Transcription
How to value a self-storage facility. Storage is very, very unique. So, in this video, we are going to walk through, first of all, what value means, and then how to do it. Price does not equal value. Those two things are not the same. We're going to show examples of one of my facilities, and we're going to walk through the exact numbers, how we came up with a price and a value.
Now, where does value come from? This is the premise of everything we need to understand. There's two sides of value that we have to build up off of to get to what you should be paying or not be paying. And that's the first to understand that there's intrinsic and extrinsic value. Intrinsic value is the revenue, what's actually coming in in the form of revenue. That's it. Extrinsic value is simply price.
But markets don't seem to understand that. We are in a time where the extrinsic and the intrinsic value have switched. Transactions have dropped off a cliff. So, the buying and selling of storage facilities, the assets or the market of it, has just halted back to levels that we haven't seen since 2008, 9, and 10. Because the owners are looking at intrinsic, but investors are looking at extrinsic. An owner is saying, "The price of my asset has not changed because the revenue hasn't changed." Now, you're telling me that the value of that asset last year was $4 million, but today it's only $3 million. And the investors are saying, "Yes, the value of your asset is only $3 million."
In storage, and all commercial assets, value is pegged or attributed to a few numbers. And there's a lot of ways people look at it, but a very simple one that is universally accepted is cap rates. Which a cap rate, in its simplest form, is an expression of a return. So, if you pay a million dollars and it makes $100,000, that is a 10 cap or a 10% return. Now, if you make $100,000 but pay $2 million, that's a five cap. So, the lower the cap rate, the higher the price. The lower the cap rate, the less return theoretically.
Why it's important here is because cap rates do not include things like the cost of money or debt. Intrinsic value didn't change, but extrinsic value did. And the inputs that change extrinsic value don't have anything to do with the asset. They have to do with the market and the effect of the market on investors. That's why these two things are not always correlated. This spread between buyers and sellers is making the market freeze.
We are a value investor, and I actually prefer times when extrinsic value gets haywire because that means I have opportunity to pick up good intrinsic value at a less cost. You need to protect yourself against fluctuations in the market on extrinsic value, things that are outside your control. Because at times when extrinsic value is really high, lots of people are buying and selling because that entices sellers to the market. Volume spikes. This is how we knew we were in a bubble. At the opposite end, volume crashes. A lot of sellers are enticed to sell, but there's so many sellers that have to for lots of reasons. Seller finance deals, they're deals that are under replacement cost, they're brand new. These are things we haven't seen in years. That is where the work pays off. It also means that the market's really unsettled. That means banks don't want to lend money. Investors are scared and unhappy. So, executing the actual acquisition is harder than ever. But the hard work does pay off. It is not immediate. We've already done this after 2008. We took advantage of this.
So, extrinsic, we need to learn to mitigate. Intrinsic, we need to measure, plan, and execute. Intrinsic value is the most important thing because it is what allows you to pay your debt, pay your bills. It is what's going to change the entire landscape of that asset, its potential, its risks, and the inputs that drive that revenue. And that is where your opportunity lies. And we're going to try to make it clear and simple so you know exactly what you should be focusing on and see how we view these inputs. So, extrinsic, intrinsic, how much does this stuff really matter? Now, we talked about what it is. Let's dive into the numbers. This stuff is actually outrageously impactful.
So, to create a baseline here, all things are equal. So, basically, we're just using a deal structure of 30% down at $750,000. Now, to show this, if you had income down and income up, this is the first period versus the second period. So, think of that as year one or year two. All right. So, intrinsic is income. Extrinsic is cap rate. What we're saying is extrinsic, the cap rate, or that price that would it would sell at, doesn't change, but the income does. The income goes down and the income goes up. You see an exact correlation. $100,000 to $50,000, income went down. $100,000 to $150,000, the income goes up. It's exactly correlated. Minus 111%, up 111%. That spread is 221%. Makes sense.
Where things start to get different. Let's say there are no income changes, but the market changes. So, now, not the income, but the market. So, the market goes down a six cap to an eight cap. Remember, cap rates going up means prices are going down. So, a six to an eight meant the price went down. The income stayed the same year to year or period to period. So, extrinsically, the market doesn't want to buy as much, so prices go down, cap rates go up. You have a 55% at a six to an eight cap. All things being equal, the same with this one.
