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223: Self-Storage and Why Boring is Sexy

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Buck: Welcome back to the show everyone. Today my guest on Wealth Formula Podcast is Mr. Lew Pollack. He is the managing principal of Reliant Real Estate which specializes in self-storage facilities and now a partner of RWF Partners which is our new partnership between Reliant and Wealth Formula, which of course that’s where the RWF comes from and that’s where we’re going to combine our skills and operations and strategy etc to bring our community of accredited investors you know some really nice curated self-storage opportunities. Obviously, we’re not going to talk about anything specific related to that right now but that is who Lew is. He has been in this business for a very long time and I’m excited about the partnership. Lew welcome back to Wealth Formula Podcast.

Lew: Well thank you very much, Buck. It’s nice to see you again.

Buck: So Lew just to reacquaint yourself with our group here our audience, you’ve been in the Self-storage business for a very long time. Why don’t you give us a little idea of how you got started in Self-storage because as I look in your resume what’s striking to me is I think you have a Ph.D. in education from back in the 70s right?

Lew: That’s correct. I was a schoolteacher that’s a natural segue into Self-storage. Oh of course that’s what I was thinking when I went to graduate school at UCLA and when I finished I realized I wasn’t going to earn more than I had earned as a teacher five years before that and decided I need to earn more money. I had a friend in Santa Fe New Mexico who invited me to come and learn the real estate business which I really didn’t know much about and so I moved to Santa Fe basically because I liked the idea. Literally the first day I got there I tried to find a place to store my belongings and could not. Now back in the early 80s late 70s Self-storage was really a garage or a Quonset hut and Santa Fe being a small town really didn’t have anything larger than a Quonset hut. I met another gentleman there who eventually became a partner of mine and we both agreed that this was a problem and how hard could it be to build some Quonset huts. We hired an engineer we hired an architect other professionals we found a piece of property and without much thought about it. We went ahead and built a 30,000 square foot building which was back then a big deal of non-climate control. We built it, it filled up we paid it off in three years and that was kind of the start of what I thought would be a successful business.

Buck: Yeah and obviously it’s worked out I mean you know tell us a little bit about the Self-storage business model in general that really makes it an attractive asset class. Obviously you know I think my audience is very familiar particularly with residential real estate and apartment buildings and that sort of thing but what is it about self-storage that we ought to know potentially to look at it as you know something to invest in at some point?

Lew: A few things firstly it’s robust because a typical self-storage facility of ours has anywhere between 800 and 1000 tenants. It would take quite a bit of disruption for us to see a significant reduction in their operating income. In that regard almost any event including a pandemic has very little effect on us in fact in this case with a pandemic it’s actually helped us. So being a robust business is one thing. Secondly, it is a management-based business. 50 or more of this business like the hotel business is management and our philosophy is we give our on-site managers a great deal of responsibility in making sure that we are managing our clientele and our cash directly and every day. So one it appealed to me one because it’s robust secondly because it’s a management business and I know how to manage as does my partner Todd Allen and thirdly it is a passive income in such that I don’t have to show up every day on-site to see what’s going on. The revenue will continue whether we’re there or not there for a particular day or a week. Of course we do have to keep our eyes on it but recurring revenue is something as you know in the apartment business is something that’s very appealing to all of us.

Buck: Sure you know what’s one of those things that a couple other things that I think that are unique to this and maybe you can speak to them is one there’s no real tenants there and so you know that’s got to be advantageous especially now I mean you can’t really have any facilities. You’re not gonna have a tenant strike right. And the other question that I have for you is generally speaking, how quickly can you drive up rents in these spaces because as I recall that is probably one of the most unique aspects of this kind of asset.

Lew: That’s true we are our business reliant real estate management is a subset of Self-storage and the subset we are a niche business, we are a value add company. We look specifically for troubled properties that for one reason or another are not performing as well as they ought to in our eyes. Typically because the industry is fairly fractured we’ll find mom and pop operated stores where the rental rates are not nearly where they ought to be. Management is loose they don’t collect late fees, they don’t have all the products that they really need to have to compete with the REITS in any area for instance truck rentals security management is not well trained. they’re not enough fencing, all sorts of things go into why a facility is not performing the way it ought to and we pride ourselves on being able to turn those things around and add value to what we buy. And because like apartment houses, self-storage is valued on its net operating income, we can take a facility within 18 months and turn it completely around adding 20 to 25 income and the value goes up consistently higher than most other investments. We’ve seen over the years that we can add 40 to the value of a business in a very short time.

