#190: Navigating Self-Storage Investment in a Changing Market
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We welcome back Jacob Vanderslice, Principal of VanWest Partners, a Denver-based real estate firm managing over $195 million in assets. Jacob discusses the challenges of today’s real estate market, from rising interest rates to shifting investor sentiment. He shares strategies for managing risk, the effects of market fluctuations on self-storage investments, and how VanWest uses conservative underwriting to stay resilient. Tune in for his insights on the state of real estate, the bid-ask spread, and the importance of conservative leverage in today's economy.
In this episode, we're discussing...
Challenges in the Market: Jacob discusses the difficulties faced in capital raising due to rising interest rates and how they’ve impacted real estate transactions.
Risk Mitigation: VanWest Partners takes a conservative approach to underwriting, ensuring their models account for possible market fluctuations.
Investor Sentiment: The episode covers the shift in investor behavior, with many opting for safer investments like treasury bonds over riskier real estate projects.
Bid-Ask Spread: Jacob highlights the gap between buyer and seller expectations, particularly in self-storage and other asset classes, as interest rates affect asset valuations.
Self-Directed IRAs: Learn how investors can use self-directed IRAs to invest in private real estate vehicles and the tax implications of using retirement accounts versus cash.
Resources from Jacob
LinkedIn | VanWest Partners | Jacob's Email
Resources from Mike and Nichole
+ Read the transcript
Mike Stohler
Hey everybody, welcome back to another episode of The Richer Geek Podcast. We have a returning guest, Jacob Vanderslice. He's the principal of VanWest Partners, Denver-based real estate investment firm focusing on the acquisition management of self-storage and other opportunistic real estate throughout the United States. They've established a track record of over 195 million in real estate assets. Him and his partners are driven by a commitment to delivering expertly executed, adaptable strategies, and they concentrate on this institutional investment approach. Welcome back, Jacob. How are you doing?
Jacob Vanderslice
Good to see you again. We were just talking before we started recording. You know, last time we talked was around April of 2022, a couple little things have changed since then for sure.
Mike Stohler
Just a bit, we're just kind of coming out of the great unknown. It was crazy. So what's nuisance the last time we talked to you?
Jacob Vanderslice
Man, it's been a long time. So I think when we talked way back then, we had just launched our third fund. We've unofficially closed that fund. We've done a couple single asset deals along the way. We got a few single asset deals coming up. You know, 22 was kind of the beginning of that interest rate shift. And when capital raising got a little more difficult, and it continued to be difficult in 2023 we got deals done. But raising money to get them done was definitely a knife fight, for sure. I think we're going to look back in the rear view mirror as more time goes by. But I feel like sentiment, I hope, kind of bottomed out in Q4 of 2023 or Q1 of 2024 and I feel like some confidence is kind of returning. There's some visibility into the notion that interest rates are not going to go up any further and maybe even go down in September. As we sit here talking in late July, we're excited for some rate cuts, and we're excited for some sentiment to improve once we get through all the different events this year.
Mike Stohler
Yeah, it's crazy. I think every one of us that are investments, it's we're at that point. I'll ask you if it's the same thing in your world where we're trying to purchase things, but someone else is trying to sell it, and you're at that point where they still want the price from four or five years ago. We want the price because the DSCR rates, we need to at least be able to cover the debt. And we're just like, kind of at that stagnant part where it's like, "Look, I can't afford." Yes, your asset was worth this four years ago, but because of the interest rates, we can't buy it for that. Are you seeing the same thing?
Jacob Vanderslice
Yeah, otherwise known as the old bid, ask, spread, and you know that statement you made. You could translate that to all asset classes. You're in hospitality, we're in self-storage. You could translate that to a multi-family industrial office is a bit of a different story, right? You know, lot more pain there, but yeah, the bid ask spread remains pretty wide, and you're exactly right. Buyers are saying, "Hey, seller, look at my spreadsheet here. I can only finance half the purchase price versus, 70% back in the day, and my return is not going to work, so I gotta pay you less than you want." And the seller says, "No, it doesn't work for me." So transaction volumes went way down for sure. We're still finding deals, but it's harder than ever to find deals that meet our risk adjusted return requirements for sure.
Mike Stohler
So let's talk about that. You know, a lot of the LPS out there say, "Okay, who is this General Partner? Who is this company, VanWest Partners?" And I like hearing that you're saying, "Look, we still have some risk adjustment. We still have to analyze these things or not." This person just goes in. It's like, "Hey, all I want to do is get something done, collect as many fees as I can, and whether it works or not, you know or not, if you see so much of that." And that's kind of how people have gotten a little bit weary about doing syndications and funds. Let's talk about some of that risk mitigation that you're looking at, and describe some of that to our listeners so that they're a little bit so they get to know VanWest partners a little bit and how you look at risk?
