Self Storage Real Estate At Scale, With Kris Benson

Self storage is a real estate segment that appears to be unstoppable, even in an economic downturn. But how can passive, accredited investors participate in this growth story?

Kris Benson, chief investment officer at Reliant Real Estate Management, joins the show to discuss self storage investment strategies and more.

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Episode Highlights

  • Whether the US economy is already in a recession — and the implications that has on the self storage real estate segment.
  • A birds’ eye view of the self storage industry, including publicly-traded REITs, mom-and-pops, and everything in between.
  • Kris’ performance prediction for self storage real estate in the next recession.
  • The reason that Reliant usually prefers to execute a value-add strategy, rather than ground-up development.
  • A unique “roll-up” opportunity that exists in the self storage industry, and how Reliant fits into this picture.
  • Kris’ perspectives on underwriting, performance, and leverage.

About The Alternative Investment Podcast

The Alternative Investment Podcast covers new trends in the alternate investment landscape. Hosts Jimmy Atkinson and Andy Hagans discuss tax-advantaged investment strategies to help you grow your wealth.

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Show Transcript

Jimmy: Welcome to The Alternative Investment Podcast. I’m Jimmy Atkinson.

Andy: And I’m Andy Hagans.

Jimmy: Hey, Andy, how’re you doing? Today we’re talking self-storage on the podcast today. It seems to be an unstoppable segment even during periods of economic downturns, which we’ll get to in a minute. But how can passive accredited investors participate in this sector? Joining us today to discuss these topics is Kris Benson, Chief Investment Officer at Reliant Real Estate Management.

And Kris is located in Roswell, Georgia, just north of Atlanta. Kris, thanks for coming on. Welcome to the show.

Kris: My pleasure. Thank you, Jimmy, Andy. Nice to see you.

Jimmy: Nice to see you, too, Kris. Excited to dive into the conversation and explore self storage today with you. But before we get sector-specific, I want to get your take on the economic condition that we find ourselves in. Kris, do you think we’re heading toward a recession or might we already be in one?

Kris: I guess it’s how you define economic recession. And if it’s something that you base it on, this morning, I read an article about we are now officially in a bear market from the U.S. Stock market side of things. I mean, I don’t know how to measure it, but what I can tell you is inflation is real, right, we just hit another inflationary peak of in the past 40 years, and I think that is playing a role in how that’s impacting people’s day-to-day pocketbooks.

Everyone is chasing opportunities on the institutional capital side for yields. And so I don’t know the exact answer or the exact moment when we say we are in a recession, but it certainly feels like most of the indicators point that we are headed in that direction.

Andy: Yeah, absolutely, Kris. I mean, there is a technical definition of a bear market, and there is a technical definition of recession. And I think, you know, a lot of us, you know, I guess when I see it on the front page of “The Wall Street Journal,” then I guess it’s “official,” but I kind of look at it, like, you can’t just take one data point, right?

There’s all these different data points: consumer, debt levels, consumer spending, inflation, as you mentioned. And it’s just starting to seem to be one data point after another. Everything is pointing towards recession. And, you know, the central bank level they make those calls, what, four, six months after the fact. You know, they say, “Oh, it turned out we actually entered recession March 15th, 2022, and, you know, we realized that in September,” or whatever.

So, you know, the data is certainly starting to look that way. And even if it’s not an official recession, we’re definitely in a bear market. And so what I think is interesting about self-storage, and Jimmy and I were just, you know, playing with your website, clicking around, great website, by the way, and it mentioned that self-storage lost 3.86% in value in the last recession, which compared to every other sector, multifamily was listed as losing almost 7%, retail 12%, office 8%, and of course S&P lost over 20%.

So self-storage outperformed. It was very resilient. So do you think that self-storage will continue to be resilient in the next recession, whether we’re already in it or it’s, you know, five years down the line? Do you think that trend will continue?

Kris: I have no idea. I would say, look, the demand drivers for self-storage are really interesting and somewhat different than some other asset classes that you just mentioned, right? Kind of think of the core four as like apartments, industrial, office, retail. Those generally, when the economy is booming, generally those asset classes are doing really well.