Buck: I mean that’s really just math right I mean for those of you who are out there and you know you’re you might be an investor club already but we talk about this all the time. If you are dealing with these larger real estate assets they are you know ultimately selling on a multiple we call it Cap rates right and if you have a cap rate that’s a relatively constant in over 18 months you’ve increased the value of it significantly you are going to end up being able to sell it for a significantly higher value because it’s based on a multiple and then you add leverage to that. So that’s where you know being able to drive up NOI very very quickly is pretty unique in this situation. Now you know let me ask you this obviously we’re in the middle of these extraordinary times and you kind of alluded to how things are going with Covid19 but tell us a little bit about the portfolio and how it’s performed you know through this pandemic mess.

Lew: Well our income has gone up on a monthly basis by a significant amount. And part of that is due I alluded to the cash management aspect of our business but also to marketing. Prior to the pandemic, we had switched over to a web-based marketing system wherein a potential tenant can actually sign on and lease over the web not having to come into the store. That kind of mitigated the circumstances where thirty percent of our clients come through drive by to seeing it. We’ve compensated for that with the web-based app and in fact we have surpassed what we were doing before the pandemic. On top of that is the fact that our clients are not moving out. They don’t come to see the belongings.

Buck: They’re not going anywhere right?

Lew: No they’re not. So our return is normally 30 it’s dropped down to below 10. So we’re keeping the clients we have it’s always our philosophy to raise rents when we can and we continue to raise rents during the pandemic. Our occupancy typically 80 percent is the low end of where we are, as high as 90 percent and we are edging toward that with all our facilities. So we’re in a very healthy position. I would say the only facility that is not doing as well as we had hoped is one that we built out of the ground and because school hasn’t started, it’s very difficult to rent up when people are not moving so even that one is running up but not as quickly as we had hoped.

Buck: Yeah so basically what you’re seeing is maybe there’s a little bit of a decrease in new people who are coming in to put their storage stuff in there but you’re making up for that in the part of the portfolio that’s already been occupied.

Lew: That’s true there are some other factors that we weren’t expecting. One the government loans which we’ve taken full advantage of to help us get through the tough times, although we never really needed the loans to get through the tough times they certainly are nice to have. The statistics on what’s happening nationally are just that, they’re national. Self-storage is a local business, it’s a five-mile radius business. And so we’re unique in that we only go in second and third-tier markets we don’t go in primary markets where which are typically over supplied with Self-storage. So that also adds to what we’re doing because as you’ve read in the papers, I’m sure many people in the cities who can are moving out to the suburbs and that has also helped create what we see as a surge coming in the last quarter this year and next year of new tenants.

Buck: Yeah it’s interesting so there are some asset classes that are that appear to be, in the grand scheme of things, sort of for better or worse benefiting from the current situation. Certainly in working-class apartment buildings are seeing the same thing and it sounds like you know the Self-storage space is sort of experiencing something similar. You know I gotta ask you in comparison to you know because in 2008 we saw a similar self-storage resilience during the financial crisis. Why was that and you know do you see any parallels between that and what’s going on now?

Lew: Well the only peril I can see is that there was a recession. The recessions were caused by different reasons, obviously, the pandemic was the factor that caused what’s happening now. Back then it truly was almost a depression. The only thing that changed for us was the character of our tenants. Small, independent contractors who depended upon the real estate construction boom moved out and kind of disappeared but they were replaced by residential folks and in 2008 there was really a dearth of product. There was a huge influx of new construction that went on between 2008 and 2018, the number of facilities went from 37,000 to 60,000 and yet most of those facilities were built in major metropolitan areas. And so we are left with still a pent-up demand in the areas we are in. And so this recession is kind of artificial. We still see people needing and being able to pay for what they get, which happened in the other recession in that regard they were the same. This one, the only other similarity is that people continue to pay their rent and our accounts receivable is typically three percent, we’re at 1.8 percent now which is very low. We consider that to be because people don’t want to lose their belongings, we don’t like selling their belongings but most people don’t want to leave their stuff to be sold.

Buck: Sure. You know again going back to this idea that you know Self-storage performed pretty well even through 2008 at the national level and I know in conversations with you that certainly, your portfolio did not significantly suffer during that period of time. Assuming we come out of the current recession, again in a similar situation relatively unscathed, what happens to prices in this space after that?

Lew: Well this is there’s a crystal ball question, but in our opinion if cap rates remain where they are and we continue to gain NOI, there’s no reason to think that what’s going to happen three years from now which is typically our low end of what we’re looking at, why we wouldn’t be seeing the same gains that we see under any other circumstances.