Now, inverse. All things being equal, income period one to period two. But extrinsic, or that cap rate, more buyers come in, so prices go up, cap rates go down. At the same level, except inverse. Six to four. So, you went from a six cap to an eight cap, and then a six cap to a four cap on this one. That is 111%. Now, what's interesting, what you should notice here, all things being equal, is that the effect of the cap rate change, or the market change, is not equal where the effect of the income change is. All right. I know this is a lot of numbers, and you're like, "Okay, AJ, I'm starting to get this." Just bear with me for a minute. This is going to make more sense.
The combination of these things, and where it gets really interesting here, and what we learn and derive from this. Income down, but a market is up. So, your income year one, year two, goes from $100,000 to $50,000. That's the income change change that we saw in the first, the first example. But the cap rate goes from a six to four. That means your income went down, but there's so much demand for assets that somebody is willing to pay you more. So, your cap rate went from six to a four, like we saw in the other chart. And that is a 55%. Remember, on this example, when we went from a six to a four, all things being equal with the income, it went up 111%. But the same effect with income going down is minus 55%. Okay. This is all things being equal. All we're looking at is the relationship. No other examples, no other that stuff, just the relationship.
Now, income up and market down. So, now, let's say the income goes up, but the market goes down. Inverse of this. So, income goes up by the same amount that it went down in this example, and the market went up the same amount that it went down. It's purely an inverse of the 55. We have a positive 27%. This, everyone, is what is important. The intrinsic value, increasing that income, is a much better determiner, obviously, of success. A lot of people in real estate think, "Oh, the market makes you. You just buy it and everything goes up in value, right?" We don't play that game. And you can see market fluctuation and changes in overall market demand, right? Have a big effect, but not nearly as a big effect as the income. In fact, it almost completely cancels it out.
Now, to show the magnitude of these two things, and this is our entire investing thesis and strategy. In fact, this is what we're doing in our fund that is opened up to do our value-based investing that we're doing an opportunistic fund to take advantage of these differences and spreads in the marketplace right now. You can follow the link below to see more of the assets that we have and what we're doing in fund two. This is why this is important. What we focus on is intrinsic because intrinsic value, raising that income, and everything is a hedge against our drop in the market and rates. It's a controllable. Okay.
Now, when you get both of these things right or wrong, which what we do is we focus on intrinsic value and put ourselves in places where markets that are coming in with institutional money and values are rising because of certain types of buyers and different things like that. So, we're trying to get the wave of the extrinsic value, but we're focusing on intrinsic. Income goes up by $50,000, and price goes up or cap rates go down. That same relation. That is a 277% increase. Whereas both of those things going down at the same rate is a 138%. That's bankruptcy. And that is very, very wealthy. The net spread between that is 416. This shows exactly my entire investing thesis and what we have done over the last almost 20 years. Is a focus on finding where that income can go up, but it's measurable. I'm talking about a spread that is measurable and known today. And then put ourselves in place for that.
Now, here's the big thing. Now that you understand that, we're going to dive into the example of my facility. The important thing, and what you want to focus on here, is these controllables. So, how does all of this work into place? What can you do to hedge against these market changes? What can you do to actually find that intrinsic value? The market is something that I hedge against, while the intrinsic, or the income, is something that I build to extract. Of course, the market helps, demand helps, rise income rates, everything else like that. But I don't project those income spreads or anything on future. That's the cherry on top. The other two things we want to get right. I hope you guys understand my thesis and my understanding of intrinsic and extrinsic better through our examples and the relationship between the two.
Now, let's look at an actual asset and numbers and what this may look like. So, this is a very unique asset that we purchased because of the fact that we believe everybody got this wrong. This asset was owned by the state. It came up for auction. We went to buy it. We did not think we would be able to purchase it because we thought that other people would have saw what we saw, and it didn't. To give you an example, this is the large asset that is right here in this location, major freeway exit, high density. This is all multifamily, very fast, big growing market, right in the center of where everything's happening. The appraisal had it at $3 million. We started to look at it, and we realized right out of the gate here that there was something wrong with that $3 million. It didn't fundamentally make sense. There was huge spreads. It didn't take into account a lot of things. So, what we did is we built out our own scenario. We said, "Look at market rates. What is the revenue going on for per square foot?" This facility hadn't gotten rent increases in a decade. They had been run very poorly, high delinquencies. So, we looked at the spread of what it should be doing. And we went to our own bank and we said, "Hey, we want you to do an appraisal on this facility, but here's actually how the market's working and operates." The state didn't do it because they couldn't give rate increases. They didn't want to rock the boat. They just basically didn't do anything with it.