Jacob Vanderslice
Sure, I'll talk about risk in a moment, but let me touch on the wariness right now of the typical limited partner investors, fund syndication investors. The challenge right now in this environment is you've got, let's say, for example, you can park your money in a CD or a treasury, whatever the vehicle is, and you get a 5% return, right? That's a lot higher than it was a while ago. And it's okay. It's not great, but it's okay. And you might argue that that return profile has zero risk, right? There's no risk to it. I mean, there's some risk to a degree, right? The US government could default, probably not, though. So let's say you get a 5% return there, and let's say someone like me is out there pitching a targeted IRR of say, "15% okay, yeah, so that's a lot more than five." Obviously, but if you look at that targeted 15% IRR, your equity is at risk of a loss, right? You're probably behind secure debt.
You're investing in an environment that's kind of touch and go where interest. It's going to be where rents are going to go, consumer demand, obviously the election coming up, your risk perception of that's very hot, so you might get triple the return than you will for the five. But you might think in your head that I'm taking 10 times the risk. So what? So what do you do? I'm going to stay safe and do the five, and I'm going to kind of position myself to strike when the iron is hot. That right there, kind of in a broad stroke, is sort of investor sentiment right now. Why would I take a lot of risk for a maybe 15, when I can take no risk for a five? As far as how we mitigate risk?
First of all, any model that you make for a hotel acquisition, or any model that we make for a self storage acquisition is always wrong, right? The deal always goes better, or it always goes worse, and the spreadsheet says it will. We can't predict cap rates in five years from now, let alone in five months from now, so we mitigate risk in a couple different ways. First of all, the biggest risk in this environment, I think in general, is your debt if you're over-leveraged, even if the banks let you right now, which they probably won't. But if you're over-leveraged and the deal underperforms, you get a big problem. So you have to be conservative with your debt. We've always been conservative with our debt, but especially in this environment, I think lower leverage makes a lot more sense. But the main way that we're conservative, I think in our underwriting assumptions, and nobody knows me from Adam here listening right now, so take this for what it's worth, but we strongly believe that we bring to bear reasonable, achievable and conservative underwriting assumptions. So what we're not doing is saying, hey, if everything goes best case scenario perfectly, you're going to probably make a 15% IRR. We leave a lot of room for error in the different levels or levers you can pull on these underwriting assumptions. I think the two that move the needle the most are your exit cap rate and your net operating income, right? And the two play off of each other. Obviously commercial real estate deals trade on a multiple of the income stream they produce, otherwise known as a cap rate. If you're being aggressive there, and cap rates expand, you can really miss your mark. So what we'll typically do is we'll look at a deal today and objectively and objectively, we'll analyze what would this trade for on a stabilized cap rate basis, and then we'll go into our model, and we'll add a bunch on to that. So cap rates and values have an inverse relationship. Of course, the higher the cap rate, the lower the value, and vice versa. So if we think today, a project's going to trade at a stabilized, say, 5% cap rate, we'll assume an exit cap rate of maybe 6% in our model, and that's some kind of margin for error there the other level, which lever that's pulled, which is net operating income, which is purely gross revenue minus expenses, will will layer in very conservative revenue growth assumptions. And I think where a lot of people got in trouble was the market kind of transition, as they were underwriting some kind of covid, post covid rent growth into their models.
And just like, everything can't last forever, and things kind of moderated. So there's a little bit of distress out there right now with these kinds of unreasonable and untenable underwriting assumptions. So we show what we believe to be conservative rent growth and NOI growth over the whole period, and a fairly conservative reversion cap rate. But again, these are educated guesses on financial metrics and assumptions that are not going to happen for years. All you can do is look at what's happening today, add some, subtract some, and go out and buy a deal with a risk adjusted return that meets your requirements.
Mike Stohler
Yeah, it's so well spoken. You know, what we like to do is to perform, to do the numbers, and then stress it.
Jacob Vanderslice
Yep.
Mike Stohler
And then what I do is, then I give to the investors somewhere in between. It's not what I think will happen in five or seven years, and it's not the stressed one, but it's like, "Wow. Okay, if I go anywhere in between and I can achieve anywhere in between, we're making money." So it's very important for listeners out there that may be getting into this to do a stress test. Don't over promise. It's better to under promise, over perform, and then everyone's going, "Wow. You know, Jacob's the smartest guy in the world." You know?
Jacob Vanderslice
Little do they know, I'd rather be lucky than good.
Mike Stohler
That's right. Absolutely. Some of the things that, and we can talk about this people, a lot of times, they don't want to give us their direct money. It's out of their savings accounts. But there's this little known thing, maybe it's a little known for our listeners, if you can kind of use that money that's just sitting there, it's not doing anything. You can't even touch it. That's a self-directed IRA. Is that something that you guys look at within your company, and how is that? -For people that don't know what that means, how can they utilize that money? It's just they can't do anything with it anyway.