Buck: Do you do you think Lew, I mean part of why I’m asking that is I would think that you know coming out of this recession I think that there are certain asset classes, for example, I think it’s the same is true for our working-class apartments which are doing extremely well during this time that there may be additional movement from you know larger investors into the space because they start looking at it potentially as you know a little bit more of a safe haven asset.

Lew: Well it’s already it’s already started to happen there’s a you probably know there’s a huge amount of venture capital yeah that is around for safe haven and certainly commercial real estate doesn’t look very good right now and this asset class during the last recession and even now outperforms everything else that one could look at. So there’s no shortage of appetite on behalf of the REITs who only grow by acquisition or others we’re not really, to say we’re not worried is an understatement. We’re very optimistic about what’s going to happen in the next three to five years.

Buck: What’s ironic to me, and again this has a lot to do with your own ability to manage these assets and really create value with the value-add programs that you have. But thinking about this as a potentially safe-haven asset is kind of funny when you think about it, I understand and talking to you and todd before that you know the types of average investor returns have you know annualized have been in the 40 range, is that true?

Lew: Yes and it’s because of what we are we had already discussed about we try to buy them at what amounts to a steep discount and through our expertise and experience kind of jerk these things into where they ought to be.

Buck: Yeah nice safe haven numbers there though I would think so that’s great. Of course, you know these numbers don’t happen just like that and you talk a little bit about you know the role of good management and that sort of thing requires a good business plan requires flawless execution. You know you mentioned sort of value-add but can you dive into that a little bit more I mean you know one of the things I think is interesting is you focus you know a lot more on A-class facilities. Why is that? You know when you look at these tertiary markets what are you looking for and you know what kinds of business plans do you know what do those broadly look like?

Lew: Okay well firstly I’ll let you know, you know this already. We have a department that is devoted to doing nothing but culling through 100 facilities a month to see and we get them in all different ways they get thrown over the transom by people that know when we put something under contract we close. In fact in the past 10 years there’s only one facility we did not close on a deal at the price we gave them. So we have our own internal appraisal department that scans everything and so once we find a facility whether it’s in bad shape good shape poorly managed or not that is in a location that we think can be brought up to class A quality, and I’ll get to what that means in a minute, then we’re not afraid to dive in. So we do a couple of just generally speaking analyses one is competition the other is demographic. So first we want to know how many people live in that area and we use certain algorithms to determine how many square feet per head that area can sustain without worrying about diluting other storage facilities, the competition. Secondly then comes competition how many square feet is available to that population now and if we built one, would it impact the rest of them, are we just diluting the soup. So once we’ve convinced ourselves that both of those metrics are in our favor we are willing to take a risk on that property. So we’re very careful about what we go after and again they have to be at the price point that we know if we do what we need to do that we can increase rates significantly over a two to three year period. As I mentioned earlier the industry is fragmented. Most of the industry is not public storage or extra space, it’s just mom and pop, I call them mom-and-pop people that own one to five maybe six, seven facilities all in all. And those people, some of them may be sophisticated but a number of them are not. The metric they use when we first come in which is music to my ears is our clients love us and yeah to me that means the rates aren’t high enough. I know that sounds brutal but that’s really how we think. They’re not at market rates then these people are leaving money on the table. We’re looking for those types of opportunities. Now I mentioned the class A facilities we’ve always thought that the best facility in any category is the thing that sells first and for the highest price so we’ve decided that anything we do has to end up being a class a facility class a meaning security, it’s got good security, it’s well maintained, the management is well dressed, uniformed, courteous, well-trained, the unit mix is a good one so that any unit that someone might want is available, the advertising is first class, we rent trucks, we have a showroom that we sell all sorts of retail items in. All in all when people walk in, and people means women. Sixty percent of our clientele rent are women. And so when a woman walks in our showroom, she’ll walk into a well-lighted place that has clean bathrooms, has well-stocked and orderly looking materials, that our managers stand up when they walk in, give them a tour of the facility, anything that you can imagine that any good retail facility of any sort would want as a showroom is what we try to do and when we go up against any of the REITs in a particular market area we want to be the best in class in that market area. So if all things are equal a client potential client would rent from us rather than someone else.

Buck: Let me ask you a question here for those who are again part of the Wealth Formula Accredited Investor group, for example, they see frequently you know these business plans in the apartment buildings where you know there are very discreet you know very typical types of value-add things that you do you know, you’re putting laundry machines in you’re renovating kitchens and you know putting in nice floors. What does value-add look like typically? Give us an image of what that looks like in Self-storage.