So, when we looked at it, we said, "Here are our numbers." That intrinsic value was everything we were focusing on. We actually ended up buying and closed this at $4.8 million. So, when we looked at this thing, we closed on really almost $2 million more than their appraisal. Now, it should be known that by the time we hit $4.5 million, everyone, including the REITs, had stopped bidding. Everyone except one person, which was U-Haul, at $3 million. They're looking at $4.5 million is that was way too much. What we didn't understand is no one else except us had gone and actually looked at a value outside what was given in that $3 million. Our value and our appraisal came back at $7 million. So, this was still at a discount. They thought we vastly overpaid, and we thought we vastly underpaid.
So, how'd it play out? The first thing we did is we went in, and year one, we had $77,000 in cash flow. By year two, we already increased that to $150,000. By year six, we were at almost $300,000. So, just on a cash flow basis, I mean, we really, we were by year three, we were doing over, you know, 30% already cumulative. Our overall cash-on-cash return, we were hitting 80-plus percent. And this was purely based on a spread that we were looking at measuring. Now, what did that do to value? So, these increases right here in cash flows, which once again, that's the only thing we focused on was the increase in cash flows, okay? That made our cumulative return by year six almost $2 million. We haven't sold it. This is what we did. We refinanced it, but we haven't sold it. The value, the fair market value on that, at this time in year six, conservatively was well over $8.8 million. That gave us a roughly, if you looked at it all together, I mean, we were talking about a 425% return on our revenue basis. We knew that we could achieve very high returns at a level that was almost to about $5 million. And that allowed us to see something that other people didn't. That's the difference of intrinsic and extrinsic. If it was sold or bought anywhere normal, it would have achieved way, way higher sales value. But because of that simple appraisal and that amount that was put on it, it skewed the market, right? And people didn't do their homework. This is a prime example of what we're talking about when we're looking at price, when we're looking at value. The value that we saw and we understood was the difference of $3.5 million, meaning there was a $2 million value difference on this asset from us and everyone basically else.
Now, this change, you guys, in market cycles can trap you. Because if you need to sell or you need to refinance, and the difference of value between that $3 to $5 million, that can destroy you. If you're saying it's worth five, but the market's saying it's worth three, and you got to refinance, there's a problem. And this is what we have seen. We've seen a lot of it. Cap rates have risen, interest rates have changed, the perceived value from buyers, banks, everybody else, even though intrinsic value, most of the time, has not changed. So, what happens is people that need to refinance and they need to sell when extrinsic value is below this line, they get trapped. That's why we lock in our debt as well as our need to sell for 10 years. What we're trying to do is we're trying to even this out. So, in year five, right? We have an option. It's down low. We're not doing that. So, we're going to refinance or we're going to sell closer to that. That's how we hedge against these market cycles. We don't want to sell, we don't want to refinance, we want to have time. And we're not dependent on executing on external factors. That allows us to lock in that liability and through this time, work on our intrinsic and increase our revenue flows. As the revenues increasing, right? And those values go, the spread is really, really big. Price and income, they're two different things. They don't equal value.
Inefficiencies in the marketplace like we're seeing now, like we saw in 2008, are a great time to buy. Why? Because essentially, everyone, you're buying this line when markets are putting a very low valuation on the same income. If this right here is income, that will change to here. Now, I just want to focus on the income increasing it and take advantage of these fluctuations, right? That is the name of the game. You plan and measure on income. We buy. And when we bought that facility that we showed you an example, the spread that we were looking at, that wasn't that we thought the market was going to go up. Our $5 million value, you know, wasn't future. That was today. That was delinquencies. That was what the market could achieve and what they should have been doing today. The difference between income and value that is measurable and known, not future, not future cap rates, not future income. That's the spread. And that's our strategy. And that's how we look at value. And you should too. Identify on every project, intrinsic or extrinsic, where do those two things converge? Where do they separate? And that's where you find the gold. Make sure you subscribe, like, and please comment. What are you seeing today? Comment. Are you guys seeing separation? Have you found any great deals? I want to see about it. We'll keep telling you about ours and what we're seeing in the marketplace. Thanks, everybody.