SRI

There are many different real estate asset classes with their own pros and cons. In this episode, we take a look at self-storage spaces as an asset class and find out how to leverage them for profit. Shannon Robnett is joined by Jacob Vanderslice of VanWest Partners to discuss self-storage as an asset class. Jacob talks, and he talks about diversification in real estate the best ways to leverage self-storage. If you are looking to learn more about what to look for in a sponsor if you’re considering investing in a private real estate fund or syndication and how to take action, Jacob has all the information you need to get there. Tune in and hear what Jacob has to say.

Welcome to Episode 275 of the show. You're going to want to tune into this show because I've got the great privilege of talking with a fellow pilot friend of mine, Jacob Vanderslice. We're going to talk about what it means to be in professional grade assets. What asset classes are fantastic like maybe mini-storage, some commercial, some residential or some multifamily? How are you doing it? How are you funding it? What are the options available to you? How can you be involved in professional grade stuff with amateur grade time?Welcome to Episode 275. It's hard to believe it's been that long but I've got the great pleasure of having a fellow pilot friend of mine on the show, Jacob Vanderslice. Jacob, how are you?

I’m doing great, Shannon. Thanks for having us on. We appreciate it.

This episode for you and I unfortunately is going to be about real estate. It’s my second greatest pastime other than pilots, which we both are. The readers will have to appreciate that you and I are diverting from what we wanted to be talking about to be talking about our second favorite thing, which is real estate. Jacob, tell us a little bit about your journey into real estate, what you focus on, where your markets are, how you got from the high school graduate to where you're sitting?

We've been investing in real estate full-time for years. We started off doing single-family fix and flips many years ago. We scaled that business up quite a bit. We've done well over 1,000 of them over our careers. Not doing many lately, deal flow is tough and it's not a line of business we've been focused on. It was good to us for many years. We got into commercial real estate back in ‘13 and ’14. We started doing a lot of adaptive reuse retail around Denver, which is converting old warehouses and 100-year-old warehouses in some cases into multitenant experience-based retail concepts like breweries, restaurants, coffee shops, yoga studio and stuff like that. We held on to some and sold off others. That's been a good line of business for us.

We got into self-storage in about 2015. We liked the asset class because it's been historically recession resistant. It performed well during the financial crisis, the pandemic and still is. We started off by doing ground-up construction projects around Denver with a programmatic JV with some high-net-worth folks. We expanded that in the Midwest. Leading up to 2019, those were all single assets syndications but with a common capital base. We launched our first storage fund in ‘19. We closed that out in ’20. We're in the most recent fund. We've got about $170 million worth of self-storage across 30 plus facilities, mainly focused in the Midwest and Southeast. It's been a good line of business for us.

I want to dive into the yoga studio, brewery part. That would have been a great combined experience. You could have gone. You'd have been a little tight. You had a couple beers and all of a sudden, you get into a little bit, “Let's get back to real estate. All right, bye.”

That's not real estate. People asked, “What are some of the more fun projects you've done?” There's one specific one in Downtown Denver. It's an 18,000 foot, very historic looking brick bomb shelter. The seller used it to store a collection of Porsches. He was one of the more prolific Porsche collectors in the country, if not the world. He sold his last car off and put the building on the market. This thing he bought in 1976 for $20,000. We're in the deal for $5 million. We bought it. We demised it and made it look cool. We preserved the historic aspect of it. We got a brewery in there, an escape room and a restaurant. That's been one of the more fun projects we've touched. Self-storage is great too but it doesn't tell as good of a story as this deal’s going to do.

It started out as the guy that had some extra farm ground in the late 1990s. I remember building my first storage facility in ‘04. It was evolving out of that pole barn mentality where you park your motor home. It's gone through its evolutions over time. We've continued to build storage as we have need with our clientele or hire a builder. One of the things that people maybe don't like about it is that it's boring. It's a very simple asset class that has high yield on fairly low maintenance. There's not a whole lot goes on. The eviction process is similar. Talk to us a little bit about the actual operations of the self-storage and why it's such an attractive asset class from that point of view.
 

