69. Why You Should Be Investing In Self-Storage With Ryan Gibson

PILF 69 | Self Storage

 

You might have heard of self-storage as a great recession-resistant investment but what are the reasons behind the recent success of self-storage assets? In this episode, Jim Pfeifer sits down with Chief Investment Officer and the co-founder of Spartan Investment Group, Ryan Gibson, to answer your questions. The two discuss what makes self-storage an attractive investment in this economy and what you should be looking out for prior to investing. Ryan has invested in many asset classes but his risk-mitigating nature led him to self-storage. Why? Listen in to find out! Plus, Ryan discuss the benefits of the Fund model to minimize your losses and achieve greater returns.

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Why You Should Be Investing In Self-Storage With Ryan Gibson

I am pleased to have Ryan Gibson with us. He is the Cofounder and CIO of Spartan Investment Group, a self-storage syndicator and preferred partner for left field investors. Spartan has almost $500 million in assets under management and 54 facilities that operate under the FreeUP brand. Ryan, welcome to the show.

 

I am very excited to be here, Jim. Thanks for having me.

 

You have been a great partner and we appreciate that. The way I like to start out is if you can talk about your journey. How did you get into syndication, self-storage, and real estate in general? What is your financial journey to get yourself where you are now?

 

That is a fun process. As you mentioned, we have about $500 million of assets under management. It started with an entrepreneurial drive to build a business that could sustain being vertically integrated and have all these assets and investors. It started with my business partner and me meeting in our nation’s capital in Washington, DC as neighbors, and we became friends and started a business together.

 

The thing that inspired us to work together was the fact that we are very risk-averse, and we like to mitigate any risk possible. We also were very focused on building a holistic company, not just doing a bunch of deals. That alignment led us down this path and opened our curiosity to wanting to build a place where we enjoyed working.

 

We could also hire employees who also enjoyed working at Spartan. That is what fueled that passion. My background is as an airline pilot. It is interesting. I love flying and enjoy the industry. A lot of people do not like their 9:00 to 5:00 or do not like their job, and they are trying to income replace. I am in the same boat, but I would say I am unique and I like what I do in the airlines and flying airplanes. What I want to do is build legacy wealth and that financial freedom that is not achievable necessarily in a normal career that an airline pilot would go through.

 

I wanted to build something that would last and make money while I slept. That is why I focused on starting a business and going that route. It has been a lot of fun. I am passionate about serving the 100 employees that we have and excited to see our investors get great returns, invest in great projects, and deliver projects that otherwise might go to a REIT to the normal day-to-day investor and allow them to own a piece in each project.

 

Explain a little bit more on how did you get into self-storage. You are an airline pilot, hanging out with your neighbor buddy, and you guys said, “Let’s start a business.” No offense, but probably the last thing I would think of is, “Let’s go start a big self-storage company. How do you get there?

 

It is risk mitigation. I think the first deals that we did were all residential. We did multifamily and condo development. We did a single-family, new build homes. We started flipping houses, taking things down to the studs. What we liked about what we were doing was we were doing all new development which takes out a lot of risks.

 

Three Es: Easy to Own, Easy to Evict, Easy to Maintain Click To Tweet

 

If you are flipping a house, you do not know what you are going to find behind the walls. If you know you are tearing it all the way down to the studs, you know that you are tearing it all the way down to the studs and there should not be many surprises, if any. We like the new construction and new development. We were good at finding properties that were difficult to entitle and getting those positioned.

 

What we did not like was where the market was headed. We did not think that the residential space was going to be something that we were doing short-term bets on. In 6 to 12 months, we can sell this house for X. We did not like the short-term that we were making on assets so we looked around the industry. We looked at multifamily, office, or single-family. We looked at the whole gamut. The asset class that performed the best during the last four recessions was self-storage.

 

Being risk mitigated-minded like Scott is a military vet who served in Iraqi Freedom. If he makes bad decisions, people die. If I make bad decisions, people also die. We are very risk mitigated in that respect, and self-storage was unequivocally one of the best performing asset classes during the last downturns that we have had in ‘08 and the last 3 or 4 recessions.

 

It struck us as a very recession-resistant asset type. That is what we liked about it. The other thing about it is Scott will always joke. He hates people. He is a people-minded person and good with people, but we did not want to kick anybody out of their dwelling. In storage, you do not have eviction moratoriums, lots of cabinets, turnover, and people, so you are not kicking somebody out of their dwelling. We liked that.

 

We had that aligned with our values where we are not having to go through removing somebody from their house. To summarize three Es, Easy to Own, Easy to Evict, and Easy to Maintain. That gave us the asset type that we knew we could scale a company with lower risk and have the ease of operation so that we could completely vertically integrate our construction company into our Spartan brand and our FreeUP Storage national brand. We knew that we could scale those two verticals and control the process, thereby mitigating a little bit of risk.