Well, with self-storage, demand is somewhat driven by what we would call a transition, right? We joke about the four Ds of self-storage demand. It’s death, dislocation, downsizing, and divorce. So if those four things are happening in your life, generally, you’re going to utilize self-storage, right?

If you’re downsizing your house, most of the time you put stuff in storage until you get situated or you sell it or whatever the case may be. Usually, what happens is people put it in storage with plans to do something and they never do anything, and it just sits there for another two to three years. Those are the best customers, right? Get them on credit card auto pay and that revenue just kind of continues to churn.

But overall, our world, our demand curves are driven by transition. And in most, at least the last two kind of economic events that we’ve seen, right, the Great Recession in 2007, 2008, 2009, and then again through COVID, we’ve seen a lot of transition in people’s lives, and in all facets, right, socially, where they worked.

And that transition is what created demand. Andy, you mentioned 2007, 2008, 2009 in that data. That data is coming from the National Association of REITs, which is a public access database that tracks all of the publicly-traded REITs across all asset classes, so you really get to see a very long history and kind of see some of the trends over the years.

I love that database. And what’s interesting in it is, you know, through 2021, self-storage absolutely crushed it. So COVID was actually a huge boon for our asset class. I can speak specifically at Reliant, 2021 was one of the best years in the history of our company when we looked at same store revenue growth, right, just occupancy was off the charts, and with occupancy came rental rate growth.

So, you know, we’ve really been blessed that in the last two kinds of economic cycles storage has performed very well. As far as predicting the future, I’m not very good at it. I’m usually wrong, so I’ve learned over time to basically just say, “I don’t really know, you know, time will tell,” but I’m hopeful.

I’m obviously biased that I think it’s going to, but time will tell.

Andy: You know, I actually really respect that answer. It’s a kind of answer that I want to hear from an asset manager or an underwriter that, you know, what I predict may or may not happen, you know. So that’s really interesting because, you know, I would kind of think that the investment thesis might be predicated on this is a counter-cyclical sector, which maybe historically it has been, but we want to get into the fundamentals, though, of this sector.

And I know that historically, at least my experience with self-storage, is there’s a lot of mom-and-pops, a lot of, you know, local, independent operators. So could you just walk us through the industry landscape and its fragmentation, you know. Is it still mostly mom-and-pop operators?

Is that changing? Is it more corporate? What are you seeing right now?

Kris: Yeah, for sure. And, Andy, I think this is a trend that if you go back and look at almost all of the asset classes, they follow a very similar path. And what happens is, right, you know, self-storage today is still very fragmented. There are six publicly-traded companies in the space. There are five REITs, and then the sixth company is U-Haul, which everybody knows.

They’re a publicly-traded company but they don’t operate as a REIT, and they own about 30% of the square footage in the United States when it comes to self-storage. And so what that leaves is there’s kind of a, you know, we Reliant are the 27th largest operator in 2021. So we’re not the biggest, we’re not the smallest, we’re kind of somewhere in the middle.

I would say we’re like a regional operator. And so, you know, there’s groups like us kind of in the middle, and then there’s a huge pot of what we would consider mom-and-pop operators. The statistic that I love is about 55% of the square footage in the U.S. is owned by operators who own less than five facilities.

So when you think about that ,what that allows for, and what our thesis is, Andy, going back to, you know, kind of how we think about the world at a macro level, is we are consolidation or a roll-up machine, right? We’re trying to take those mom-and-pop operators. There’s some value-add we feel like we can add to those properties.

Somehow we force appreciation into them or grow net operating income. And generally, we’re rolling that up into a much larger portfolio. And, you know, we get the question a lot, are we going to trade that someday? Maybe or we just continue to grow. There is a lot of appetite from what I would consider institutional or big-boy capital, right/ think Blackstones, KKR, Apollo, pension fund, insurance companies, that kind of money looking to get into self-storage.

The challenge they have with doing it is the transaction size deal by deal is very small. So if we can consolidate a portfolio for them, and they can come in and, you know, deploy $1 billion at a time or a couple billion, that to them is very attractive, you know. So the marketplace still has a lot of fragmentation.

And, Andy if you go back and look at any asset class, they all start this way, right? They’re all kind of, you know. Mobile home parks is a good example. Self storage is a good example. I would say things like car washes and marinas are probably about 10 years behind where storage is today. But the same thing is happening.