We'll bring investors into the conference room who are in our retail deals and storage deals. They want to talk about how the brewery's doing. They don't care how the storage units are doing. They do it to a degree but they're not as excited about it. It's a good business. Every deal is pretty similar. You've got different deal types. You've got single-story drive up, non-climate controlled units. You've got single-story climate control. You've got more institutional grade multi-story elevator access climate control buildings. They all operate a little bit differently depending on the market.

By and large, you were leasing metal boxes to people to keep their stipend. Being in the business, it's amazing. People will pay more rent than their stuff is worth because it's out of sight and out of mind. It's their credit card every month. By the time they pay rent in there for a couple of years, in many cases, sometimes longer, they could have bought new stuff multiple times over but they don't want to think about it and don't want to deal with it.

In general, we like the business because first of all, we like the dynamic aspect of the revenue streams. You can respond real time to supply and demand changes both within your facility and at the sub-market level. For example, the 10x10 is full. You can raise rates on that with a 30-day notice because all the leases are month to month. Likely, you won't get a lot of customers who will move out because your rates might already be below market.
Let's say you have a 5x5 unit type that's not well occupied. You can drop rates there well below market, get to critical mass occupancy and start raising rates over time. We liked the dynamic aspect of being able to pull these revenue management levers to maximize our revenue streams and turn our net operating income.

The second reason we like it too is the granularity of the revenue stream. We're relying on thousands of people to pay us $50 to $300 a month. The chances that a big chunk of them is going to roll over at the same time or very low. Whereas for example, the brewery we have and the cool building I was talking about are doing great. They got through the pandemic well. Their base running rent is about $18,000 a month. They're going to pay it or they're not. Thankfully they are and doing great.

If they don't pay, it's going to be a long time to get them out. It's going to cost probably $200,000 to find a new tenant. We're still dealing with the effects of the pandemic. Retail has changed quite a bit. It might take you awhile. The chances that $18,000 of your self-storage rent roll is going to roll over on any given day is very low. If it did, for some reason, you could probably get that release fairly quickly. Dynamic revenue and small little bite-size income streams are why we like it.

My brother had a very similar situation. He stored his stuff. Two and a half years later, he pulls out all this nice furniture because he's decided, “I am going to stay gone.” He sells it at the garage sale. My brother is a numbers guy so he literally pulled it out. He was $40 short of paying for the storage. He couldn't even reimburse himself for the storage cost. A lot of people are going to look at that. They're going to go, “It went up $9. I'm not going to spend two hours to drive to the storage, get it out of that storage and take it to another storage that's $9 less. I’m just going to leave it there.”

It's a Chef Tony thing. It's a set it and forget it. It comes out on your credit card and you keep going there. Let's talk about your investor base, the people that you use in your fund, syndications and the different investment vehicles. Tell me about who they are. Are they all ultra-high-net-worth individuals? Who are they?

The only common theme between all of them is they're all accredited, which means they're either worth $1 million outside of their primary residence or they make $200,000 a year if they're single or $300,000 a year if they're married. One or the other means you're accredited. It doesn't have to be both. Beyond that, they're all over the country, all different walks of life, all different levels of net worth. Some of them are small business owners. Some of them are worth $100 million.

We have investors with $50,000 and $5 million plus with us. It's all across the board. A lot of professionals might be attorneys, doctors or they run a small business. They want to get into real estate investing but they don't have time to go out and do their own deals. They look to us to deploy their capital with. All walks of life and our partners are amazing people.

That's one of the things that I've experienced. I have many years in the industry of construction and development but I'm just getting into the syndication portion of it. Honestly, I got to the place where we were doing developments that were bigger than single check writer, people that I JVed with in the past could handle. One thing that I see is everybody has a different reason for why they're doing it but they all have a common reason as to why they're doing it.

The common reason usually is that they know, like and trust you. They value what you bring to the table and they also value their own free time or their own income stream. They realized that they can't do both. They're able to come to you and say, “Jacob, why don't you give me that professional grade experience while I go make my XYZ over here, my professional grade money over here or run my business? The $100 million guy jet around on his yacht.” We all accused the rich guy of doing that. In fact, he's probably the one working the hardest.

Everybody's got a different reason for doing it and they're all different but when they come to you, they come to you for that one reason because they understand that you have a superior business model to what they could come up with on their own. They realize that you have contacts, contracts and things in place that they could never get because you're running at a level right here with the business where they would be getting in at a level much lower than that. Having to feel their way up, learn some of the mistakes, bumps and bruises that you've gone through along the way.

