information about the property.

It is not what it is worth to someone or the price they are willing to pay – or the price they are willing to sell at.???If the self storage property is worth €10m to the owner but the market will only pay €9m, the market value is still €9m! ?And if an individual bidder in the market might think that the property is worth €11m to them, they should only pay €9m.?

The approaches

?When valuing any commercial property, the valuer has to put themselves in the shoes of the market participants and reflect how they would price that asset at that date.???That involves looking at recent evidence and market trends obtained from being close to the market players.

There are two main approaches for valuing property – the market comparison approach or the income approach.

The market comparison approach can include the yield on the income, or a benchmark like the capital value per square metre of the maximum lettable area (MLA).?The yield is the income as a percentage of the value – i.e. if the asset produces an income of €500,000 per annum and has a value of €10m, the yield is 5%.?The multiple is the inverse of the yield i.e. 1 / 5% = 20 and reflects the number of times the income would be multiplied to get to the value.

These are all implicit approaches: they do not explicitly show the growth potential in the income which is why multiples are dangerous in a sector that has high future growth and where the income is not fixed, like an office let to a tenant.

The pitfall with relying on multiples is that no two self storage properties are ever exactly the same – they have different occupancy and rental levels even if in the same catchment area.

An income approach is much more explicit and analytical – ?simplistically, it looks at the current income and reflects how it will grow in the future and is how most buyers look at pricing assets.?For self storage, this explicit approach reflects increases in occupancy, changes to floor area as buildings are fitted out, increases in rents and also improvements in retail and insurance income as well as cost efficiencies that can be implemented. ??Those net income projections are then discounted back at a market observed discount rate which is based on how investors and operators who buy self storage are pricing assets.

Consider this market transaction of a self storage building which sold recently.

The reason it sold for a very high multiple is that it has the ability to significantly increase its income.?The buyers in the market could assume that the rent could rise to €300 pm with good management and that the extra floor area will be fitted out.?If they did that, the future EBITDA would be approaching €1,000,000 per annum.

From a mathematical perspective, the yield on a property is what the investor’s return requirements are less growth.?So if an investors requires a 8% return and they buy a property with a yield of 5% it means that they expect an annual increase of 3%.?????Or in other words, paying a 20 multiple will be achieved if the income will grow at 3% per annum if the investor wants an 8% return.

So that is why I favour an income approach where you explicitly model the future cash flow.?This would show that a €15m price would represent an internal rate of return of around 7.75%, assuming that the income would grow by around 2% per annum once it reached maturity which is calculated by building a forecast model.

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By then reapplying that discount rate to future income streams on other self storage properties, you get a much better sense of how parties price self storage and more accurate valuations.

This graph shows the multiples by occupancy of two similar portfolios that sold a few years ago – showing that just relying on multiples is dangerous as even with similar occupancy, the range of multiples can be wide.

However, a multiple is a useful sense check – as well as the capital value per square metre. So in my view, it is really helpful for us to talk as an industry about all of these – IRRs, multiples and values per square metre!

And finally a word of caution about rental levels.???The valuations are hugely sensitive to the eventual rental level that a self storage property will achieve.?Blind shopping competitors can lead to spurious data as street rates are often different to achieved rates, and the mix of unit sizes is crucial in understanding the net achieved rate which is what purchasers use to determine the turnover of a store when pricing assets.???

Ollie Saunders has more than 25 years’ experience in the self storage sector across the UK and Europe advising a wide range of operators, investors and lenders.