Institutional capital is trying to find yield and they’re going out and finding it wherever they can. They’re buying vet practices, dental offices, right? And it’s just a consolidation play because it’s just cash flow. And storage is probably a little bit, it’s not quite apartments, and it’s not quite car washes, it’s somewhere in the middle.

There’s been some institutionalization. I’m not sure if that’s a word or not, but if there’s been some of that consolidation, but this is something I feel comfortable predicting in the next 10 years. There’s going to be a lot more institutional capital in the space than there is today. And my opinion is the big will just keep getting bigger because it’s performed so well historically and a lot of people are trying to get access to it.

Andy: Okay. So, I mean, my interpretation of that is, anytime there’s a roll-up, you know, we’ll see best practices and even simple stuff like marketing and having a website and being on the Google business profile and just really simple things. When you have scale and you have a sharp marketing team that, you know, they’re being leveraged against 100 or 200 or 500 independent businesses, they can repeat those best practices.

That’s just one example, the marketing department. So with the roll up, you can kind of deploy those across all of these individual assets. And then the other side of it, this kind of macro, big perspective is it’s almost like multiple arbitrage where, you know, at the acquisitions level, buying mom-and-pop businesses, they’re going to have a certain multiple certain economics.

But then at the very large end, you know, you mentioned these huge companies that want to deploy $1 billion, well, they’re looking for big liquid assets to enter that will generate cash. And so I imagine the market dynamics, the cap rate, if you will, is going to be different at that level, so it’s…which to me is always odd.

I mean, I’m an entrepreneur, and so I’m used to thinking, well, smaller is better, because when you’re small you can be lean and you can be, you know, plucky and you can find those efficiencies. But there’s no way to do small when you’re managing $1 billion, right? And you’re willing to pay up for it, too.

You’re willing to pay that higher multiple.

Kris: Yeah, I mean, Andy, think of if you’re like the portfolio manager at, like, CalPERS, right, the California teachers’ pension. You know, they have hundreds of billions under management, like, to deploy $50 million is irrelevant. It doesn’t move the needle, right? So they have to make transactions at such scale to move the needle on the total portfolio. And really that’s, you know, not to get too much in the weeds, but, you know, as you think about how institutional capital works, like the Blackstones of the world are deploying capital for those kinds of groups, right, because they’re saying, “Hey, we don’t have a team big enough to deploy this amount of money, so, hey, Blackstone, here’s $1 billion. Go make us some money, you know. Kkr, here’s $1 billion. Go make us some money.”

And that’s how they manage. And same thing with the large, you know, insurance companies, there’s just so much capital that’s being pushed out. And what I think that’s leading to today, Andy, right, especially in our asset class, is I don’t want to call it artificially low cap rates, but we’ve seen this compression of cap rates over the last 12 to 18 months because all this capital is going to try to find a home, and it needs somewhere to go.

And, you know, the real estate as an asset class has always been in-flesh or people believe is a good inflation hedge. And so a lot of it is pushed into real estate. We’ll see what happens.

As interest rates start to rise, historically, cap rates follow. I would tell you, and they’re usually a lagging indicator, right, interest rates come up first, and then cap rates kind of follow behind. And for those people not familiar with cap rates, think of cap rates as basically just a representation of value. So if cap rates go up, generally values are going down, and vice versa. If cap rates are being compressed, then values are going up.

And what we’re seeing in storage right now is interest rates are coming up, right, so the cost of our capital is higher, but the values are not adjusting, right? There may be less buyers, but the buyers who are still in it are very aggressive.

Andy: Well, I want to get to that in a second, but are these cap rates the lowest that they’ve ever been in the history of self-storage? Okay, so they’re the lowest they’ve ever been, and we may be entering the recession, and interest rates are being hiked, but those tab rates are staying compressed, so that’s interesting.

And, Jimmy, we just talked about this on your podcast where I was a guest, the “Opportunity Zones Podcast,” financial repression. I mean, that’s the theme that I am seeing when bond yields are, you know, 2.5% or 3% and inflation is 8.5%, you’re just getting killed in the bond market, and so this cash, you know.