 

Self-storage, I get how you picked it because of the recession-proof asset class. In the last several years, it has been one of the hottest asset classes in any economy. Why self-storage? Why is it doing so well? Why has it done so well?

 

The last several years have been very interesting. I think a lot of institutional investors have come into the space. A lot more people are lending. It is driving down cap rates and interest. It is drying up the opportunities to buy. We have had to look hard for the right projects. We have had to develop a lot of relationships with sellers and portfolios, especially. We have had to look off the market to find well-vetted opportunities to get into the space because it is a hot space. You want to make money when you buy.

 

We want to make sure that we are buying something that has got below market value to it and is not all picked over. We have stuck to the value-add approach. We want to find a property that we are buying on a per square foot basis lower than what the market is trading at and we want to buy a property that is below-market rent. Let’s say the rents on a 10×10 are $100 a month. The market is charging $130 or $140 a month.

 

PILF 69 | Self Storage
Self Storage: The asset class that performed the best during the last four recessions was self-storage.

 

We want to find that because the industry is getting overheated. There is a lot of competition. There are a lot of people buying, and it is pushing down cap rates and making it harder to find the right project. A great example is we have put out an offer every single week. This time in 2021, we had already bought 4 or 5 properties. In 2022, we have not bought anything yet because the market is hot.

 

We have to look at more opportunities to find what fits our criteria because our criteria have not changed. We are in a rising interest rate environment and more money is pouring into the space. We want to be careful about what we buy and make sure that we are controlling our risk and what we do to make sure that we have good projects for our investors.

 

You mentioned value-add. I know some of the value-adds is you sell locks and get U-Haul in there, but what are the best value-add options for self-storage to push valuations?

 

I would say the one thing is you have got to come in and have a facility that is well occupied that is below market rents so you come in. Maybe the owner has got 100% occupancy with a waitlist out the door. He is charging $100 a month for a 10×10. You go mystery shop every single competitor and find that they are all charging $130 for a similar sized property.

Everybody is full, so now you know, “I have got demand out the door and I can bring my rents to market.” Not increase the market rents but bring the rents to where they should be. That type of property is difficult to find. That mom-and-pop owner has not been paying attention to the market because maybe they have a low basis in the property that allows us to come in and tighten things up.

 

The second thing is adding additional units. We do a market study where we could look at the demand within that three-mile drive time and benchmark that against surrounding cities to determine a surplus of demand by X amount per square foot. Now we know that we can add on additional units. We have a lot of different things happening there. We have data scientists and researchers are finding that data for us. We have a construction company that focuses on the entitlement aspect.

 

They can look at the land, know how much we can physically build there, and what the cost would be, so when we come in, we know what we are doing. We know how much value we can add to additional square footage. We also know how much demand there is in the market. We can build those units ourselves and have that all in-house as part of our due diligence process.

 

The third thing is tenant insurance. We require every single storage customer to have tenant insurance. They do not have to buy our tenant insurance, but if they do, we make revenue off that. A great example is you might buy a 300-unit facility. There is no tenant insurance in place. We take over. We require it. We might make $6 to $10 a unit if they use our insurance. That is instant $1,800 a month on revenue coming in at no additional expense other than requiring the insurance. Those are probably the three main pillars of value that can be driven in those shortest periods of time.

 

In any deal, you can play with the cap rate, and that will drive returns. Click To Tweet

 

When you are talking about the value-add when you are putting new units in, it seems like there is always convenient land that you can build on. How do you find the deals that have that land nearby, or does the current owner already own the land and have not done anything with it? It is interesting that in a lot of your deals, there is this big plot of land there that you can build some new units on. Do you find those intentionally? Why is there always that empty land ready for you to take advantage of?

 

It could be a number of different reasons. I will give you one example. We bought the property back in 2018 or 2019. It was from a seller that was about 85 years old. He had owned this property for 30 years, and there was a half-acre in the back that we could expand about 14,000 square feet on. It was not an easy development. You had to go through a site development plan.

 

First of all, we had to rezone it from residential to commercial, then we had to go through a site development plan and get our building permits. We even had to use dynamite to blast the granite to put in our foundations because we built this in the mountains of Colorado. From a one-person band, a mom-and-pop operator who has owned this property for 30 years and has been full on a waitlist. Maybe he has a very low-cost basis in the property. He is not too excited about doing all that stuff, hiring an architect and a civil engineer, finding dynamite at an Air Force base to bring the property and blowup granite.

 

That is an extreme example, but that is one side of it. The other side of it is maybe they are not well-capitalized, they do not have the means to go through the headache, or they do not want to go through the headache. There is always some unique thing that eliminates an owner from being able to do it, or maybe they added on in their comfort level with adding on even more units is not there. Sometimes, we find a lot of deals where the owner says, “You can build a bunch of stuff in the back.”