People understand that being a part of syndication and/or a fund is hugely advantageous to them. It also opens them up to do things that they couldn't do with their IRAs and other things like that, other investment vehicles because they can invest in things that they want to own and manage or want to own and be a part of without having to manage because with an IRA, you can't.

What you said was especially profound and that's the phrase, know, like and trust. People invest with sponsors. It doesn't matter how good your deal is or how good your program is if they don't know, like or trust you. That's important. People invest in syndications and funds with sponsors that they have that for. They know, like and trust them. Their strategy is important. As a passive investor, you're investing with the people first then to a degree, secondarily, the strategy that people are doing.

You’re probably at the level that you are at in which you don't get this as frequently as you used to but I know when you were starting out, people would come to you and go, “Jacob, tell me a little bit more about how you're underwriting this or how you're doing this?” What they were doing was they were quizzing you about, “Did you know what you were doing?”
When you're done with that, you've created the trust and the belief that, “Jacob has read this spreadsheet.” He's not just some good-looking guy that has put this together that's trying to hawk this. There are some other guys in the back and people pulling levers. He understands what he's selling and what he's doing. From there, they can create that belief that their money is safe with Jacob.

One of the things I often like to say, especially during an initial contact with an investor is, first of all, the spreadsheet will tell you whatever you want it to. If the numbers don't look good, make them different and that's it. You have to believe what you're putting into the spreadsheet. Secondly, after you believe what you're putting in the spreadsheet, no matter what, your spreadsheet is wrong. Things are not going to go like the model suggests they will. They're going to go better than you expect or worse but either way, the model is wrong. We're forecasting out income streams and cap rates 5, 10 years down the road. We can make an educated and conservative assumption of what those look like but no matter what, it's wrong.

That's one of the reasons why I like being involved in ground-up development because you've got an appraiser involved that tells you what the actual product is worth, new product versus new product. A lot of times in a value add, you're not getting an appraisal that you're including in your underwriting. You're not dealing with ground up costs that give you that double-check. You can make it say anything. Jacob, I want to clarify for my readers. Did you exit a deal in 2020?

We exited a deal in 2020. Not a storage deal but we've exited a number of deals.

That deal was how many years old when you exited?

The specific one I can think of was a townhome development project that we did on the side. It was not old at all. We broke ground down in probably January of ‘20 and sold it between November to January of ‘21.

Did you underwrite that with a pandemic in there?

Yes, we did. We knew COVID was coming when we broke ground in January 2020. We lowered our revenue and increase our expense options. That'd be conservative.

This is why you use Jacob. He can predict pandemics. What I want to know is why he didn't tell the rest of us. Seriously, if you think about that, you pulled the pin two months before a pandemic started.

As you know, being a developer all these years, if you buy raw land and the lights go out, you've got a big problem, raw land, the carry costs. Let's say you buy raw land and maybe you've completed 20% of your construction and lights go out. That's even a worse situation. We were concerned. We were remaining rational and optimistic but nobody knew what the world was going to do. March, April, it was scary. We didn't have a semblance for many months thereafter and to a degree, we still don't.

The reality is with the right underwriting, you probably weren't making the assumption that you're exiting at a poor cap. I know this was a townhome development but you probably weren't estimating that you were going to see inventory levels drop to the level that they did. All of those things probably helped you a little bit but your underwriting had to be conservative enough that if you were wrong, it wasn't devastating.

If you were right, we exited months ago and our investors were into the 30s on the return. They were blown away surprised and wonder at how intelligent I was. I had zero to do with it. The market was what carried me there but it was conservative underwriting that made me look like I knew what I was doing.

Sometimes you look like heroes and all that happened is we got lucky and all the boats flooded on the rising tide.

Here we are. We're not little guys. You've got $195 million under management. I'm half that size but how do you compete with the REITs? How do you compete with the guys that come in and go, “No problem. Don't worry about Jacob. I can write a check that's bigger than that. I can do this. I can do that. I'm Blackstone?”