I think the thinking is if I put this money into real estate, this $1 billion, if I’m CalPERS, if I put this $1 billion into real estate, I can at least preserve wealth with capital appreciation.

So the yield could go almost to zero, I’m still going to be way better off than I would be parking this money in bonds. Jimmy, is that what you’re seeing in the OZ space?

Jimmy: I think that is what I’m seeing in the OZ space. That’s right, Andy. I know we don’t want to talk about OZ all day, but part of the attraction of OZ is it gives an incentive to traditional investors who may be overweighted in stocks and/or bonds. It gives them an incentive to diversify into hard assets or real assets like real estate.

I think that’s a topic that we talked about a little bit on our podcast episode a couple weeks ago, Andy, and a point that I expound on pretty frequently on that podcast. But I wanted to shift gears a little bit, Kris. You mentioned, you know, the pull into real estate.

I wanted to get your take on another property type or sector within real estate, which is multifamily. Andy and I talk quite a bit about multifamily on this podcast. It’s no secret that it’s definitely Andy’s favorite asset class within real estate. I think it’s mine as well. It seems to be the most popular asset class among real estate investors certainly.

And actually, as a matter of fact, Kris, I listened to another podcast episode about you on “BiggerPockets” a while back that mentioned that you got your start in multifamily. And there’s a lot of good to be said about multifamily. It’s got a lot of positive trends within that sector. And certainly it’s another asset class that is highly resilient, inflation-resistant, recession resistant, you know.

I guess it’d be hard to argue against. It’s probably the most essential sector within real estate. Everyone needs a roof over their head. But it’s interesting, that concept of self-storage being counter-cyclical as we head into a recession, I think, Andy thinks, maybe you think or not, Kris. It looks certainly like we’re heading that way. Do you feel like a lot of investors, given the popularity of multifamily and how prominent it is, you feel like a lot of investors are missing the boat on self-storage?

Are they focused too much on multifamily?

Kris: I don’t think it’s missing the boat. You’re right, Jimmy. I still own a fair amount of multifamily personally. Like you said, when you look at the demand for housing and where our housing supply is right now, it’s hard to argue against the long-term bets of multifamily. You know, I think they’re just different asset classes, right? What drew me, and let me go back to a prediction that I was wrong on yet again, Andy, about six years ago, I was convinced that cap rates in multifamily couldn’t possibly get any lower, or values couldn’t go up anymore.

Whoops, I was wrong on that one, too.

Andy: I think we all got that wrong, and I think we’re all still getting that wrong like every day, so.

Kris: Yeah. And really that’s what kind of pulled me into some other asset classes was I was really interested in seeing where I had additional runway for maybe the next 10 years. And that brought me to mobile home parks and self storage and ultimately, you know, made the decision with self-storage.

But, you know, Jimmy, to answer your question, multifamily and self-storage are both really good asset classes. I think the interesting part between the two is, I’m biased, but I’m going to say self-storage has got a couple advantages. In the environment that we’re in today, let’s argue that we are going into a recessionary environment, history would say generally storage is going to do really well.

The second thing that’s really interesting is, with inflation, you know, real estate is a good hedge, right? Because, generally, in any asset class, rents are generally going up and keeping pace with inflation. Well, multifamily, generally, leases are going to be 12 months. Well, in the inflationary period that we’re in today, where, you know, we may be seeing 8% inflation, I don’t know how long rental rates can continue to go up by that and keep pace.

Because it’s different when you’re raising rents 8% on $1,500 a month apartment versus, you know, a self-storage unit that might be 120 bucks a month, right? So it’s a much larger percentage of a person’s disposable income when you raise the rates by that much.

And so if inflation keeps pushing up, and I don’t have an answer for what the logical question is, well, what’s the alternative right? I mean, what happens if apartment owners all have to raise rates, you know, 8% next year to keep pace with inflation. You know, I guess we just adapt. I don’t know what the answer is, but what I can say is the interesting part about storage is we’re 30-day leases, so we can be very nimble on pricing, right?

Jimmy, if you rent today, we’re recording this on June 13th, on July 13th I can charge you something different. In multifamily, I can’t do that, right? I got you for 12 months in a lease, generally. And for some other asset classes, office, apartment, or office, industrial, sometimes those leases are 5, 10 years, and so you got to be really thoughtful about what your rent bumps are during that lease period so that you are keeping pace with inflation, right?