Lew: There are several different things that we would do. The variables are one, rent rates for sure, that want to make sure that our rental rates are eventually at market rate, and typically the ones we buy are 25 to 30 lower than they ought to be. So that’s a value-add feature that’s a given. Secondly, most of them need to have deferred maintenance of one sort or another. Air conditioners aren’t working, paint peeling onto walls, just lack of maintenance, there’s dirt on the floor, so we always rebrand these facilities, new paint, everything is fixed, it’s kind of the Rudy Giuliani theory of you know you don’t want to see a broken window. Thirdly, security. We always have fences, we always have electronically monitored gates, we have cameras everywhere. Fourthly well-lighted, no one wants to walk in a facility where you can’t see where you’re going and you know if you’ve been you’ve been in storage facilities they have long halls and they’re kind of dreary looking if you don’t have them well lighted well ours don’t look like that there there’s there is light as one can have them. So security, fencing they have to be paved, I know that sounds funny to someone that lives in a suburban area but a lot of these places come with dirt aisles between them so we have to do that. A significant other element would be additional space. As an example, in one facility we just bought in Florida about two years ago it was 50 000 square feet of storage, which seems like a decent-sized facility and it is it had another three acres next door that came with it and we decided it could stand another 50,000 square feet. So we doubled the size of that facility and it filled up in six months. So value-add well we added value by building more and as you said we’re leveraged so every dollar we get is three times what it is because we don’t borrow that much against them. And then there’s management. I mean typically a mom-and-pop store is managed by a mom and pop. And if they’re not mom and pop they’ve hired somebody at minimum what rates, not well-trained, not uniformed, they don’t look professional. We train everybody we have they have to be on staff for six months as an assistant manager before they even get the opportunity to be a manager. We have residential we have residences at every one of our facilities because we want our managers to have ownership of the facility. Now we control everything, pricing included, from our central office in Roswell Georgia but these folks take responsibility and they sign off on our budgets and they are responsible for making their quotas on sales. So to give you an idea of how happy our staff is our average length of stay for our managers right now is eight years. So yeah we pay them well, we pay them much higher than the industry standards and we expect them to perform well and we outperform literally every other chain I know of.

Buck: I’ve not even stayed the same kind of career for eight years. I know you said you don’t have a crystal ball, I think we have some idea, if you’re asking me you know you’ve got a situation here right now where you know if this comes out the way we think it’s going to come out and another repeat of you know some you know safe haven type results through this we may be looking at some additional cap rate compression but there’s an additional factor, that the future in my mind plays a big role in self-storage and that’s demographics. Tell me how an aging population of baby boomers affects self-storage.

Lew: Well the aging population, I’m in the aging population demographic, so you bought all these belongings for your ki and you say what am I going to do with them if I’m going to downsize and the answer is you don’t want to sell them because you get nothing, you think your kids are going to get them eventually, so that’s a fairly significant number of people that once they put it in there, they never want to sell it, I know this sounds cynical but that’s the way it is. The young folks who are moving from apartments to houses have to store their things and if they’re downsizing if they’re going to new housing which doesn’t have the closet space or the garage space that they may have had, have to store their things as well. So we get them coming and we get them going.

Buck: Yeah I mean I think it’s a really interesting to see what will happen in this space is this you know I guess you are a self-described aging population yourself but you know more and more people are downsizing from the McMansions and from the larger homes and then you’ve got a new generation of individuals who don’t seem particularly interested in those homes so where does that stuff go you know and that’s a big part of I think one of the driving factors for growth in Self-storage as well. Anyway, lots of different things I think we could talk about but Lew, is there anything else that you want to say about Self-storage that we should know?

Lew: Generally speaking we’ve covered what we need to. I think talking about the robust nature of our sector which is a very narrow sector is the most compelling argument for any investor to know that if they put their money somewhere it’s not going to disappear because an anchor tenant has that they thought was going to be forever like sierra’s roebuck has vacated their 20% of a shopping center. It’s robust because of the elements I told you.

Buck: No tenants, no rent strikes, right?

Lew: We haven’t had a rent strike yet. They don’t talk to each other while they’re there. There’s so few in there on any given day I don’t think they can organize it. It would have to be a two-person rent strike.

Buck: That’s right, that’s right, fantastic. Listen, Lew, it is great having you on the show. We are looking forward to continued partnership in the future and we’re looking forward to you know hearing from you in the Wealth Formula Accredited Investor Group. Thanks for coming back though on Wealth Formula Podcast.

Lew: It’s my pleasure and we really are excited about our partnership going forward and look forward to many happy days.

Buck: We’ll be right back.