Valuation • Section 14


of vacancy: physical and economic. It is important to exam- ine the historical physical occupancy. Are there any seasonal patterns that need to be accounted for? For instance, oc- cupancy rates in a college town may increase during the summer months and then decline during the winter months. It would not be wise to assume a physical occupancy based on the occupancy rate in July, nor would it be wise to as- sume a physical occupancy based on the occupancy rate in January. Therefore, it is best to look at the occupancy on an annual basis while understanding the occupancy pattern at the facility.


Economic vacancy is also known as collection loss or con-


cession loss. This figure accounts for the loss of income on a lease. For instance, a tenant may default on its rental agree- ment or may receive a month free on a new lease. Either way, this loss is collectively known as the economic loss. The eco- nomic vacancy at a facility is quite dependent on the local area of the facility but generally ranges between one and three percent.


To be most consistent with the investment market, the ef-


fective gross income (EGI) is forecast in line with the historical pattern; therefore, if a property is located in an over-supplied market, where rental rates are increasing at three percent a year, an investor would typically continue this pattern. However,


if the property’s income has been increasing


considerably over the past few years, an investor may include a similar increase in rental rates into the forecast.


With that said, there are certain cases where an investor


may view a deal as a “value add” opportunity and forecast the rents to grow at an above-average rate the first few years of the cash flow. For instance, an investment group with sig- nificant experience with the self-storage asset class locates a facility that is currently underperforming in its market. Per- haps the rental rates and/or the occupancy rate are below average, but the trade area is performing well. The invest- ment group is interested in this facility for the “upside” or “value add”. In other words, the investment group will ap- ply changes that will increase the income at the facility that is not consistent with the historical pattern. Typical ways this is achieved is through new management (personnel or software), property upgrades, and boosting other rev- enue through retail sales or perhaps even requiring tenant insurance.


The resulting income figure is known as the effective


gross income, and this is the total income projected to be collected at the facility.


EXPENSES Expenses at the property include these basic categories: Real Estate Taxes, Property Insurance, Repairs & Maintenance,


Market Analysis A comprehensive study of the market area is necessary to determine the underlying fundamentals that impact the


occupancy rates and rental rates. The first step is to define the trade area as a radius. Generally, a suburban property will have a trade area radius of three


miles; a more rural property may have a trade area radius of five or 10 miles. Very dense areas, such as Manhattan, may only require a trade area of one mile. The general rule of thumb is to have a minimum population of 50,000, however, there are many market areas that have a much lower population and are still viable.


Next, a survey of all the facilities within the trade area must be taken. The most important information to be gathered includes the number of units, the net rentable area, and the occupancy rate. While this information can be difficult to obtain, due to its proprietary nature, estimates should be obtained from sources such as assessor’s offices, phone surveys, and other public sources. This will allow the supply per foot to be calculated.


Demand for self-storage is difficult to quantify; however, the following four demographic variables have been shown


to induce demand for self-storage: population, percentage of renters, average household size, and average household income. Additionally, there may be further demand factors that are difficult to quantify such as a nearby university or highway. An estimate can also be compared to the average supply on the state and national level.


On a per-person basis, if the supply is less than the demand, the market is deemed to be under-supplied. If the supply


is greater than the demand, the market is deemed to be over-supplied. As a test of reasonableness, a comparison of the conclusion to the average occupancy in the trade area can be made. Generally speaking, over-supplied markets have occu- pancy rates less than 80 percent and under-supplied markets have rates greater than 90 percent. A market with an average occupancy rate between 80 and 90 percent is deemed to be near equilibrium.


Understanding the supply and demand of the trade area is a key component to analyzing and forecasting rental rates. 2018 Self-Storage Almanac 151


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