Here’s What I Learned From Our Worst Self-Storage Deal
Self-storage facility in Bradenton, FL
Wellings Capital just wrapped up our worst self-storage deal. We thought you might want to hear about the process and lessons learned along the way these past 3.5 years.
Spoiler alert…
Though it’s tempting to surprise readers at the end, I don’t want you to get to the conclusion of this article and feel tricked when you realize the deal finished successfully. So I am telling you now that our investors ended up with a net ROI north of 20% annually.
But that doesn’t mean we consider this a total success, and I’ll explain that in this article. And that doesn’t mean we would do this deal again, which I’ll also explain below.
The Backstory
I sold my company to a public firm in 1997. After that, I started investing in real estate to protect and grow my wealth. I did all kinds of residential deals including flip homes, waterfront lots, new construction, rent-to-own, a small subdivision, and a marketing firm that sold leads to Realtors.
Over the years, I wanted to get into commercial real estate, but I didn’t know where the onramp was. I knew almost all the world’s wealthiest invest in commercial real estate, but I had no idea how to get started. Then my business partner and I constructed, managed, and sold a multifamily asset in North Dakota.
I decided to stay in multifamily and eventually wrote a book on apartment investing called The Perfect Investment. But after beating our heads against the wall bidding on overpriced apartments, we decided multifamily wasn’t the “perfect investment” if we must overpay. This was too much risk for a fifty-something guy who wants to protect investors and my family from a repeat of the drama of 2008. For the record, we still love multifamily and will evaluate deals as they make sense.
We decided to expand into asset types with more value-add opportunities. And we were pleasantly surprised with the opportunities to acquire value-add self-storage and mobile home parks from mom-and-pop owners.
But we had a problem.
We had over 100 investors who were eager to invest. But we had no track record, no team, and no technology to acquire and manage self-storage and mobile home parks. We understood how to do it, but we weren’t comfortable taking investors’ money to invest in something we hadn’t done before.
Additionally, we saw many new operators making big claims about their capabilities. The rising tide helped everyone, but we were deeply concerned that many of these folks would get caught skinny dipping when the tide went out.
So we started asking our investors if they would like us to be a due diligence partner to invest in these assets. We promised everyone we would undertake the due diligence they would do if they had the time, knowledge, and resources.
The response was overwhelmingly positive. We began our search for the best operators and deals in the self-storage and mobile home park arenas. (Fast forward several years, and over 475 investors have trusted us with their hard-earned capital.)
That’s our history leading up to our first self-storage deal…
The Deal
We first learned about self-storage from an investor who had also given up on multifamily. This gentleman excitedly explained the value-add strategies of the firm he invested with. A firm he would soon become a partner in, and strategies I would later include in my BiggerPockets book on self-storage investing that hit Amazon two weeks ago.
Our team made multiple trips to this firm’s headquarters. We got to know the CEO and the team. We visited numerous self-storage projects under management and in their pipeline. We did due diligence on the firm, checked their track record and references, and more.
During those months, I was self-educating on self-storage and simultaneously getting to know the syndicator. I was deeply impressed by both. The syndicator’s operating partners had decades of experience in self-storage. They had never lost investor money on a deal. They have a professional team. They hired skilled property managers. And they made a lot of money for their investors.
The syndicator had a contract on two self-storage assets in Bradenton, Florida. It was a pair of new assets about a mile apart. One was mostly stabilized, and the second had a significant new addition that was not available for leasing yet. We made a trip to the facility and evaluated the area. Here are some of the factors that impressed us:
The buildings were located amidst America’s second-fastest-growing master-planned community (Lakewood Ranch - 29,000 residential units).
One building was on a main thoroughfare with high visibility (50,000+ vehicles per day). The second was on a dead-end road that was about to be opened up as a main connector between two major roads.
The climate-controlled buildings were attractive and cutting edge. The operations were set up for U-Haul rentals, a showroom to sell retail items, and more.
We decided to get involved in raising capital for the properties. We raised nearly $3 million from about 40 investors. The property closed in July 2018, and we were off to the races with our first self-storage deal.
“What could go wrong?”
Here’s what could go wrong…
Two national storage REITs were about to construct facilities in the same area. Sure, the booming population growth would eventually provide demand to fill these facilities. But we were about to learn how difficult it is to lease up vacant units with two deep-pocketed REIT competitors undercutting prices and breathing down our necks.
Learning Point: Make sure to invest with an experienced operator with deep pockets and do not underestimate the REITs. REITs hold properties forever and can afford to not make money for a while. A newbie with little or no reserves would never have survived what was about to come.
The second shoe dropped before the second month. Apparently, the original builder-operator had some “special tenants” (family members/friends) in a significant number of units.
Learning Point: Self-storage tenants are on monthly leases. This provides several impactful benefits, including the opportunity to capitalize on inflation. But it can also cause problems in situations like this. This herd of “special tenants” moved out right after closing. Shenanigans like this can be difficult to detect in due diligence, but exercise extreme caution when evaluating rent rolls. Even the experienced operator had never seen something like this.