 

We do our due diligence, and you can’t. Sometimes, you see there might be a big gas line easement, setbacks, or restrictions on what you can build in that market, whether it be zoning or requiring a conditional use permit. I think people think that, “You can build these things everywhere.” It is not true. There are a lot of moratoriums out there and zoning restrictions. We do a lot in Texas and have even found that sometimes in Texas, you have to jump through a bit of a hoop to get the property constructed and built. Many different reasons why people do not do it. Sometimes, they do not see the opportunity to build the additional units and lease them up.

 

As you know, our communities built up passive investors that are actively investing in these syndications. When we try to analyze the deal to figure out is this something we want to invest in? The default is always multifamily because that is where most of us start and now we have to transfer our knowledge to self-storage. A couple of things that I look for in multifamily. I am looking at the rent increases in the proforma, the economic vacancy, and the taxes. Those are the first three things I look at. If I am a passive investor, I am looking at self-storage, not from underwriting it ground up as you would, but from a passive investor perspective. What are a few things that I should be looking at, a few metrics, or something that I should look at when I am evaluating a self-storage deal?

 

Go to the annual P&L on an underwriting file and look at five things. 1) Gross revenue change year over year. 2) Property tax increases. 3) Insurance increases. 4) Expense to gross income ratios. 5) Cap rates. Those are the five things that I would quickly scan to either throw a deal out or continue digging in deeper. There are a lot of other things that go into this, but those are the five things that I would come to the table with looking. Let’s go through them one by one.

 

For gross revenue, I would look at what the operator has underwritten the change to be year-over-year. That is basically increasing your collections. If it is more than 6% every single year, it might not be a bad reason, but I would ask why. For example, in the first year, they may have a market study that shows the rents are those $130-a-month units and you are only at $100, so you are going to raise rents to market. It does not happen overnight. Even though we are on a 30-day lease, I would give myself 18 to 24 months to do that so you have plenty of runways.

 

PILF 69 | Self Storage
Self Storage: Go to the annual P&L on an underwriting file and look at five things, one gross revenue change year over year, two-property tax increases, three insurance increases, four expense to gross income ratios, and five cap rates.

 

The second thing I would look for in the subsequent years, if there is more than a 6% increase in revenue, I would ask, “Where is that coming from?” Is it coming from bringing rents to the existing market that is well occupied and well-documented in a market study, or is it the operator thinking that the rents are going to keep growing? If the operator thinks the rents are going to keep growing, I will question why they think that because that is the crystal ball that none of us have? That would be one thing I would sass out.

 

The second thing is property taxes. When you buy a property, you get re-assessed and your property taxes go up. If I do not see property taxes doubling over the whole period within the first five years, I do not think that they have properly accounted for property tax reassessments. That is a big deal in this market. It will not only kill your valuation but it will also kill your cashflow. Make sure that they have accounted for it in the underwriting.

 

The third thing is property insurance. Whether you believe in global warming or not, I am not here to debate that. The reality is insurance companies are experiencing more weather events than they have ever experienced before, and that is increasing their claims and costs. I would want to see insurance going up 20% to 35% over the whole period. I would also want to know that they have worked with a broker that has provided an A-rated carrier specific to the industry.

 

They have already gotten a quote per square foot. They want to dig into the insurance to make sure that they have that dialed in. The fourth thing is the expense to gross income ratio. If you make $1 of revenue, how much money and expenses as a percentage of that $1 have you accounted for? For example, if you make $1 in storage, it should cost you $0.35 to $0.40. That is typically normal. I would want to see going in expense to gross income ratio about 35% to 40%.

 

You are typically spending about $0.40 for every dollar you are earning. That can get better over time because if you are increasing your revenue, obviously, your expenses are going to go up. They are not going to go up at the rate your revenue typically goes up, but I would not mind if that number shrunk a little bit, maybe down into the mid to low 30s but I would want to see it around 40% in the first year.

 

Lastly, cap rate. As you know, Jim, in any deal, you can play with the cap rate and that will drive returns. I can underwrite everything at an eight cap and make things look bad on the exit, or I can underwrite everything at a four cap and make it look great. Here is what we do. We do not have a crystal ball. We do not know where cap rates are going. Every single month, we show our cap rate getting worse in our projected hold period.

 

If we go in at a 5 cap or a 6 cap or whatever we are going in at, we are going to end it at a higher cap rate for that project. Specifically, Jim, the deal that you are invested in Tyler Longview, we are showing that exit cap rate at 6.91%. That is a very conservative estimate based on the fact that it would trade below a five cap in this market. We do not know what is going to happen tomorrow or the next year. We need to account for that in our conservatism to be good underwriters.