In an environment that we’re in today where this inflationary pressure is really high, I really like the ability to be nimble. But that being said, ultimately, when you guys think of passive investors, going into apartments, industrial, self-storage, whatever the case may be, my lean is always going to be right team, right track record.

Find the people, right, the people that you feel like you can trust are going to make good decisions with your capital and that they have a track record of what they’re saying they can do, they’ve done before. And generally, no matter what the environment is around them, there may be some ups and downs along the way, but generally it’s probably going to turn out okay.

Jimmy: Yeah, those are some really good points there, Kris. If you’ve been to the grocery store recently or been to the gas pump recently, those prices change by the minute, by the hour, by the day. You go to McDonald’s and you’re paying a lot more for that quarter-pounder. But, yeah, if you’re renting, maybe your rent rate actually hasn’t increased if, you know, you signed the lease 6 or 9 or close to 12 months ago.

Maybe that’s still coming down the pike for a lot of people. That’s a good point there. Whereas in self-storage you’re changing those prices not quite like a grocery store might but maybe like a McDonald’s might, on a monthly basis. You’re probably looking at that. I wanted to shift gears again and get back to your strategy at Reliant, Kris, if we could. If I understand correctly, you’re not really doing a lot of ground up.

You’re doing a lot of acquisitions. Have you characterized your pipeline, what it currently looks like, and how you source your deals?

Kris: Yeah. Let me take that first part first, Jimmy, in regards to how do we characterize what we do. So we are what I would consider a value-add shop. We do a little bit of ground-up development, usually maybe one or two a year, but we’re not a developer. We just don’t have the team to support it. So, you know, for those guys not familiar with development, ground-up just means you’re going buying a piece of dirt, right, getting it entitled, and then building the facility from nothing.

The most risky but arguably the highest level of return. But there’s no cash flow for two to three years, so a lot of investors in the environment were now get a little bit antsy about that. What we do is we’re buying existing assets. If I could wave the magic wand and say our perfect facility is a facility that’s mom-and-pop-owned, potentially, you know, built kind of ’80s, ’90s, it’s been family owned few generations, they’re ready to get out of the asset class, and they haven’t done a lot.

Our sweet spot really is value-added secondary and tertiary markets, so smaller markets. And the value-add that we do, if you guys talk a lot about apartments, Jimmy and Andy, like most people are familiar with, they go in, they put in granite countertops, hardwood floors, stainless steel appliances, they charge more rent.

Well, we’re renting a garage, so we can’t really do that, or we haven’t found markets yet that will pay for hardwood floors in their garages.

Andy: Well, actually, to interrupt, I’ve been seeing these, like, luxury garage condos around.

Kris: Like car condos?

Andy: Yes.

Kris: Yep, for sure there’s these little niche pockets, they’re awesome. They’re really cool. But what we generally do, Jimmy, on the value-add side is it’s mostly expansion. The biggest lever we can pull is expansion. So we’ll build additional square footage, so we’re adding units to the rent roll, and then our job is to get those units leased up, and that’s where the NOI growth comes from.

NOI is just Net Operating Income or, you know, basically profit before we pay our debt. And what I would say in the environment we’re in is how we look at the world is everything is more expensive, right? Price per square foot we are paying more today than we did three years ago. Full stop.

Every property. Well, almost every property. So what we look at is, can we grow NOI? Because, in commercial real estate, that’s the name of the game, right. That’s what you should measure us as a sponsor against is can you guys grow profit at the facility? And so we’re really leaning into those NOI growth projections to say, look, in this environment where our basis is higher, can we grow NOI to get this property to be worth more?

Because, generally, if you grow NOI, all of the things being equal, it’s worth more money. Now if the market adjusts and values drop, but you’ve grown NOI, well, you may not have the value to sell it, but now you have a cash-flowing asset. It’s producing cash quarter over quarter. So then we would say to our investors, “Hey, now is not the time to sell, but we’re going to clip coupons until the market comes back to us.”

And so, you know, to your point of what we do, that’s our sweet spot is we go in and do value-ads. Sometimes it’s expansion. Sometimes it’s thing like adding U-Haul truck rental, tenant insurance, some of those ancillary items. And I would say, the second part of your question, what does our pipeline look like and how do we get our deals.