We've deployed about $45 million in 2021 into the self-storage space. Deal flow is becoming increasingly difficult. Three quarters of those deals were sourced off market. That's a term that I use with some hesitation because sometimes off market isn’t really off market. These were truly off market though. We had a brokerage relationship with a prolific self-storage broker. He brought us these deals before they hit and he knows we're going to perform so we're able to get those that way.

The other deals that we bought that were widely marketed were marketed but poorly marketed. Unprofessional brokers, their financials aren't very accurate. On the competition side though, outside of the deals we bought so far in 2021, if it's a well-marketed class A facility, we can't come close to the strike price. We were off by millions of dollars. Within our fund structure, we try to blend distributable cashflow with capital appreciation.
We like about half of our return to come along the way from quarterly distributions and the balance of that on either a refinance or a sale event. We're looking for income and growth. There's a lot of operators out there who were good with income. They'll buy it, put the dividend yield and probably sell it for a breakeven when the time is appropriate. Hopefully, they make money.

Other operators are relying on no cashflow along the way but a bigger pop at the end. We're trying to blend both together. Our acquisition criteria are narrow. It's been tough finding deals. We're still finding them. We're closing on $30 million worth of deals in September 2021. We'll see all deal flow remains for the rest of 2021 and 2022.

Let’s break that down. Let me put some numbers to this. If you're looking at a deal that you want to get half of your money from cashflow, let's say that you're looking at a deal we could have got all day long in ‘19. You would have been looking at an 8.5% cash on cash. You'd have been looking at about a 19% IRR. I see a lot of stuff that's coming out that's a 10% pref, no upside. That's the second deal you're talking about. I also see ones that are 4% cash on cash with a 12%, 14% or 16% IRR. Why do you see those as dangerous?

I want to diverge this for a moment into IRR. I assume most of your readers know what IRR is. It stands for Internal Rate of Return. IRR is a time-weighted metric based on a series of cashflows. IRR is the universal way that operators will describe the return profile of a real estate deal but if you're looking at a real estate deal, only through the lens of IRR, it could be massaged in ways to make it look better than it is. In short, if you give me some money and I give you your money back, plus a little bit of profit and I do it very quickly, your IRR is going to be very high.

If that's the only metric that you're using to evaluate the performance of potential investment, you're going to say, “I gave this guy $100,000. He gave me back $105,000. Very quickly my IRR is 200%, whatever the number might be but I made $5,000 and I got my money back so I'm not happy.” We try to blend a healthy IRR. In our case, it’s 16% to 18%. We quote a range because we don't know what it's going to be. It could be 14% or 25%. We're relying to get on assumptions that are years down the road.

We try to blend a healthy IRR with a healthy, multiple on invested capital. By multiple, how much money did you make over the entire life of the investment as a percentage of what you put into the investment originally? Behind that, how much of that multiple are you realizing during the life of the investment and how much of that multiple is going to be back-end? For example, a 2X multiple, if we deliver a 2X multiple in 5 or 6 years, people are still going to be happy but if it's a six-year play, their IRR is going to be incrementally less than it would be if it were in five years.

As you look at deals, I always encourage folks to try to blend all those different viewpoints together to make a sound decision. In terms of returning to answering your question talking about capital stacks and deal structures, we see a lot of sponsors out there that are getting away with structures that we think are not aligned with investors. One of those structures would be a muted upside.

Let's say for example, to return to your ten-pref deal, investors get a ten pref and they're kicked out for anything above and beyond that. It's great if you can get it done but that doesn't enable investors to participate in any additional upside if the deal goes better than expected. We found that a more market rate preferred return and split is somewhere between 6% to 9% on the preferred return side, anywhere from 60/40 to 80/20 in favor of investors. For those of us who were getting deals done with a five pref and 50/50, that's great. We think that doesn't quite align with your LPs with the risks they're taking to a degree.

That's the argument that always happens. Who's taking the greater risks? You're risking capital but I'm risking time, effort and all this other stuff but the reality is nobody can do it without the other. It's about aligning those interests. It's sad to see because of why they invested in you. We know why they invested in you, Jacob. It's know, like and trust. We've already established that. They've invested in you. You've said this is the best deal structure for them but it's more about the best deal structure for you. It's a lot of times because you're buying over your skis. That's a term you'll understand in Denver. What that means is that you're buying something betting on the upside. I'm going to give you a 10% preferred return to distract you from the fact that I'm overpaying for the asset.