 

Everybody will tell you they are a conservative underwriter, like, “I am very conservative.” It is like, “You are not doing your job if you do not say that,” or something like that, but what you have to do is, as a passive investor, understand what is my quick, broad checklist on saying, “How can I tell if that is a true statement or not?” Those are the five things that I would look for in any self-storage deal and probably any transaction.

 

Storage may be in a recession or in a bubble, but it might not be in a market that has excess demand. Click To Tweet

 

Those are great metrics because, as a passive investor, I am going to screen the sponsor and get comfortable. Spartan is that for me. I am completely comfortable with Spartan. I am in a few deals, but now I want to underwrite each deal a little bit. I am trusting you to do all the heavy lifting. I want to come in with my five things, and I am going to go, “You got them all. I am probably good to go.” This was fantastic. One question on the cap rate. When I am doing multifamily, you typically see most sponsors that I deal with at least do the exit cap rate about a half-point above what they feel like they are going in at. Are you usually more than a half? Is your rule of thumb 1%? Do you have a rule of thumb for that?

 

It goes up. I do not want to quote what we go up at because it could be different for each opportunity. Think about it if you buy something at a seven cap in this market, you got a sweet deal. It might go down and say, “That is going to go down.” In any case, I do not think we have ever not underwritten something that goes up, at least 25, if not 75 basis points. I would not be too hard and fast on that because it depends on what you go in at.

 

If you go in at a 5 and you end up at a 6, that is pretty conservative. If you go in at a 7 and end up at a 7.5, you are being conservative. It depends on the asset type too. Where is it located? How many units is it? The answer is it depends. I would not be too much of a stickler. I think the five things that I look out at in an underwriting file are mostly the things that lead me to understand the business plan, so I can go into a deal with my eyes wide open.

 

People feel more comfortable with multifamily, and when you branch out into these other assets, it is hard to know how to figure out if this deal is something I want to pursue further. That is great advice. I appreciate comparing everything to multifamily. I want to talk about the exit of a self-storage deal. In multifamily, a lot of people are rehabbing some or most of the units and leave some meat on the bone for the next owner. How do you decide to exit a cashflowing deal? Do you have where you do all the rehab, or do you leave something for the next person?

 

Typically, what is relatable in multifamily is if someone is going to buy a 300-unit apartment building, they are going to take 100 units offline, throw new kitchen packages in, and see the market rents to be higher than that. That is your typical multifamily play. They get to a point where they get the rents to market and their units are online. Here comes a buyer who wants something well done. It is time to exit. That is the idea. To summarize in one word, we want optionality. We are not beholden to sell at X cap rate, at one-off deals, as a portfolio, or broken up as portfolios.

 

We have so many options and what we can do. A great example. We have a facility in Fort Worth, Texas, which we bought for $1.35 million. We put about $300,000 or $400,000 into the deal and fixed it up. We paved the units. We took it from 14% to 95% occupancy and increased the value to over $4 million. We did a refinance, and 100% of the investors’ capital got returned to them, plus the cashflow.

 

Plus, they have got all their money back out of the deal and still own the cashflow that comes off that property and the additional equity that the property gets when it sells. At this time, that deal is a five-year hold in our target projected the whole time, but they have got all their money back. At this point, we are not forced to do anything. We have options.

 

I think it is important to know when you are going in that the operator has the option to pivot in a lot of different directions. That is how we have set up our shop. The other thing that we have done is we have created a portfolio nationwide. We are across nine states, 54 store locations comprising over 25,000 units, well over 3 million square feet. We have a big portfolio. We got a target on our back for someone to buy our whole portfolio and groups have already sat down and said, “We want to buy the whole thing. We want to break it apart and buy pieces of it for a compressed cap rate.”

 

PILF 69 | Self Storage
Self Storage: We’re buying something, adding a ton of value to it, or getting it below market value. We’re selling it when it’s time to sell, or we might be recapitalizing them and doing some refinance or partial sale.

 

While that is an option, it is not the only option. It is an option that presents an extreme best-case scenario, which we have got the ability to do. We have got stuff that we buy that we do not want. I know that is a funny thing to say. Why did you buy it? Sometimes when we buy a portfolio, there are things in it we do not want. For example, we have a chicken wing store North of Tampa. It came with a self-storage facility. I was like, “Are you going to buy this with the chicken wings on it or we are going to sell it to somebody else?”

 

One time we bought a deal that had a carwash on it. We had no interest in the carwash. It was not one of the good car washes. It was one of the crappier ones. We said, “We are going to buy this thing, sub parcel the carwash, and sell that and then we are going to return investors’ capital.” Our bread-and-butter business plan is to make our investors as much as possible and sell when it is correct to sell at the right cap rate and valuation.

