Everything You Need To Know About Investing In The Self-Storage Arena

Hey, it's Mark Podolski, the land geek with your favorite niche real estate website, www.thelandgeek.com. and today's guest is really going to be interesting for most listeners because we don't really talk about this asset class very often and I'm really excited about it. My co host, Scott Todd is not available today, so we are just going to get into it. Today's guest is Scott Krohn from Coda Management. So if you don't know Scott, he is the founder of Coda Management Group. And Coda Management Groups teams up with investors to purchase strategically located undervalued warehouse space and convert it into climate controlled self storage facilities. And they are a top three operator. So this is really, really an interesting asset class. I can't wait to get into it and get in the weeds with Scott Krohn. Scott Krohn, how are you?

I'm doing well. Thanks for having us. I appreciate it.

Yeah, yeah. So you've been doing this a while, haven't you?

I started Coda 20 years ago, but I've been involved with real estate and real real estate investing for about 25 years now.

So, Scott, you wake up one day and you're like, okay, let's do this. Like, how does that even come to.

Be real estate or self storage?

Well, taking a, we're taking an undervalued warehouse space and converting it into climate controlled self storage. Gotcha.

You're all right. It's not like one day you wake up, you're like, I just want to, you know, build lockers. Right. It's not the most sexy real estate investment out there in terms of appearance, but, you know, it's a gradual progression. I began my career doing multifamily working for a top 20 developer in the country and got to really see the ins and outs of larger real estate deals, up to $100 million. And so when I started COTA, obviously I didn't have that bandwidth. But we began doing multifamily and smaller, mostly single family and smaller multifamily projects in mixed use. And then the crash came in 0809 and we began buying into the commercial realm. And that's when we began seeing that there were some real inefficiencies within the self storage arena in terms of new product coming online. And there were some market discrepancies that we could take advantage of. So to me it's apartments without toilets. It's a more simplified version of it. So our cost basis is about a tenth of what it would take to do apartments or multifamily. So there's a lot less risk and we can analyze the market a lot more specific, tangible results. That way we can make sure that our products are going into healthy markets.

Yeah, really, really interesting. Self storage is one of these interesting asset classes that we all see it on the side of the road. I mean, everyone's kind of familiar with maybe sureguard and some of these bigger players. I think what most investors don't realize is that it is the safest asset class in real estate. It has the lowest default rate of all asset classes. And interestingly enough, second is mobile home parks. Did you know that, Scott?

We did, which is one of the reasons why we studied it and looked into is because of the fact that we're not confined by a lot of the tenant regulations and laws in terms of, you know, evictions and those sorts of things. So it's, you know, we can base the price pretty fluidly, you know, what is going on in the marketplace. So it's a lot easier to get leased up. It's a lot easier to manage on a daily basis because the fact that there's just not as much headache to deal with. So, you know, our cost basis, while multifamily might be 45 to 55% of your economics were like a 35 to 40%. So we inherently have a cost basis differential right there.

I love it. Is it fair to say that in the way that you acquire the warehouse space and then do the conversion that the value is really in that piece as opposed to, let's say I'm going to go create a syndication for multifamily and really if I'm going to buy a C class apartment building and upgrade it to B and do a value add that way, the money is kind of finding the deal is one aspect. But really money is going to drive that. So if I'm the investor, it's like, well, the money is really driving this deal. I think you could make the argument that in your asset class, management really drives that deal. Is that fair to say?

I believe so because of the fact that when we are taking a building and repurposing it, we're buying it well below replacement cost. So if I'm comparing our building to a brand new one, we're at 65% cost valuation, you know, and so we can enter into a market knowing that we can effectively undercut the pricing to get people in there because of the fact that we have a margin of 35% there because of our Cost basis. And so for us, that's a huge competitive advantage. If we're comparing our product to new self storage, we're coming in, you know, significantly below replacement cost. I mean, the last building we bought, we bought it for $11 a square foot. It's a five story building. I just can't build a building for $11 a square foot.

That's insane. That's insane. So given your expertise, what's some of the biggest mistakes you see people making in self storage?

