Real estate has long been a favored investment avenue, offering stability and potential for significant returns. However, within the broad spectrum of real estate investments, there are distinct categories, each with its own set of advantages and challenges. Two prominent categories are alternative commercial real estate (self-storage facilities, mobile home parks) and traditional real estate, such as single-family homes and offices or malls.
Let's delve into a comparative analysis of these two, highlighting the potential returns, cash flow, and other pertinent factors.
Expense Ratios: Lean Operations vs. High Maintenance
Self Storage:
One of the standout advantages of self-storage facilities is their low operational expense ratio, typically ranging between 25% to 40%. Minimal maintenance requirements, low utility costs, and streamlined management contribute to this lean operational model. At Patriot, we operate a remote leasing model with little onsite overhead, further boosting net operating income.
Traditional Real Estate:
Offices, apartments, malls, single-family homes, or other traditional real estate assets often have higher maintenance costs, a need for onsite management, property management fees, high turnover costs when new tenants move in, and other associated expenses. These can significantly eat into the potential returns.
Lease Flexibility: Adapting to Market Dynamics
Self Storage:
The predominantly month-to-month lease structure in self-storage facilities offers unparalleled flexibility. In inflationary times or when the market is booming, operators can adjust rental rates upwards almost immediately, ensuring that revenues are always optimized. At Patriot, 70% of All Purpose Storage customers are on autopay, allowing for easy rent adjustment and collection.
Traditional Real Estate:
Leases for offices, single-family homes, or apartments are typically longer-term, often spanning several months to years. This fixed structure can be a double-edged sword, providing stability but also potentially locking in rates that might be below market trends.
Ownership Landscape: Diverse Opportunities vs. Consolidated Markets
Self Storage:
Over 80% of self-storage facilities are owned by smaller, 'mom-and-pop' operators. This fragmented ownership landscape presents numerous acquisition opportunities for investors, especially those looking to consolidate and optimize these facilities.
Traditional Real Estate:
Single-family home, office, and retail assets, in contrast, are more consolidated, with larger players and real estate investment trusts (REITs) holding significant portfolios. This can make entry and expansion more challenging and competitive.
Income Diversification and Economies of Scale
Self Storage:
A single self-storage facility offers multiple units for rent (typically 100 to 200 + units), ensuring a diversified income stream. If a few tenants vacate, the impact on overall revenue is minimal. Additionally, larger facilities benefit from economies of scale, with management, marketing, and maintenance costs spread across numerous units.
Traditional Real Estate:
A single-family home or large industrial warehouse, on the other hand, is a singular asset. If it's vacant, there's no income. Even for larger retail and office properties, there is less diversification, making cash flow more volatile if a tenant leaves.
Other Advantages of Self Storage Over Traditional Real Estate
Scalability:
There are multiple ways to scale a self-storage portfolio - from expanding an existing asset to developing or acquiring new assets. New development and expansion costs are much lower than other asset classes - making this a very profitable way to grow revenues and net operating income. Centralized management systems, standardized unit designs, and unified marketing strategies make scaling more seamless. The cost to build a self-storage facility is approximately $40 to $90 per square foot vs. $100 to $200 + for other real estate asset classes.
Recession Resilience:
As discussed in previous articles, self-storage facilities have demonstrated resilience during economic downturns, often outperforming traditional real estate assets.
Lower Turnover Costs:
With self-storage, there's no need for extensive renovations or refurbishments between tenants, leading to lower turnover costs and quicker unit readiness. If a tenant vacates a mall, office or multifamily residence, there are often significant costs to get the unit ready and leased to a new tenant.
Conclusion
While traditional real estate investments, like offices, malls, multifamily apartments, and single-family homes, have their merits, the advantages of self-storage facilities are hard to overlook. From lower expense ratios and lease flexibility to diversified income streams and scalability, self-storage presents a compelling case for investors seeking robust returns and consistent cash flow.
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