 

I think, generally, what we are doing is we are taking investors along on the value-add cycle. We are buying something, adding a ton of value to it, or getting it below market value. We are selling it when it is time to sell, a good time to take our risk off the table, or we might be recapitalizing them and doing some refinance or partial sale.

 

One of the most important things is there are so many questions in the economy. What is going to happen? Can assets keep inflating and everything? One of the things I look for is the ability to pivot your exit. You have multiple exit plans for an asset so that if things do not go according to your proforma or plan through no fault of your own, you have a different exit.

 

I think that is important. I like the way you said that. It gives you a lot of confidence knowing that you can go multiple different ways. That is helpful. I want to pivot here to sponsors. When we are trying to find a self-storage sponsor, how would you vet a sponsor? What questions would a passive investor ask a sponsor to know that, “Maybe this is one that I want to dig deeper into?”

 

Asking for referrals is a tricky thing because we all know that if somebody asks you for a referral, you will not give them somebody that you did not like or did not like. You would probably give somebody that would speak highly of you. What I would do is whenever I ask for referrals, I have a strategy for doing so. I invest passively as well. I am in over ten different syndications. When I am usually interviewing an operator, I will say, “Can you provide me with an example of your worst deal?”

 

You might belabor on the worst deal you ever did and what happened and things like that. We had a property in RV Park that got wiped out in an F1 tornado. That was pretty bad. When the operator gets done describing that worst-case scenario, I would say, “Would you mind providing me with a referral from that investment?” That person might go, “Okay.” You can ask the operator or that investor, “How did it go when that F1 tornado happened, and that deal did not go so hot?”

 

The investor will tell you how the operator responded and performed. That is one thing. I would give them a little bit of a softball and say, “I understand a lot of investors reinvest and they have invested in every deal. You said that a lot of people reinvest. Would you mind giving me the investor that is invested in over 75% of your offerings?” Get the story from them. What do you like about these guys?

 

You can’t know everything about a deal before you buy it. Click To Tweet

 

The last type of investor that I would ask for is, “Give me an investor who is only invested in you one time.” They invested in one deal and have never invested with you again. I know that we are not talking about self-storage specifics right now, but I do like the soft-touch stuff. Somebody could gee whiz you on. They could have a self-storage podcast, a big social media following, and on stage. They could be the perceived self-storage expert, but what it boils down to is they should understand the business that they are getting into. The experience that an investor has had with that group is critical to understanding if you are going to like the experience.

 

What I like to say is things are going to go wrong with our properties, 100%, and any operator is going to have something go wrong with their properties, but do not measure that. Let’s say you have an economic downturn or something go wrong. It is how the sponsor gets the most out of that opportunity when it goes bad. Those external environments come in. It is how does that operate or do better? How do they get the most out of more than what they deserve, given the economic circumstances surrounding that particular property or that investment?

 

That is critical for an investor to look at. People get infatuated by the returns, by somebody they heard on stage or listened to on a podcast or whatever, but it is about, “Let me talk to people that have experienced you to try to see if I am a good fit for your operation.” The other thing is you can take a risk with an inexperienced operator but know that you are taking a risk. If you do that, you should probably be getting an outsized reward for it, like an outsize split or outsize return or something like that.

 

I like the operators that have been in business for a few years, have a portfolio, and can have that scale where they have a team. They are not outsourcing everything. I would be fearful of property management, and our industry is a strategy to acquire your property. On one token, you can say, “That is a good thing because you have got a buyer lined up.” On the other hand, you can say, “The buyer controls your revenue. Is that the best situation? They could artificially throttle your revenue or de-throttle it, or pull it back.”

 

I like the vertically integrated companies. I like the companies that do the whole thing. I like to see operators that know how to build it, how to operate it, and how to find them and get good opportunities that have investors that speak highly of them. It was a long-winded answer, but that would be my answer to that.

 

I have gotten away from asking for referrals because I asked for a referral and get whoever their favorite customers are. I was having a conversation with someone on an investor forum and saying that I had one sponsor, the deal went bad, and the sponsor handled it horribly. I had another sponsor, the deal went bad, and the sponsor handled it beautifully. Guess which one I am going to invest in again? If that second sponsor used me as a referral, I would say, “The deal did not go the way they wanted. It was not their fault,” and they killed it. They fixed it. Everything was great.

 

In our community, we now use each other to find sponsors. A sponsor recommended by someone you know, like, and trust, who is invested with them. With the new way you have asked for referrals, it gets you quality information. I think that is brilliant. I liked that answer. Thank you very much for sharing that with us. There are a lot of new-build apartments going up everywhere. They always seem now to have a self-storage facility on the property. Why is that? Is it becoming overbuilt, or are these like the Class A apartments that have self-storage near them? Are you noticing that? Are you concerned that self-storage is peaking?