Because of our volume in the marketplace, I mean, last year we bought 23 properties, so we’re always churning. Our current fund, we have 29 properties identified. I think we’re going to close it at 30. So we’re constantly churning properties. We have an acquisitions team that’s underwriting deals, you know, all day every day. I would say we get our deals from a combination of sources.

We certainly look at all the listed properties and see if there’s meat on the bone for us there. We also, because of our reputation in the marketplace, and, you know, the two managing principles that Reliant have been in the business 20 plus years, and so we know a lot of owners, brokers, operators, and we get limited looks at a lot of stuff or off-market deals where people just bring us stuff, you know.

I’ll give you an example, a deal we had last week come to us came from our mortgage broker. One of his best friends owns a storage facility, and we had done a mortgage with him on another facility, and he called his buddy and said, “Hey, we just talked to this group, you know, do you want to talk to him?” And he said, “Yeah, I’ll look at it.” So, you know, it’s a combination of all of those things, Jimmy. And because we are a vertically-integrated sponsor, meaning we manage the properties we buy, it’s our employees there, generally we have a geographic target of where we already have facilities, you know.

We’re trying to expand thoughtfully so that we can create those operational efficiencies, you know, when we add a new site to the portfolio.

Andy: So, Kris, I want to talk a little bit about those operational efficiencies. So from the value-add perspective, I mean, that makes a lot of sense. You add more units, you add more square footage, you increase your rental income, you increase NOI. Do you also find that just bringing in your scale or, you know, professional management, are there other like tactical opportunities that just make operations or sales, you know, click, or does the converse happen?

I’m trying to imagine running 100 self-storage facilities, gives me a little bit of a panic attack just thinking about how many, you know, the HR network that you, you know, and all of that. So can you just talk a little bit about, operationally, you know, how do you make this into a well-oiled machine, and how do you enhance value after making the acquisition?

Kris: Well, starting with your first comment of “Are there operational efficiencies we can bring in,” that’s why we really like the secondary and tertiary markets, because generally in a tertiary market, Andy, when we come into a market, we’re not competing against institutional competitors. We’re not competing against the Public Storages, CubeSmart, Extra Space, right, some of those publicly-traded REITs that are really sophisticated in what they do, right?

We’re competing against other mom-and-pop shops. So when you talk about things like digital advertising, right, where we can come in and be very sophisticated in how we approach it comparatively to maybe some other operators you mentioned earlier that may not even have a website, right, and most have websites by now, but they’re not approaching it, you know, in a sophisticated manner.

Andy: You’d be surprised. What’s the word for after tertiary market?

Kris: Is there one? I just can’t throw them all in that bucket.

Jimmy: Well, I think it’s “quartiary” maybe. I got to look that up.

Kris: You definitely made that word up.

Andy: A lot of underwriting work then with like a mom-and-pop, you know, some of these smaller, or maybe I should ask, you know, how small or are you willing to even look at? And does that make underwriting more challenging when you’re dealing with the mom-and-pop, you know, could be folks that are completely honest but are doing their accounting, you know, with a pad and a pen, right?

So that has to make underwriting a little bit challenging sometimes.

Kris: I would say, for us, what we’re generally underwriting, Andy, is the income, okay? We don’t care about their expenses because we’re plugging our own expenses into the platform, right? So things like property taxes, insurance, that matters, you know, like, we’re not going to change that. But it’s our payroll, their utilities.

But all the other individual expense line items on the cost to run a site, we’re just using our own data to feed that. What we’re really underwriting the rental income. And there’s a couple ways we can validate that. When we have a property under control, when we have it under contract, our operations team go and do lease audits where they’re literally auditing each lease against something on the bank side, right, to make sure that, hey, you know, you said you had, whatever, $50,000 of gross revenues, can we tie that out to, you know, 50 leases?

So that’s usually the work that’s being done. I will say most operators at the size we’re looking at, which is generally about 50,000 square feet, if it’s smaller than 50,000 square feet, there has to be a pretty large expansion component to it or probably too big.