Jacob Vanderslice
Yeah, self-directed IRAs are a fairly common way to invest in private real estate vehicles, syndications or funds. And high level there's some advantages and disadvantages to using, say, cash versus a retirement account. On the cash side, the advantage during the whole period is you're enjoying the passive losses because of depreciation that deal will generate. And as I understand it, hotels can be pretty attractive with cost segregation and bonus appreciation. Sure to do that. It's not as turbocharged as hospitality, but it still moves the needle. And. So you're enjoying those passive losses during the whole period with a cash investment. But the common misconception is you can use those to offset your W-2 income if you're employed. That's not true. You can only use passive losses to offset other passive gains in a given tax here. So that's the benefit of cash. But the downside to it is, when there's a sale of the asset, you've got two tax issues. Hopefully it does well, and you've got depreciation recapture and you've got long term cap gains, so investing through a retirement account is the opposite. You're not able to enjoy that passive loss generation during the whole period, but you have a material tax savings when there's a reversion by saving money on capital gains taxes and depreciation recapture, and that's a very small nutshell on kind of retirement accounts versus cash, but I have to look at this. But maybe 15% of our investors come in through self-directed IRAs, sometimes 401(k)s, but that's a little bit more rare. So yeah, it's a common element to kind of go out there and use the house money, so to speak, depending on your age that you can't really touch yet, and kind of park it in real estate for a while and hopefully watch it grow.
Mike Stohler
Yeah, again, ladies and gentlemen, especially if you're getting ready to retire, or I've several guys that are in their 50s, and they're just like, they switch jobs and like, "Oh no, do I roll this over? Do I do this?" It's going from this account to this account. And they just say, "Hey, Mike, if you can do this, go do it." Because why not? So it's good to talk to us about, and I've come across this with self-storage, where people say, "There's too much of it's oversaturated." What say you about? And I go, "You know, have you seen people's garages lately? And it's still stuck, stuffed." But what do you say about those people that say, I don't want to get into self storage because there's just every block there's another one going up.
Jacob Vanderslice
I would say those people are right, depending on the market they're talking about. You can't really say that. You know, nationally there's too much or too local self-storage. It's so sub-market dependent, so self-storage is very local supply sensitive. So there are certain markets right now where it makes sense to buy or build, and other markets where it doesn't make sense. And then the pendulum kind of shifts over the next few years, and suddenly, okay, this place was oversupplied, oversaturated. Bunch of people built at the same time, but now they've absorbed those units no one else has built for a while for those reasons now, now it makes sense to develop again.
Denver is a good example. Denver saw hyper supply roughly around 2017-2018 a lot of developers had the same idea at the same time, including us, and those deals suffered for a while, because everyone came online at the same time, supply and demand rents. Occupancies went down, but eventually those units filled up and during that period, everyone kind of backed away from Denver because it was oversupplied. Well, Denver became under supplied two years ago, so we decided to get back in and build again. We built a project north of Denver in a town called Longmont that opened up about six months ago. We have a deal in southeast Denver that's going to deliver in probably Q1 so hopefully a bunch of people didn't have the same idea at the same time that we did. We haven't found anything yet, but it really just kind of depends on what cycle you're in and what market you're in. For example, the Florida Panhandle. We have a number of deals down there, and those were our best performing assets, kind of coming out of the pandemic in 2021 and 2022 and a bunch of people started building because of that. And thankfully, we have two advantages. We've got cheap debt, and we've got a low basis, but consumer demand has suffered down there because a lot of supplies come online. So it just kind of depends on the market that you're in, for sure.
Mike Stohler
Yeah, absolutely. And what kind of asset are you building? Is it the outdoor ones? The inside mall type? I see all these different things, and people are converting strip malls or old Kmarts, Targets into self-storage. You know, there's all these different types of self storage. What are you focusing on?
Jacob Vanderslice
We have had some big box retail conversions over the years. We haven't done one for a long time, and those are generally difficult to get done because the city does not necessarily want storage use. They want to believe that Whole Foods is going to come in someday. So they want to change the zoning. That'll never happen. We, as far as the product that we're doing, we're not doing much development. We're just not seeing development deals kind of pencil right now and not really paying us for the risk building. So the deal that we're currently building is a five story class, a climate control elevator act. That's kind of the institutional grade, multi-story storage facility you might see in a variety of different markets, but most of the deals we do are existing facilities that will buy, that are already built, that are more of a value-add lift from a revenue management perspective, some capital improvements. And those are generally single story combinations of climate control, non climate controlled units. Maybe they've got eight or 10 buildings on the site. Two of the buildings are climate control. The rest of them are non climate controlled. That's kind of our typical deal type, multi story deals. You really have to be careful if you're buying or building a multi story one, because the consumer, if they can avoid it, does not want to ride an elevator to store their stuff. So if you got an elevator access building. And you need to build it in a location that's pretty dense, pretty infill, where your consumer doesn't have other options that are necessarily easily accessible. We've seen deals in certain markets with $1.50 per square foot per month on the ground floor in rent, and they can't give units away on the second story and higher, because nobody wants to ride the elevator. So gotta be careful when you're doing those. So we'll do those here and there, but most of our deals are single story for the most part.