Just as filling vacant units significantly impacts income and asset value, the sudden vacancy of roughly 10% of the occupied units seriously affected income. Taking a significant chunk out of net income set back the asset’s performance substantially and caused the debt service coverage ratio to drop below healthy levels. This is another reason to invest with large firms that maintain meaningful reserves.
So our operator was now in a very challenging situation. Their occupancy and income were far below their expectation, and they were faced with two unexpected national competitors. These competitors would offer concessions and undercut prices to fill units. This can drive smaller, under-capitalized competitors out of business. These large players are often right there to acquire these failing assets, giving them local monopoly power.
The riskiest period for a self-storage facility is during lease-up. The riskiest event during lease-up is the introduction of a significant competitor nearby. This facility faced both challenges.
Things were off to a poor start. After a few small payments, our syndicator announced they were suspending investor distributions to maintain cash reserves. This situation continued into the next year of 2019. We were deeply concerned, and many of our investors were, too.
But our concerns had grown significantly in the following year. Ben Kahle made an unannounced visit to the property in January 2020. He spent hours interviewing both managers, reviewing the facilities, and touring the vicinity.
Ben gave me the report that evening, and I showed up in the syndicator’s headquarters early the next morning. I requested a meeting with the CEO, who set aside a significant block of time to speak with me. (It helps to be a significant investor in an important deal.)
The CEO explained the situation and their plan in greater detail. He seemed calm and reminded me again of their progress and prospects to get to stabilization.
Learning Point: The unprecedented eviction moratoriums that accompanied Covid and the political landscape plagued the residential real estate industry. These moratoriums did not touch the self-storage industry. The opportunity for quick and efficient evictions in the self-storage space is one of the positive features of this business.
A New Year…a New Outcome
2021 brought a refreshing wind of good circumstances for this investment. Here’s what happened next…
The operator retained A-Player onsite managers at these facilities and continued their aggressive marketing campaigns
Covid’s impact lessened, and people were out and about again, especially in Florida.
The popularity of Lakewood Ranch boomed as more people chose to work from home and migrate south.
The impact of the competing facilities lessened as their occupancy grew, concessions expired, and pricing expanded.
The results were powerful. Check this out…
Avg. Occupancy: Q3 2020 occupancy = 65.7%. Q3 2021 occupancy = 95% (44% increase)
Revenues: Q3 2020 revenues = $392,587. Q3 2021 revenues = $701,205 (78% increase)
Net Operating Income: Q3 2020 NOI = $176,425. Q3 2021 NOI = $429,235 (243% increase)
Amidst continuing good news in mid-2021, we got word that several institutional investors were looking at a portfolio of stabilized assets owned by this operator.
Learning Point: One of the most powerful strategies in commercial real estate involves putting together a consistently branded, professionally managed portfolio of assets and selling them to an institutional investor. These investors need to write big checks, and they don’t want the hassle of dealing with un-stabilized assets. They will also pay a premium for a stabilized portfolio.
How did this end up?
We got word that closing had taken place in late November 2021. Investors received their principal plus a profit of 65.7%. The final ROI, including meager earlier distributions totaling about 1.4%, totaled 67.1%. With an approximate 3.3-year hold time, the annualized ROI came in at 20.1%.
Excerpt from Final Letter to Bradenton Investors
We’ve written about the ups and downs of this asset for many quarters. At 20%, the ROI is within the range we projected for a planned six-year hold, and above our projection for a 3.3-year hold.
Using the slide from our original PowerPoint investor presentation in mid-2018, the 3.3-year projection was 17.1%. So your annual ROI came in 3% above the projection for the actual hold time. From that perspective, this investment was a great success.
But that doesn’t mean we consider this investment a total success. Some of you invested for cash flow. You expected cash flow along the way, and you didn’t get it. To you, we are truly sorry.
What would we do differently now?
Honestly, our experience with this asset has strengthened our conviction that our current fund model is the best way forward. Over 460 of our current investors agree with this thesis and we couldn’t be happier with our current model and the investments we are enjoying through our four Wellings Income Funds.
Our goal through these funds is to provide diversification across asset types, geographies, operators, and strategies. For example, our Wellings Income Fund III includes 36 properties/portfolios from seven different operators, four asset classes, and many cities/states. Our secondary goal is to provide tax-advantaged cash flow, and these funds provide this through depreciation.
End of investor letter excerpt.
Summary
Wellings Capital has since invested tens of millions of equity across dozens of self-storage properties, and some have sold, producing much higher returns than even this one. The past few years have been wonderful for most real estate investors. Wellings Capital and our investors are enjoying the prosperity of the resulting cash flow and appreciation.
But we are not sitting still. We continually have an eye on the inevitable shift in the market cycle and the risks that will bring. We are confident that trees don’t grow to the sky, and we are reviewing asset classes, operators, portfolios, and deals that will best position you to prosper in any economy.
We wish you and your loved ones a safe, happy, and profitable 2022, full of celebration and rest.
If you have further questions, please email us at invest@wellingscapital.com or use this scheduling link to set up a call to see if Wellings Capital’s investments are a fit for you.
As with all financial matters, please do your own research, draw your own conclusions, and seek professional advice. The information contained in this article is for informational purposes only and is not intended to provide investment advice. Investors should consult their own tax, legal and accounting advisors before engaging in any transaction.