 

You can’t say that self-storage is peaking. It is hard to say that blanket statement, like “Storage is in a bubble. Storage is peaking or look at all these charts, graphs, and data.” Storage is hyper-local market-dependent. Storage may be in a recession or in a bubble, but it might not be in a bubble in a market that has excess demand. When you talk about markets, people might say, “Ryan, how’s the Houston market for storage?” I have no idea.

 

PILF 69 | Self Storage
Self Storage: Things are going to go wrong with our properties, 100%, and any operator is going to have something go wrong with their properties, but don’t measure that. It’s how does that operator do better?

 

I will tell you that in this specific main and main address, location, or submarket, it is doing exceptionally well. Even if you are in a recession or an economy, and you think people are going to move out because they can’t pay or you are the only self-storage facility in that market, you have excess demand and you are going to absorb that in your property regardless of what the economy is doing.

 

It depends on how well-vetted your specific location and the specific submarket are. If you want to talk about a market that I would tend to say is not a great market for storage, I will say Denver, but we have a property in Denver that is doing quite well. It is because of where it is located and its surrounding competitors. It depends. Making blanket statements like that is misleading. It may depend on where we are.

 

For example, we built a property South of Seattle, and there are moratoriums in all the surrounding cities for that property. I am not saying that it is going to make it recession-proof or anything like that, but there is a surplus of demand and restrictions on any new properties coming in. It is dependent on where it is. I also know areas of Seattle where I would not build because it is overbuilt. To say that it is one thing or another so assertively, I think, is a bit misleading.

 

You are moving to a fund model and we are seeing a number of other sponsors and syndicators doing that as well. I was always preferring one asset so I could evaluate the asset. My thinking has changed and evolved as I learned and have more experience. I liked the fund model for a sponsor like Spartan, where I might want to invest in 2 or 3 deals a year. Now I can invest that same cash in one deal. Can you talk a little bit about why the fund model? Why are you doing that? What might the benefits be to a passive investor of the fund model over the single asset deal?

 

I am going to go a little deeper than I normally do on the benefits. I will give you a great example. We have $15 million or $14 million sitting in bank accounts for each deal. When you think about the efficiency of that capital, and this is in the eyes of the investor, so you put money into a specific single syndication deal. You may have to equity inject so much to start your construction draws to expand the facility in the future.

 

That cash has to be raised from investors. It has to sit in that account and be inefficient until that money is deployed when you are ready to build. It might take a year or two years to build because you have got to go through all the permitting and entitlement for that expansion so that cash sits. You spread that across to all of our properties, that one specific example, and you end up with all this dead cash.

 

It was sitting there doing nothing so we went round and round. If we could invest it, or we would put it or whatever, the management of it would be atrocious. What this means to the investor is your money is now more diluted because you have to raise more for it to sit there and there are less distributions to go around when you do that. It is inefficient cash.

 

When you go into a fund model, every dollar that is going in is being better utilized across more assets, spreading out your risk, and potentially creating the opportunity for higher returns. Whereas if you are doing one deal, you are putting all your eggs in one basket on that one project and that one deal. Here is the reality, Jim. I know you are above average or way above average doing due diligence on syndication or on a specific property, but I am going to spill the beans here.

 

Do your due diligence on the jockey and not necessarily the horse because you're banking on their ability to find a deal that's well-vetted that they're making a decision to buy. Click To Tweet

 

We do our best to vet a deal. Sometimes, we are so right we do better than we thought. Sometimes we are about on point, but the reality is you can’t know everything about a deal before you buy it. If you are a passive investor, you are definitely going to be way behind where we are. You are not going to the properties. Maybe you do. You are not going through every single property inspection, every single title report, or in all of our due diligence calls.

 

You can’t possibly know every single thing about that asset before you buy it. That is the inherent risk you take. With a fund, what you can do is you can vet the operator, and you can do it when that operator is not trying to pitch you something. If an operator is doing a fund, you have got time to go vet the operator. Go to their office, meet their property ops team, meet their construction team, sit down with the principal, and see how they interact with each other. Do your due diligence on the jockey and not necessarily the horse because you are banking on their ability to find a deal that is well-vetted that they are making a decision to buy.

 

I have talked to a lot of investors about 2022. It is like you try to pick the deals. I even asked an investor the other day, and he was disappointed. We are doing the fund and he wants to do it deal by deal. I said, “You did about most of the deals we did in 2021. Why didn’t you do this one deal?” He said, “I did not have funds at that time to do it. “I said, “Do you have done it?” He is like, “Yeah.” I am like, “If you were at a fund, you would have participated in that deal.”

