The Role of Cap Rates in Self Storage Investment
All types of individuals invest in self storage properties, and they are not all “numbers” people. Novice property owners can be mystified by the complexity of number crunching and analyses that a more experienced owner uses to buy or sell a self storage property. Nevertheless, it’s a good idea to understand some of the more mysterious jargon. A particular calculation that remains baffling to many is the “cap rate.” What is a cap rate, and how is it determined for a self storage investment property?
What is a Cap Rate?
If you’re looking to purchase, sell, or refinance a self storage property, your appraiser will determine a property value using cap rates.
Cap rate is short for capitalization rate. Cap rate is one of the most important calculations a property investor needs to know in order to convert income into property value. The cap rate will vary with rent rates, construction, location and other differences.
Calculating a cap rate for a self storage property is straightforward:
- Establish the rent roll from a given property. If there are vacant units, you’ll need to assign a market rent for each one.
- Add annual expenses associated with the property.
- Add vacancies, maintenance, taxes, insurance, and utilities.
- Add annual mortgage.
Once you subtract the total expenses from the total income, you will conceivably have a positive net operating income number. Capitalization rate is calculated by dividing a property’s net operating income by the current market value (purchase price).
John Manes, CEO and Co-Owner of Pinnacle Storage Properties states: “To calculate value, divide the net operating income by the cap rate. If you can increase the numerator and compress the denominator, you can dramatically increase the value of your assets.”
Let’s say that your facility has a gross income of $200,000 and operating expenses of $80,000. Gross income less expense equals a net operating income (NOI) of $120,000. Your self storage broker states that storage facilities of this size, condition, and location are selling for 6% cap rates:
$200,000 – $80,000 = $120,000
(Gross Income – Operating Expenses = NOI
If the cap rate is 6% = 0.06
$120,000 / 0.06 = $2,000,000
The value estimate = $2,000,000
The lower the cap rate, the higher the facility value.
The higher the cap rate, the lower the facility value.
Factors that Determine Cap Rate
Lower Cap Rate, Higher Value
|Higher Cap Rate, Lower Value
Why Do We Use Cap Rates?
The above chart shows some of the factors that appraisers use to determine cap rates. They need a method to compare properties with different conditions, locations, and management levels. Self storage properties are valued on their income producing ability. Cap rates take this income stream and give it a value, based on the property’s ability to produce and maintain future income. Additionally, cap rates consider the perceived risk of maintaining that income stream.
Now that you have a fundamental understanding of cap rates, please know that there is more to the subject than is presented in this overview. It’s best to consult a professional storage broker or appraiser to determine the cap rate for your property.