Here's a 10% return but you get no upside because there may not be any. What happens if I can only do an 8% pref and we're constantly chasing that deal? I'm not going to sell any time soon and lose money. You can be stuck in this deal. Let's quit talking about everybody else. There's plenty of problems out there. How do you create a storage fund that can scale your portfolio? How did you do it so that you're not having to do these kinds of things so when you do see a good deal come along, you can go, “That's what I'll take. I'm going to take down $30 million worth of real estate in one month?”

As you know, real estate funds or syndications are typically expressed in the amount of equity they're raising versus their gross capitalization. In our case, our fund is $30 million in equity. We might increase that to $35 million if we could find a few more deals in Q4 that makes sense. We raise money programmatically as we acquire properties. What doesn't happen is we get a bunch of commitments for $30 million. We take the entire year to deploy it.

We're marketing and developing investor relationships as we go. People are coming into deals as we make acquisitions. One critical piece if you're a fund manager or considering doing a fund is timing your capital raising with the timing of your acquisitions. For example, you can't accept $30 million on day one and begin accumulating preferred return when you have no assets under management. The day that we balance our capital raising with our acquisitions cadence is probably going to be never. We always have too much money, not enough deals or too many deals, not enough money. It's never perfectly imbalanced.

That's what keeps the fire lit on the hair on your head.

I'm staring at 40 in the face, a perfect eyesight and a full head of hair. I'm happy.

You're trying to balance the deal flow and the equity. Sometimes operators get caught up in, “I got to spend the money.” They don't do the best deals. How do you make sure that when you're doing it, you're consistently picking the right location, markets, time to deploy the capital? How are you pulling all of that together that you've got years of experience? Did you start this in ‘15?

We started doing self-storage in ’15. We started investing in real estate full-time in 2006.

Where are you finding that you're getting that matrix to come together where you're able to find the right location, timing and purchase price? How are you drilling down into that?

Regardless of your asset class, first and foremost, it's got to be good nuts and bolts real estate. It's got to be well located in a submarket that's got a growing population. Density is important. Income demographics are less important in self-storage but rooftops and density are very important. Self-storage specific criteria, as you know self-storage is very local supply sensitive. We track supply ratios and the 1, 3 and 5-mile trade radius. Nationally, there are about 7.5 square feet of self-storage per capita in the US.

If you're getting into markets that are 12 or 15 square feet per capita, you're seeing some over-saturation, a decline in rates and increasing occupancies. If you're in markets that are maybe 5, 6 or 7 square feet per capita, rates are a little bit more buoyant as well as occupancy. That's one thing we track carefully. It's not a hard and fast rule of thumb. We can't say that submarket has 12 square feet per capita. We're not going to do a deal there. Some markets have that. Every facility is at 98% occupancy.

It's a data point but it's not an end all be all, buy the deal or don't buy the deal. Within the context of our fund, we're sourcing two deal types. They're all existing storage deals that are under managed, below market rates, above market expenses. Sometimes I have a website. There are two deal types we’re targeting. One, we might buy a deal that's at 98% occupancy. You might wonder where's the meat on the bone at 98%.

In self-storage, if you're too full, you're not a hero. It means your rates are too low. You ideally want to be like high 80s, low 90s in your occupancy because churn is not a bad thing. It's an opportunity to raise rates. On a full deal that we'll acquire our year one business plan is bringing below market customers up to market rates, layering some of the ancillary revenue streams that self-storage has at the end of the project like late fees, a one-time administrative fee, the customer's payment when they move in and customer insurance, which is a big piece of our revenue stream.

The second deal type that we're buying are deals with lower occupancy. Maybe they're at 50% or 55%. People were often asked, “What's the cap rate you're buying these at?” You might guess it depends on the deal. Providing the deal at 55% occupancy are going in cap rate might be 3.5% or 4% because the rates are below market. They're not managing it well and not advertising. On a deal like that, our year one business plan is obvious. It's occupancy growth.

Once we get to critical mass, we start jocking with our revenue stream, getting below market customers up to market rates. Those are the two deal types we're targeting. We like good markets with good demographics if we can find low supply ratios but in general, we're focused. It's become a cliche in the last couple of years but we're focused on more secondary and tertiary markets. We're finding those markets have the best blend of good cashflow, to a degree, a lack of institutional competition at least in 2020, that's changing in 2021 and then the opportunity for capital appreciation as well.

