It’s not uncommon for self storage investors and those in the industry orbit to have a limited understanding of cap rates. Certainly, they may know what’s considered a “good” cap rate but may not have a full mastery of the equation that created it. In this article, we’ll define and demystify cap rates, apply it in a real-world example and offer guidance on their importance in self storage investment decision-making.
Cap rate, short for capitalization rate, is a core measurement used to estimate a property’s ROI. Imagine having a crystal ball to tell you what kind of profit and security you’ll receive on a potential investment. That’s the goal of a cap rate. A property’s cap rate is measured utilizing a simple equation: The asset’s net income (NOI) divided by its value, expressed as a percentage. That percentage, the cap rate, acts as an estimated return on the investment and level of risk.
For a self storage investor, cap rates are best applied when comparing self storage properties or determining an accurate value of a property or what you’re willing to pay for it. Let’s say you have your eye on a self storage facility listed at $1.2 million. Your team’s research tells you that the expected NOI on the property is $347,000 and comparable self storage facilities in the area carry an average cap rate of 4.65%. Using the cap rate equation, you can determine whether the property is in line with the market or worth your investment: $347,000/$6,940,000 = 5% cap rate.
While our above scenario is simple, self storage valuations are anything but. That’s because establishing a cap rate relies on highly accurate asset value and NOI calculations. Miss a key component on either of these values and you’re left with a false cap rate. It’s critical you work with a trusted and experienced brokerage team that can navigate the nuanced art of valuation.