How to Structure a Self Storage Deal
Self-storage is one of the fastest growing sectors of commercial real estate. Since 1970 it has grown to over 58,000 self-storage facilities in the U. S. today. There are two reasons for this considerable growth. The first is consumption. Americans love to buy of material goods. When household storage has been exhausted, they have to find another solution. The second is the expansion of small business. As businesses grow, the need for space becomes paramount and expensive. Self-storage fulfills that need by providing affordable unit and warehouse space, flexible leasing terms and convenient logistics services.
Self-Storage investing is a great way to reap tremendous cash flow. You don’t have the headaches of a volatile stock market or single- and multi-family investment, and you have a stabilized cash flow. A self-storage investment deal is composed of four basic components: find the deal, raise equity, sign on the debt, and manage the asset. Nevertheless, when purchasing a self-storage property, one of the most critical negotiating details is how to structure the deal based on the above-mentioned four components.
It could be argued that any one of the four components are more or less important than the others. For example, let’s value each of the four components at 25%. If you find a deal and place it under contract, you would be entitled to own 25% of the deal. Even though you found the deal, you may not have the network or skill set to raise the equity to purchase the property. You would need to give away 25% of the deal to an individual who could help you raise the needed equity. The original person who secured the deal would also need to allocate a 25% share to someone with the ability to sign on the debt. Finally, if this person is not familiar with the day-to-day operation of storage properties, the last 25% is allocated to an entity with this capability. The 25% allocation of the investment is not set in stone. Make the agreement using whatever structure it takes to finalize your deal.
Legal Descriptions of Common Deal Structures
The most common types of deal structures are general partnerships, limited partnerships and LLCs (Limited Liability Company). When entering into these types of partnerships with a company or another individual, your roles, duties, and liabilities should be clearly outlined. The following information is an overview of these partnerships.
A general partnership is a business arrangement by which two or more individuals agree to share in all assets, profits, and financial and legal liabilities of a jointly-owned business.The partners are permitted to unilaterally enter binding agreements, contracts, or business deals, and all other partners are obligated to adhere to those terms.
Setting up a general partnership is considerably less expensive than setting up a corporation or a limited liability partnership, because a general partnership requires less paperwork. At the local level, certain registration forms, permits and licenses may be necessary, but filing with the state is typically not required.
Be aware that this unlimited liability arrangement means that either partner’s assets may be liable to the partnership’s obligations. It also means that even blameless participants can be held fiscally accountable if other partners commit illegal actions. The potential liability is not capped and can result in seizure of an owner’s personal assets. Another issue to take into account is that taxes do not flow through the general partnership. This means that partners are responsible for money earned from the partnership on their personal income tax returns.
General partnerships routinely terminate when a partner dies, becomes disabled, or exits the partnership. The agreement can include provisions for directives subsequent to these situations.
A limited partnership is formed when two or more partners join to create a business in which one or more of the partners is not involved in the business operation and is liable only up to the amount of their investment. A limited partner, frequently known as a “silent partner,” serves merely as an investor in the business with no decision-making powers.
Limited partnerships typically have at least one general partner to handle the day-to-day business operations. A general partner may invest in the company, but is also personally liable for company debts, while the limited partner is not.
Most U. S. states govern the formation of limited partnerships under the Uniform Limited Partnership Act, which was introduced in 1916 and has been amended multiple times, most recently in 2001. You should contact your secretary of state to determine the proper steps, required forms, and associated fees.
All limited partnerships should maintain an agreement that indicates how to split profits and losses, resolve conflicts, and structure ownership, as well as how to close the business. The form for dissolving a limited partnership is called either a “certificate of cancellation” or a “statement of dissolution.” Once the partnership is dissolved, partners can prevent others from binding the limited partnership to new liabilities.
LLC (Limited Liability Company)
An LLC is a formal partnership arrangement which requires articles of organization to be filed with the state. An LLC is easier to set up than a corporation and provides more flexibility and protection. LLCs combine the characteristics of a corporation with those of a partnership or sole proprietorship. In an LLC, the above-mentioned 4 basic components of a deal typically share in the side known as the Manager.
In many states, anyone can be a member of an LLC, including individuals, corporations, foreigners and foreign entities, and even other LLCs. Banks and insurance companies cannot form LLCs.
LLCs don’t pay taxes themselves. Profits and losses are listed on the personal tax returns of the owners. If there are fraudulent activities, creditors may be able to go after the members. Members’ wages are deemed operating expenses and are deducted from the company’s profits.
Requirements for formation of an LLC may vary by state, but there on common features. The first thing that has to be done is the selection of a name. Articles of Incorporation must be documented and filed with the state, accompanied by a fee paid directly to the state. The submission of paperwork and additional fees must be submitted at the federal level to obtain an EIN.
The primary advantage of an LLC is that it limits the principa;s’ personal liability. An LLC is frequently viewed as a blend of partnership, which is a simple business formation of two or more owners under an agreement, and a corporation, which has liability protections. From another perspective, an LLC may not be the best option when the ultimate objective is to become a publicly-traded company.
Example: How the above-mentioned components work with an LLC
Suzy goes out and finds a $2 million deal in Houston. She has neither the network nor the net worth to sign a mortgage to purchase the property. She has no knowledge of the self-storage industry, so she has to find an individual with the expertise to manage and operate the property. She places the property under contract with constraints allowing sufficient time to close the deal.
To raise the required funds, Suzy partners with Erik. She also partners with another friend, Tim, a physician with a net worth of $4M, who is willing to sign on the mortgage with her, Erik, and a fourth partner, Jim. Jim has an extensive knowledge of the storage industry and has agreed to operate the property after purchase.
Suzy opens an LLC named Houston, Texas Self Storage, LLC and structures the deal as follows:
Members (with equity in the deal) – 60%
Sponsors (managers of the deal) – 40%
- Suzy – 10% (found the property)
- Erik – 10% (raised the equity)
- Tim – 10% (signed on the mortgage)
- Jim – 10% (will operate the property)
It’s important to understand which part of the deal structure you bring to the table: (1) locate the deal, (2) raise the equity, (3) sign on the debt, or (4) manage the asset. Then you have to determine the legal structure that works best for your deal (GP, LP, or LLC). Once you’ve established this criteria, decide who you want to partner with to finalize the deal.
As always, all partnership agreements should be drafted by an attorney with expertise in the structure that you and your partners choose.