Well, you know, I can't speak to everybody. The thing that, you know, that drives self storage is really not if it's a growing economy or recessionary economy. You know, self storage will thrive on either one. In fact, some would argue that it even does better in a recessionary market. We've seen greater cap compression on the purchase of self storage facilities in a recession rather than in a growth period. So the biggest factor is saturation level. When I see people going into a market that already has a tremendous amount of self storage products in a very saturated market that is going to delay your lease up, period, it's going to hurt your pricing, you're going to get less revenue. So those are things that are going to put pressure on it. I was just at a conference and one existing operator was looking at buying another facility. And, and you know, the operator, the current operator was selling it because there's new product coming online. And he was trying to evaluate, you know, how much this was going to negatively impact his facility. Was it going to be a class A facility versus his being a class B, you know, class B meaning partially environmentally controlled versus 100% environmentally controlled. And my response to him is, well, this is your stress test. This is going to be, you know, the evaluation. How, how much can your product absorb with this new product coming online? And so you should be looking at this as a stress test scenario in terms of what your valuation should be when you buy the property. And if you overpay for it, then you're going to be at a competitive disadvantage. If your pricing is above the stress test level, you got to be below the cost of that. That new product is coming online and that's how you'll know if you can enter the market in a safe position.

Very interesting. So in self storage, is it all about location, location, location?

100%. It's down to a three mile to five mile radius. Every time we enter into the market, we're doing feasibility studies not just on the city, but specifically on that location. We looked at one location in Milwaukee That I immediately knew that the demographics did not support it. There was a tremendous amount of single family homes, but as I looked around I could see five or six other self storage facilities. And so I just had the immediate premonition that there's going to be way too much product already online for that demographics. And we went to another location and there weren't, there wasn't any. And so the first one was way oversaturated, it was above the saturation level and the second one was tremendously below it. And so that's why we ended up buying the facility that's tremendously below the saturation level. And these are both within the Milwaukee city limits.

Yeah, very interesting. One of my clients, Jeff Dettmer is in self storage and bought and sold the self storage facilities, looking to buy another one. And he kind of like we'll kind of talk about it casually and he's like it's really hard now to find good deal. And so why is it so hard to find a real value add self storage facility? I mean, what's your solution to that?

The reason why it's hard to find added value is that you know, the easiest way to do that is through expansion. So if a facility, you know, let's call it a traditional class C or class B, when I'm saying class C, that's not a bad neighborhood, that means it's third generation. So your typical drive up facility, which the site may or may not be paid, but you have your basic garage lockers all in a row and they're not conditioned. Class B would be that same sort of product, but having conditioned facilities. Class A would be fully conditioned drive in, you know, more urban type setting. So let's take a class B or C. The only real way to do value add is either through improved management or expansion. And so a lot of times expansion is not possible. So if you're looking at improved management, you may be looking to raise your rental rates, cut your costs a little bit, but there's going to be a small amount of gap within that that you can really improve upon. Now if you're a single operator, that could be some serious significant dollar for you. But if you're working with investors, there's just not enough margin there to make it worthwhile for everybody. With what we are doing, we are taking buildings that are not even self storage. And so that's how we're doing the value add. We're actually creating the product as opposed to expanding the product. And that's the main differentiation of what we're doing compared to what others are doing. When we were at this conference, I would say 90% of them were non developers. They were looking to buy an existing facility and add value to it. We were the only ones that were buying non facilities and adding value to them to make them into facilities. There's one other developer there. We were the only two developers out of the group of probably 50 people.

So what's the biggest risk then? Because when I think of developer, I think, well, you know, we looked at stats. 85% of developers go under now. The 15% that survive go do really, really well. But often they end up running out of capital in the development phase. So how do you sort of mitigate that risk?

Well, my background is I got my master's in architecture from Illinois Institute of Technology and my first job was working for a developer where we did design, build. And so we were the developer, we were the architect and we were the contractor. So that's the background that I learned. I learned how to build and how to put together the financial performance and the design and all those things. So that is how we mitigate it. Because we're controlling the build ourselves. We're not just looking to hire someone to do it for us. You know, we've developed over the past 25, 20 years within our company of developing the systems to making sure that we build it appropriately and do it well. And so that is how we mitigate the risk.

Very interesting, very interesting. So how do you create massive value by changing a property's use?