Mike Stohler
Yeah, how do you compare and compete with, you know, the monsters out there, the REITs and I deal with this also. Some can come in and just build something and they don't care about the cap rates, and it just takes over the market, you know, kind of like the Walmart effect. How do you compete with the REITs and the market?
Jacob Vanderslice
Public storage is a good example. They have very low cost of capital, and they will build a bomber, and they don't care if it takes them five years to stabilize it. They're never going to sell it. They're going to own it forever. They've got the scale and the dollars behind them that we don't. So that's definitely a risk in the deals that we do, as far as how we compete. We're definitely not smarter than the REITs, but we care a lot more, and we pay a lot more attention, and that's the reason that we self manage. When we got the business way back almost 10 years ago, we didn't know what we didn't know, so we outsource our management to the REITs, and we were dazzled with their revenue management algorithms and their branding and their online marketing. And we found over time, big surprise, third parties don't care about your deal as much as you do there. There was a misalignment with operating expenses, with marketing overhead, with ancillary income stream. So we started self managing, kind of taking our deals back in the REITs.
Yeah, the REITs are, if the public builds 100,000 footers next door to you, you probably got a problem. Probably got a problem, but we try to defend against that as much as we can by buying deals at or below replacement cost, buying deals in sub markets with higher barriers to entry from a zoning and entitlement perspective, buying deals in markets where rents don't support new construction costs, the rents start high enough to justify building but yeah, re competition is definitely a concern, but we can mitigate that as much as we can.
Mike Stohler
Yeah, and ladies and gentlemen, and that's how we compete also, is because people know that they can get hold of me. They're not just a number. And we care, we care about the investors. Investors, number one, they're just not a number. And I think that's very strong. That's what people want nowadays. They're tired of these just being a number and people not caring about them, so talk to us about a little bit. You know, what you can I don't know if they're accredited investor type projects. What do you have going on now?
Jacob Vanderslice
Our deals are generally 506(c) offerings, which means we can only accept accredited investors, but we can also kind of advertise and generally solicit. We've unofficially closed our third fund vehicle. We have an analysis yet, but it's basically closed for the time being. We don't think the timing makes sense, just given the kind of light deal flow out there and unknowns with capital markets in the election, we don't think it makes sense to launch a new fund vehicle at this point. What would that fund do? There's not a lot of deals to put into a fund.
So for the rest of this year, and probably going into early 2025 we're just doing single asset syndications. So we've got a deal in Jacksonville, Florida that we're raising capital for to complete an expansion we already closed on about two months ago. We have a deal coming out in northeast Atlanta. It's a value add play, a really unsophisticated seller does a lot of meat on the bone in terms of revenue growth and occupancy growth. And then we have a deal that we're working on. It's fairly close in Las Vegas. It's a pretty simple one, multi story, just not efficiently managed. So we got a few kinds of single asset deals in the hopper, and that's really what we're going to be focused on for at least the rest of this year, until we can see a market shift that might justify launching a new fund vehicle.
Mike Stohler
Yeah and that makes complete sense. So how do people get older if they go to vanwestpartners.com, VanWest Partners, what is your website?
Jacob Vanderslice
People can go to our website, vanwestpartners.com. They can hit me on LinkedIn, Jacob Vanderslice, or email me jacob@vanwestpartners.com. If you have a storage deal you're trying to sell, we'd love to hear from you, because we're looking for him.
Mike Stohler
There you go. Everybody, Jacob Vanderslice, VanWest Partners. If you're interested in self-storage or you want to learn more, go to vanwestpartners.com or look him up on LinkedIn. That's what I did. And Jacob, thank you very much for being on The Richer Geek Podcast and have a great day.
Jacob Vanderslice
Great seeing you again. Thanks, Mike.
Mike Stohler
Yep. Take care.
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ABOUT JACOB VANDERSLICE
Jacob Vanderslice is Principal at VanWest Partners, a Denver-based real estate investment firm specializing in self-storage centers and other opportunistic real estate across the U.S. With over $195 million in assets, VanWest is known for its adaptable, institutional investment approach. Jacob and his team focus on uncovering hidden value to maximize returns and are passionate about educating investors on self-storage, urban redevelopment, and non-traditional real estate opportunities.