 

We do not go out and buy whatever we want. We have a specifically targeted bucket that we can buy-in. That is why I think a lot of people tend to stray away from it. Here is the other thing, K1s. We have an investor that is getting 19 K1s for 2021. That is a lot of K1s for investing in every single one of our syndications, and in a fund, you get one K1. It is a streamlined process. The timing issues go away. You do not have to be like, “I am getting $50,000. I want to do this deal. I do not like that deal.” You are getting better timing. You are spreading out risk and cashflow risk.

 

Jim, you have got one deal that is producing nearly a 10% cash-on-cash paid monthly. You might be in something else that may be paid 4%. The blend in that is 7%, 8% depending on how much money you have allocated to each one. I think you get great outstanding out-of-the-park deals. You also get the 2nd and 3rd base hits and make a well-rounded portfolio that does well.

 

That is my reasoning internally. I know this does not apply to the investors but buying self-storage is difficult. Not only because there is not a lot of it to buy, but because the assets are so small. You might buy a multifamily building that is worth $50 million to $100 million. If you found that type of project and storage, you are finding a unique opportunity. To stand up to these syndications, every single time we have a new opportunity is inefficient on cost and internal time. I am spending my time setting up an offering versus spending my time doing more strategic things. With a fund, it takes the pressure off. It is a streamlined approach.

 

That was great information. I had a couple of follow-ups. You had said earlier that you had found 4 or 5 properties by this time in 2021. In 2022, you are not finding anything. You are doing this fund and raising all this money. Where are you going to find these properties?

 

We do have $100 million in our pipeline, but to clarify, we have not closed anything yet in 2022, but we launched the fund. We do have deals lined up that we are going to be closing on here. In the same way, we have always found deals. There is always this old adage like, “When you do a fund, you are going to be lazy about what you buy and feel the pressure to buy something.” That is simply not true.

 

PILF 69 | Self Storage
Self Storage: When you go into a fund model, every dollar that’s going in is being better utilized across more assets, spreading out your risk and potentially creating the opportunity for higher returns.

 

In our fund documents, what we do is we say that your profit starts accruing. The second we buy something and use your funds, your profit starts accruing. Your returns will start accruing and be distributed thereafter. We have a 90-day maximum where you would start recruiting the profit or we have to send your money back. We are under no pressure. We are not going to go out there. The principal, me included, knows we signed on these loans. We are not going to go out there and buy whatever. We have to make sure that we are adding value and hitting the targeted cashflow projections in the fund. It is a tough time to buy, but we are not going to lower our standards in that respect.

 

I hate to ask this question, but you mentioned K1s. I would get a bunch of crap from my readers if I did not ask about the state issue of filing taxes in multiple states. Again, in our forum at Left-field Investors, we have been going back and forth on, is it a big issue? Is it a small issue for the passive investor? My thought is I have invested in funds before and never had issues with state taxes. If I did, it is a small portion of the overall revenue I am receiving the distribution. It is probably going to be less than the minimum required to file an estate tax. Can you talk briefly? Do you think that it will be an issue for investors that they will have multiple state taxes to file when doing these funds?

 

Yes, but not before I give a disclaimer that I am not giving any tax or legal advice. I am not a CPA. Do your own due diligence. Jim and I are having a friendly conversation about what might happen.

 

Thank you for that caveat. I should not have done it. I am glad you did.

 

Do not take this as tax advice, and I am dead serious. I joke around about this, but I tell my team, “You are a walking disclaimer because you can’t give this advice.” Here is the issue. Let’s talk about a composite return versus a regular return. Composite return roles, the tax return and obligation by the state up to the sponsor level, and the sponsor will pay any state and local taxes that are required in the state niches.

 

We are not doing a composite return, but we want to do a composite return. Here is the issue that we are running into. If you file a composite return on that investor’s behalf for the state that the fund buys an asset in, you are only allowed to file one per state. How do we know that Jim does not have another one in that state? We have to go on this fact-finding mission to figure out, have you had other investments in the state? We have to marry that together.

 

That is the last logistical thing that we are trying to uncover, but the answer to your question on no investor left behind here. Let’s be as basic as we can. If you get a K1 from a fund and they do not file a composite return, you might be obligated to file in certain states that require you to pay a state tax on that investment. The reality is it is going to be very nominal, if nothing at all, because you typically have enough depreciation to offset any gains you would have anyway.

 

At the end of the day, I do not think it is a big deal but talk to your own CPA about it. We do not have any state restrictions. We do not buy in California, Hawaii, or Alaska because of proximity. We do not usually buy any New England states, but Texas, Florida, Georgia, Tennessee, the Carolinas, and Kentucky, are the states that we are likely to invest in, and you might be subject to that. We are looking into that because we want to provide the best solution to the investors, but we do not want to create something that we can’t manage.