Well, in commercial property, it's all driven by your noi, your net operating income. So if you can take a facility which might be, I'm just taking round numbers, making, you know, $200,000 in rent off of it, and you can increase it to a million dollars of revenue off of it. And you, granted, let's say your, your costs are increasing. Well, so if your NOI goes from $100,000 to $600,000, you're increasing the value, you know, fivefold. And so that's the biggest distinction of what we try to do within commercial properties is just increasing the cash flow because that will drive the noi and then that will drive the cap rate.

Very interesting. How long is your hold? Typically?

It's a three to five year hold. We like to describe it as a, it's not a microwave investment. It's a crock pot. You know, you gotta let it develop and come to, you know, full cooking, if you will. And the longer we hold it, then the better the Investment is, you know, my philosophy on real estate is the perfect time to sell is when you don't have to sell. You know, if you can hold it until you don't need it, then you'll get the best valuation for it.

I love that. The perfect time to sell is when you don't have to sell. That's fantastic. So for somebody that was really interested in learning more about the ins and outs of self storage, self storage investing, what would you say would be a good way to learn more? Because there's not a whole lot out there, is there?

It is a little bit of an untapped resource in terms of education. You know, people say, well, where did you read about in the book? And I didn't. I learned about it by doing it. I was doing it for another client. And then we saw how to do it and that's how we began doing it. We have created a lot of blog posts about it to educate people on it. One of the resources that we use to help our investors is when we do obtain these feasibility reports, we do give them to our investors and they're about 200 pages in length and a lot of it, let's just say 10 pages is what we need to identify whether if the project site is good or not. The other 190 pages deals with explaining the market. And so a lot of times we'll forward that on to people just so they can get a third party understanding of what the industry is about and how to evaluate it, how to assess it and what's happening across the country. So the other things that we do is we get annual reports from different brokers across the country and then we also post those out to our investors so that way that they can see what's happening on a larger scale across the country in terms of the self storage market.

Very interesting, very interesting. Are there certain markets that you like more than others?

Absolutely. I mean right now if you look at the country with the east coast being on the right and the west coast being on the left, and if you drew a circle from New York, half circle all the way around to Seattle, going down through the south, those areas are tremendously oversaturated in my mind. And so those are areas that we're not necessarily avoiding, but we're not running into. And so what we are doing is we're looking at the Midwest in underserved areas. So you know, non major cities. So you know, not Chicago, we're no longer buying in the Chicagoland market, but we're looking outside of that so right now we have investments in Wisconsin, Illinois and Ohio.

Very interesting. So will you talk to brokers then and say, hey, look, we're looking for undervalued warehouse space. Is that sort of the deal flow strategy or is it a little bit more complex?

It's just not warehouse. I mean it could be office, it could be commercial. It's any space that we're looking for 80 to 100,000 square feet. We do look at the demographics. That's first and foremost what we do. Then we look at the entitlements. Some of the other things that we consider is whether or not we can obtain PACE financing as well as if it's in an opportunity zone. So we have utilized the sale of sales towers to historic tax credits to Pace financing to opportunity zones. All ways in which to enhance our investors rate of returns. So you know, we don't just look at the investment, but we look at other ways in which we can add value to the investment to make the returns more attractive.

Okay, just for the listeners that may not understand some of the things that you're saying, so let's sort of unpack entitlements and PACE financing.

Entitlements are what the zoning allows you to do, what you are entitled to do with the property. And so a lot of times with commercial properties it might be permitted or allowable. And then the distinction between permitted is that you can go in and do it as a right. Allowable means you still have to get their approval to do it. And so if it's allowable, you have to go through the process of getting the city's permission to do what you want to do. So we have rezoned properties. You know, one of the first ones we did, it was zoned originally commercial, which would have allowed self storage. But then right before the Great Recession, it was rezoned to apartments. And then they couldn't build the apartments and townhomes. And so the property was sitting unused for three years. So we had to rezone it back to commercial in order to get to self storage allowed. We've written zoning codes because we've gone into community and they said, well, we don't know how to do this, but if you do it, we'll approve it. And you know, so we've done that and we've bought other properties. The last two that we bought, they were zoned as of right. So you know, we knew that that was less risk for us to go in and having to get the zoning. The other one you asked about was.

That Pace financing PACE financing? Yes.

