Understanding Investment Structure & Returns in a Self Storage Investment

Sophisticated investors appreciate that not every real estate deal is the same, and not even every self storage deal is the same. It is crucial for investors to delve into the details, assess risks, and comprehend the long-term plan behind each project. In this article, we will explore the structure of real estate investments, the importance of a profitable project for both sponsors and investors, evaluating the sponsor's investment structure, and understanding the risk profile of different deals. By gaining a comprehensive understanding of these factors, investors can make informed decisions and maximize their returns in the real estate market.

1. UNDERSTANDING REAL ESTATE INVESTMENT STRUCTURE:

The structure of a real estate investment plays a vital role in determining its success. It involves comprehending how funds will be drawn down and how they will be returned over time. A profitable project is one that benefits both sponsors and investors. It is critical for both parties to make a return on their investment. If only the sponsor prospers, the investment is deemed unsuccessful, and if only the investor profits, the sponsor may lose interest. The alignment of interests ensures that both groups win or lose together, fostering a mutually beneficial partnership.

2. EVALUATING INVESTOR STRUCTURE:

As an investor, your returns are influenced by the structure of the sponsor's investor framework. While a deal may seem promising, an unfavorable investor structure can hinder your ability to receive adequate compensation for the associated risks. Therefore, evaluating the sponsor's investor structure will ensure that your interests are well-aligned and that you are appropriately rewarded for the risks you take.

3. RISK PROFILE AND LEARNING FROM MISTAKES:

Every real estate deal carries a unique risk profile. While some ventures in today's market, such as building an office without pre-leased tenants, present higher risk, others, like developing an industrial building to be occupied by a credit worthy tenant, offer more stability. Generally, the greater the risk, the higher the potential reward. To gain a comprehensive understanding of risk profiles, it is essential to evaluate multiple projects, analyze financials, listen to pitches, and ask pertinent questions. Learning from past mistakes and experiences is a valuable lesson in recognizing and avoiding potential pitfalls, ultimately safeguarding your investments.

UNDERWRITING SPONSORS: KEY QUESTIONS TO CONSIDER

When evaluating sponsors, asking the right questions can confirm your confidence or expose additional areas of risk. Consider their track record and experience, such as the number of projects they have successfully completed.

1. How many projects have you done? What is your experience? Have you done this before?
   • Mistakes can be costly. Entrusting your dollars to sponsors who lack experience may lead to undesirable outcomes. A seasoned sponsor or developer accumulates decades of lessons learned, minimizing risks and protecting the interests of their investors.
2. If you have done it, how successful have you been?
   • Evaluating the sponsor's success in previous endeavors provides insight into their capabilities and the potential for future success.

SELF STORAGE INVESTMENT RETURNS

The expected returns in the self storage investment landscape vary based on the distinct opportunities available. For instance;

• Buying an existing stabilized property for cash flow, not many improvements need to be made, ideally yields a 7-9% cash on cash return.
• Development projects with a sale at the backend can offer higher returns, yielding IRR in the 18-22% range for 3 or 4 year total deal return
• Value add is acquiring existing facilities requiring management overhauls, new operators, or capital expenditure plans typically generate IRRs between 12% and 15%, depending on the required level of work and prevailing market conditions.

When it comes to real estate investments, it is essential for investors to go beyond the surface and evaluate key aspects that can impact their returns. Understanding the deal structure, assessing the project's profitability for both sponsors and investors, examining the sponsor's investor structure, and comprehending the risk profile are important steps in underwriting a successful investment. By asking the right questions and gaining exposure to a variety of deals, investors can minimize risks and capitalize on opportunities. In this dynamic environment, self storage investments offer distinct opportunities, ranging from cash flow-driven stabilized properties to development projects with high total deal returns. By aligning investment objectives with the specific opportunities in self storage, investors can strive for optimal returns in the current market landscape.