Self-Storage Valuation • Section 10
how to underwrite a self-storage facility? Whether you are buy- ing, selling, refinancing, or challenging your tax assessment, the methodology for determining your property’s value is pretty much the same. When dealing with valuation there are three standard approaches that are considered, though not always utilized: Cost Approach, Sales Comparison Approach, and In- come Capitalization Approach.
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Cost Approach - The Cost Approach is a set of procedures through which a value indication is derived for the fee simple interest in a property by estimating the current cost to construct a replacement for the existing structure, including an entrepre- neurial incentive; deducting depreciation from the total cost; and adding the estimated land value. Adjustments may then be made to the indicated fee simple value of the subject property to reflect the value of the property interest being appraised.
When dealing with valuation there are three standard approaches that are considered, though
not always utilized: Cost Approach, Sales Comparison Approach, and Income Capitalization Approach. For investment properties, this valuation technique is most
often relied upon as a test of financial feasibility for proposed construction. This approach is based upon the principle that the value of the property is related to its physical characteristics and no one would pay more for a facility than it would cost to build a like facility in today’s market on a comparable site.
In today’s market this approach has limited applicability due
to lack of market data to support an estimate of accrued depre- ciation, limited land sales and construction cost comparables, and considering that market participants do not rely on this technique when valuing properties. Therefore, the only time ap- praisers utilize this approach to value is when they are required to do so. However, it is common for lenders to require a Replace- ment Cost Estimate, or “Insurable Value.”
Sales Comparison Approach – This approach is based on the principle of substitution, which asserts that no one would pay more for a property than the value of similar properties in the market. In active markets with sufficient comparables, this approach is an accurate measure of value that can reflect market behavior. Alternatively, this approach may offer limited reliabil- ity because many properties have unique characteristics, includ- ing a significant amount of RV storage or miscellaneous income that are difficult to account for in the adjustment process.
It is common for appraisers and market participants to use this approach to provide secondary support to the Income
hat are the most common methods utilized when an owner, potential buyer, broker, or appraiser analyzes a self-storage facility? Is there an industry standard for
Approach, primarily due to the lack of recent sales with similar characteristics available. Income Capitalization Approach – This approach is
based on the premise that investors purchase facilities based upon their income-producing ability. In the Income Approach, market rents for the subject property are estimated, an econom- ic vacancy and applicable operating expenses are deducted, and the resulting net income is capitalized into a value estimate.
The Income Approach is based on an analysis of information
extracted from the market, and provides a comparison of the subject to properties of similar character and income-produc- ing ability. This is the primary approach to value that appraisers place weight on when reconciling a value conclusion. The two fundamental methods of this valuation utilized in this analysis include Direct Capitalization and Discounted Cash Flow Multi- plier. These methods are described below:
Direct Capitalization – This method analyzes the rela-
tionship of one year’s stabilized net operating income to total property value. The stabilized net operating income is capital- ized at a rate that implicitly considers expected growth in cash flow and growth in property value over a buyer’s investment horizon. The implied value may be adjusted to account for non- stabilized conditions or required capital expenditures to reflect an “as is” value.
Discounted Cash Flow (DCF) – The DCF analysis models a
property’s performance over a buyer’s investment horizon from the current as is status of the property, to projected stabilization of operations and through the projected sale of the property at the end of the holding period. Net cash flows from property op- erations and the reversion are discounted at a rate reflective of the property’s economic and physical risk profile.
It is also common for appraisers to consider developing the
Effective Gross Income Method (EGIM). However, the sales data doesn’t always reflect a reasonable correlation between ex- pense ratios and multipliers. If this method is utilized, it is more as a check method for the Direct Capitalization or DCF Analysis and secondary weight is placed on this method.
The Reconciliation of Value Conclusions is the final step in
the appraisal process and involves the weighing of the indi- vidual valuation techniques in relationship to their substantia- tion by market data, and the reliability and applicability of each valuation technique to the subject property. Understanding the profiles of potential buyers and their typical reliance on each approach to value strongly influences the weighting process. It should be noted that the Income Capitalization Approach is widely accepted throughout the industry.
Colliers recently completed a survey with several market par- ticipants that asked the question, “When you analyze a property
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