So that's through the Department of Energy. So it's the Property Assessed Clean Energy Act. And what it does is if you go and show that you are making economic improvements to the building to cut the cost for utilities and improving the green value of the building, you can actually get that money applied to the real estate taxes as opposed to debt. And so the banks view it as equity, even though it's a payment that you make through your property taxes. So they'll freeze the real estate taxes, they'll increase your tax assessment to cover the cost of those improvements, and they amortize it over the length of the improvement. So if you have like a new furnace, the furnace will last for 20 years. They'll amortize the cost of the furnace over 20 years.

And.

And then that way it gets paid through your property tax and you pay twice a year.

Ah, very interesting. And then as far as Opportunity zones, I know a lot of people know what they are, but it is a little bit complex. Can you kind of describe Opportunity Zones and why you're maybe looking at those areas?

Well, everyone refers to them as Opportunity Zones, but the real key component is the Opportunity Fund. So the zones just describe where the government wanted to encourage economic development and growth. And so each state was allowed to come up with their own zones, and they were approved by the federal government. So there's a map throughout the entire country which has these zones in it. The zone in itself is not the investment criteria. It's due to the Opportunity Fund. So if your property is in the zone, then you can have Opportunity Fund qualified money invest in that property, which is tax deferred, as well as the gains inside of it are tax free. And so there's a lot of advantages for that for capital gains. And it expands the capital gains definition. So instead of just having to do a 1031, you can invest in an Opportunity Fund and have a lot more flexibility in terms of what that investment is. If you have capital gains from your stock or any other means of a gain on your tax return, you can shelter it and defer the tax gain and through the Opportunity Fund investment. And so the way in which it works is if you invest in the Opportunity Fund, then the Opportunity Fund can then invest in the property that's in the Opportunity Zone. And so both our Toledo and our Dayton properties are located in the zones. And so therefore, our investors have looked to that as a way in which to shelter their capital gains. And so we've been very helpful to our investors by creating this other Vehicle which only magnifies their rate of return because of the fact that they are deferring their capital gains.

Wow, fantastic. Can you talk about what the investors ROI would look like if they invested with you?

Well, we view development as speculative, make no mistake about it. So we recognize that we have to offer a greater rate of return than if it was an existing facility. So. An existing facility. What we're seeing in the marketplace is that people might get a 12 to 15% rate of return on their investment. With the development, we see that we got to be north of 20%. So we model all of our investments over 20%. And, you know, our objective is to increase it beyond the 20%. So that's, you know, each project is different, but that is the minimum requirement that we won't go into it unless we can yield that for our investors. And so, you know, when we look at the opportunity zones or the historic tax credits or the sale of the cell towers or the use of the PACE financing, those are all ways in which we are increasing that rate return. But we don't project those into our modeling because we feel those are, you know, bonus or gravy situations.

All right, fantastic. Is there anything I should have asked you? I didn't ask you.

That's a big, broad question. But I think the biggest thing that we try to do is we're always analyzing risk. We're looking at stress tests, we're looking at how to minimize that risk in the marketplace. And the way in which we're doing that is really on the front end. And that's the reason why we've really chosen this vehicle, because of the fact that we can assess that risk going into it. When I was with multifamily or especially single family, it was more like the field of dreams vision, you know, build it and they will come, you know, but we don't. We're taking a much more scientific approach to how we're doing this because of the fact that we can study the marketplace.

Excellent. Excellent. Well, we're at that point now, Scott, where we're going to ask you for your tip of the week, a website resource, a book, something actionable for the auto passive income listeners to go improve their businesses, improve their lives. We've learned a lot about self storage and it's such an interesting niche, the way that you're doing it. But now we're going to ask for one more tip.

Well, when people ask me business questions about real estate, I tend to answer it more specifically about business as a whole or life as A whole. Because I feel if you can apply those concepts to your business, you'll be much better off rather than just studying one business concept. And the one that has helped us the most in the past few years is a book called the Road Back to youo. It's by Ian Morgan Crone and no relation, different spelling. So I'm not getting any residual income off of, you know, recommending his book. But the concept is that we all have different personality types. There's nine different personality types. And these fourth century monks came up with this idea and they were, they were absolute geniuses. I don't know how they came up with it, but they break everybody down into these nine personality types. And the idea of it is the more healthy you are, the less these personality types get highlighted and the less healthy you are, they become very magnified and ugly in essence. And so we each have them. But if we can understand, more importantly ourselves, we can better understand how to respond in different situations. But we can also then begin seeing what other people's personality types are and begin having our conversations be reflective of how they receive it. And so if we understand someone, then we can begin talking their language or understanding where they're coming from. We can better communicate with them. And so we have found that we have increased our level of communication not only within our office, but also with our clients by understanding the different personality types.