 

PILF 69 | Self Storage
Self Storage: It’s a tough time to buy, but we’re not going to lower our standards in that respect.

 

This has been packed with awesome information. I appreciate that. Technically the second to last question I ask is, what is a great podcast that you listened to? It can be real estate, airline pilot-related, entertainment, or whatever you like.

 

I enjoy listening to a variety of podcasts. I will tell you what I used to listen to and where I am at. I started with the BiggerPockets podcast. I liked The Real Estate Guys radio podcast. I listened to that quite a bit. Any podcasts that are specific to what I am trying to learn. I use my podcast app like Google. I am like, “I want to learn about startups or corporate culture or things like that.” There are a lot of random podcasts like TED Talks or Planet Money. I like to think outside of the space. I am more of a book guy. We read a book about once a month at Spartan, at least. The last book that I read that I enjoyed was No Rules Rules by Reed Hastings, the Founder of Netflix.

 

If readers want to get in touch with you or learn how they can invest in the fund, what is the best way of doing that?

 

You can go to Spartan-Investors.com and click on the “Spartan Storage Fund 1.” There is an intake form that will get you in touch with our team. If you want to reach out to me on LinkedIn, Ryan Gibson, CIO of Spartan Investment Group, or if you want to email me, I am at Ryan@Spartan-Investors.com.

 

This has been an awesome episode. I have learned so much. Thank you very much for being on the show. Thank you to Spartan for being a great preferred partner for Left Field Investors. We appreciate all that you do.

 

Thanks, Jim.

This is one of those episodes that I will be reading a couple of times. There was some good stuff in there from Ryan. What a great job he did talking about why he chose self-storage. It is one of the best asset classes in the last four recessions. He came up with the easy to own, easy to evict, and easy to maintain. Some of the things that make this such a great asset class. When you buy it, what do you do with its value-add? I was thinking, “Sell some locks, get the U-Hauls in,” but his value-add is to raise rents to market. That is pretty easy. You got to buy them under the market to get that, but that is one of them. He is always adding new units where he can onto the properties. Tenant insurance might add $1,800 a month, but that is revenue.

 

When you increase the revenue, you are going to increase the value of the property. That is great. He killed it when I asked the question about what some things a passive investor can look at to determine if this is a deal you want to invest in? He had five things, gross revenue to make sure that it is not increasing at huge rates and reasonable. There are reasons behind it, both those and property tax. That is the same thing I do with multifamilies.

 

I make sure that the property taxes have to be higher in the proforma than actual because they are going to reevaluate the value. Insurance costs, because all these weather events are happening, insurers are increasing the prices drastically, so you have to make sure that hits the proforma. Expenses to gross revenues he said 35% to 40%. That is another thing that we use in multifamily. That is nice that translates. Cap rate, the same thing where most people 50 basis points on the cap rate for multifamily. He had a hard time pinning down exactly what it should be. It is case-dependent but gave some great advice. I love those things.

 

When the market is like this, everyone is nervous about inflation. There is war and all kinds of things that are going on, and he has options to exit. That is what you want. If the business plan does not work out because of the things out of your control or even things in your control, as long as you have multiple ways to exit, you are going to be okay, most likely. You are going to be better off than someone who has one plan. If it does not work, you are done.

 

I liked the way he said that. One of the things he said was the referrals. I was done asking sponsors for referrals because now, as I have talked about many times, I only invest with a new sponsor if they are recommended to me by someone in my community who I know, like, and trust, who is already invested with them. That puts me way ahead because I have that trust.

 

If you ask for referrals, what are they going to give you their best customers? Ryan decided, “I want a referral from a customer in your worst deal, who is in 75% of your deals, or only invested once.” You are getting referrals, but you are not asking the sponsor like, “Give me someone to talk to that is invested with you.” They are going to give you their number one guy or gal. He is asking for very specific referrals, and that is where you can get some quality information.

 

You add that to how we already look for sponsors by using our community. Now you are digging deep and you are going to find quality sponsors that way. The last thing I want to say about Spartan is that they are a preferred partner, they do have a self-storage fund, and they have given better terms to leftfield investors. We are excited about that. If you are a member of our community and you decide to invest in this fund, make sure that you fill out the form that we have sent out to our community so that they know you are a left fielder. That way, they will give you those better terms as well. I love this episode. I hope you enjoyed it too. We will see you next time in the leftfield.

 

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About Ryan Gibson

PILF 69 | Self StorageSpartan Investment Group focuses on commercial real estate investments. In my role as Chief Investment Officer, I connect individual investors to SIG’s real estate private placement / investment opportunities.

Real estate experience includes residential development, self-storage, in-fill, finance, sales, marketing, and investor relations. Knowledgeable in the tax foreclosure process, development, inherited homes/estates, and real estate syndication.

 

 


 

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