You mentioned something that people don't often talk about with self-storage and that's ancillary income. As we all know, that's like the frosting on the cake. That's the extra stuff that you don't figure in a lot of. You mentioned you've got your late fees and administrative costs. What else are you doing in mini storage that the normal operator doesn't often think about that's a little bit of that extra stuff?

The big three are the late fees, which are obvious. If you pay late, you have a fee. Administrative fees are a one-time fee that somebody will pay you then move in. It's like a $25 or $30 charge on top of their prepaid rent. The third one and there's not a lot of secret sauce to this but a lot of the mom-and-pops that we buy from don't implement this. The REITs certainly do, especially the extra space but tenant insurance is a big piece of our top line revenue. Between those three, those make up about 8% of our top line revenue, which is a big number.

Did you say 8%? That is huge.

It's a big number. It adds some things on the quarter but that's an average. On the tenant insurance side, for example, most of us who will rent a car when we travel decline the insurance because we either have it on our credit card or it's on our auto policy. Self-storage, believe it or not, if you don't know much about the asset class, the owner of the facility is not responsible for the contents of the customer's units. That's a standard thing in self-storage.

A lot of operators like us will require them to have some insurance in place. We'll ask them to provide a copy of their homeowners insurance. If they don't have that, we'll sell them one of our protection plans to cover $5,000 or $10,000 worth of their stuff. To put a pen to paper, we'll sell the customer a $15 insurance premium that's paid monthly. Our cost on that premium is $2 a month to our carrier. We're making $13 a month. It doesn't seem like a lot but when you do that on a few thousand units, you put the cap rate on that. That's a lot of value creation and then that's a lot of equity dividend increase as well.

The other thing that you got to look at too, Jacob and I know you do is you got to look at the multiple. You resold a $2 thing for 6 times what you paid for it. Anytime you can sell something for six times what you paid for it, that is a good day.

You're only 6X-ing $2. You do that in scale and put a six cap on it on that additional NOI you've created. That's a lot of value creation.

The other thing before you told me what the insurance cost is, I was getting ready to ask you, why wouldn't you self-insure and now I understand why. For $2, why would you? For $2, you're covered but you're selling it for six times what you've got. That is incredible. Before we wrap this up, I want to thank you for your time. Where can we find you? If people want to look at what you've got, if they want to get further acquainted with you and your company, where can we find you in the worldwide web?

A couple of places, our company website is VanWestPartners.com or you can email me at [email protected] and lastly, LinkedIn, Jacob Vanderslice. Any of those three will work.

That's where we connected was on LinkedIn. I sure appreciate you accepted the invite to be on our show. I appreciate you being with us, Jacob. We're going to have to schedule another call to talk about airplanes because we had to conduct a little business here.

Shannon, we enjoyed and appreciated it.

Thank you for being part of the show. Don't forget to like, share and subscribe to the show on Podchaser, Spotify, iTunes, wherever else you get your podcasts from. You can get those automatic updates, catch this episode, many others and see the valuable information we give you. Also, if you want to follow us on Instagram, YouTube, leave us some feedback. We'd love to hear from you. If you want to follow Jacob, you got where to find him at Jacob Vanderslice and VanWestPartners.com.

Thanks for joining us on the show.

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Jacob Vanderslice is Principal at VanWest Partners, a Denver-based real estate investment firm focusing on the acquisition and management of self-storage centers and other opportunistic real estate throughout the United States. By focusing on this conservative and growing real estate sector, VanWest has established a track record with over $195mm in real estate assets. Jacob and his partners’ success is driven by a commitment to delivering an expertly-executed, adaptable strategy with an institutional investment approach. The diverse background of VanWest’s principals allows the company to look at investments outside the traditional, single focus strategy of many companies. Uncovering value when the value is not obvious allows Jacob and his team to maximize investment performance to their stakeholders. Jacob ispassionate about educating investors about self-storage, urban infill repositioning, redevelopment of distressed commercial assets, and other untraditional investmentopportunities. He focuses on investments driven by data and reveals and maximizesopportunities to make a positive and lasting impact in the lives of his clients and investors.