Okay, so what's the name of the book? And Find your.

The Road Back to you.

Oh, the road back to you. Okay, the Road Back to you. Alright, I'm gonna get it right now and we'll have a link to it as well. So the road back to you is. I'm trying to find it on Enneagram Journey to Self Discovery. Aaron Morgan.

Ian Kron Morgan. It's the, it's called the Enneagram E N N E A G R A M. And that's the concept that these 4th century monks came up with.

Very interesting. All right, awesome, awesome. Well, sometimes our calendars get mixed up and Scott Todd just jumped on. What's up, Scott?

What's going on? I feel like I missed a great podcast, but I figured I'd swoop in for like a tip of the week.

I don't know, you can give your tip of the week if you like.

Well, okay, well okay. So I'm gonna build off of the tip that we just got and I'm gonna tell everybody, just go Google the 12 steps to intimacy. Go Google that. And basically in around 1970 there was a. I think it was a zoologist who went out and he studied, he studied basically the, the, the steps to intimacy. He published this in a book. And Basically there are 12 steps to intimacy. You know, it goes from like eye contact all the way to you know, intimate, intimate relationships. And what he basically says in this book, and you can Google it and get, kind of get the same concept is that essentially, you know, you need to build, if you're going to build a solid relationship, an intimate relationship with somebody, you need to go through all 12 of these steps. And if you think about it like if you were to jump any of these steps and you miss out on them, well, essentially it doesn't necessarily build the strongest relationship. So for example, if you went from like eye contact to a very intimate situation, like almost immediately, well then you're missing all of the other steps. And so eventually like you could, you could say like, well that's going to be a very short term relationship, right? It's, it's a, it's a very short term thing because you missed all of these steps. And so you could say, well, what does this have to do with business? Well, if you think about this through the same concept as going through and building a relationship with your customer, you could apply the same 12 steps to marketing and to your customer too, right? It goes with eye contact. Well, what's eye contact? That's your marketing, that's you getting their attention. And then you go through the process of holding hands or skin to skin contact. Well, essentially that component, you know, it could be shaking their hand in person or beyond that, it could be, you know, some other component. Maybe it's, maybe it's, you know, them hearing your voice through the telephone or some other component. So if you stop and you think about, there are 12 steps to building that intimate relationship with your customer. Because when you build it all the way out, essentially you're going to have a rock solid customer, a foundation. But if you skip from like eye contact to hey, buy this right now, well you're probably not going to have a very solid relationship with your, with your customer. So think about it, Google it, think about it, figure out how you can put it into practice in your own business. And it really just goes along with the last tip because it's really about taking things that are outside, not necessarily business, and relating it back to business.

Alright, fantastic. Well, my tip of the week is learn more about Scott Krohn and his company@cotamg.com Is that correct, Scott?

That is. So that's CODAM, as in management and G as in group dot com. And that's where we have a lot of the blog posts and the other information that people want to find out about self storage. We have examples on there for people.

All right, fantastic. Well, I want to thank all the listeners and just remind them the only way, the only way we're gonna get the quality of guests like a Scott Krones. If you do us three little favors, you gotta subscribe, you gotta rate, you gotta review the podcast. Send us a screenshot of that review to supporthelandgeek.com we are going to send you for free the $97 Passive Income Launch Kit. Today's podcast is sponsored by GeekPay IO, the only set it and forget it payment system where you are guaranteed payment. You get the ach. With the ach fails, you get a credit card on backup. It is phenomenal and it is continuing to be developed and getting better and better every single day. Learn more at Geek Pay IO and get a free demo. Scott Crone, Are we good?

We are. Thank you very much for hosting. We really, really appreciate the opportunity.

Scott, Todd, thanks for jumping on, man. Better late than never, right?

Hey, done beats perfect, right?

Done beats perfect. And again, I want to thank all the listeners and let freedom ring. Thanks, everybody.