And when I say too big, I mean we put our expenses on it, and it doesn’t make sense. It’s got to be big enough to support our expense load. And so, you know, I’d say that generally around that 50,000 square feet is kind of the Mendoza line there. And we’ve certainly seen our share of interesting accounting practices.

People running their sites with index cards, no computers, just crazy stuff. We ask for paper leases, and they’re just like, “Ah, we don’t really have that anymore.” But I will say those ones that are the biggest pains in the butts, right, that have done the worst job usually have the most meat on the bone, right, for us when we go in.

You know, we joke all the time, like, when it’s a complete mess, that’s generally that where we’re looking at it saying, “Yeah, as long as we can do our homework and validate what you’re saying is correct, this one is probably going to be a home run.”

Andy: You know, that sounds like the feedback that Jimmy gives me, working together with him. He calls it areas for improvement. He says, “Andy, I’ve identified an area for improvement for you.” So that’s always a good thing, right, whether you’re looking at a business, you know, what’s the phrase I like to use, you know, is the juice worth the squeeze.

You want to make sure that there’s juice in there, like with a value-add. If you are acquiring a well-oiled machine that’s totally maxed out by the world’s best operator, well, where the heck is the value-add there?

Kris: And it happens, Andy, at different levels, right? The big boys look at us and our platform and believe they can squeeze juice just by plugging their platform in, right? When you’re public storage and you own 2,800 properties, you know, their digital advertising is cheaper than ours.

It just is what it is, right? So they can look at our portfolio and say, “Hey, guys, there’s NOI just if we buy you. When you plug us into public, you know, there’s an NOI or there’s ability to grow NOI just by plugging in.” So it’s happening all of the food chain, you know, from the guy who owns one facility, to us, to the number one publicly-traded REIT in the world, everybody has that level of efficiencies they can create.

Andy: You know, I appreciate just how transparent and honest you are about where Reliant is in that, you know, in the food chain and in the marketplace. I think it’s really helpful to, you know, give our listeners and viewers that sort of visualization. And, I mean, I would say, personally, I think it sounds a little bit like a sweet spot, because a lot of times when you go into these publicly-traded REITs, these very big, very liquid wrappers or funds, you just see there’s that liquidity premium, where to me it’s like I’m having to overpay for the liquidity, and I don’t necessarily need that liquidity, you know.

So that’s where the sweet spot where you could still be a passive investor, right, I don’t necessarily want to go buy my own self-storage facility and manage it myself. So I can still be passive but maybe have an opportunity for higher returns. You know, essentially, you know, the NOI is going to be better per dollar investment, the cap rate is going to be better, the returns, the IRR, all of that.

To me, once you go really big as an investor, as a passive investor, a lot of these publicly-traded REITs, I’m not seeing the value. I mean maybe relative value, but just on an absolute basis I don’t see it. And on the note of returns, I know we only have a couple minutes left, but I wanted to ask about your capital stack.

And I note that, you know, you’ve mentioned that it’s almost all value-add for your entire portfolio. And I know self-storage has like a stellar reputation for just being this stable cash flow, you know, clipping-coupons-type business. So does that predictability give you the ability to use more leverage than, you know, like a retail or office-type operation might be able to use.

Or I guess I should ask, what’s your philosophy on leverage? How much do you like to use? What’s the capital stack look like in your fund?

Kris: So leverage is what kills you, right? I mean, a company of our size, that’s how we go out of business, right? You over-lever. Debt is what kills everybody in a correction. We’re pretty conservative in our leverage, generally kind of a 65% LTV is the guidelines. Our fund right now is actually a little bit below that.

It’s at 64%. So, to your point, Andy, could we go out and get additional leverage? Yeah. The market is there for it, right, especially in self-storage because, you know, in the last recession, the default rate was one of the lowest in the history of all asset classes, right? Generally, self-storage properties do not default. Banks don’t take them back, at least in the last two cycles.

So, you know, debt does exist, but, you know, arguably there’s a risk premium in taking it. We’re very thoughtful in our debt with our value-add deals. We’re generally chasing kind of that three to five-year ridge loan type of product, so that if we do create the value, right, if our strategy works to grow that NOI, we can access it.

Because we can go out and get long-term debt, 7, 10-year debt that exists in the CMBS markets, or life insurance companies have those types of products, but it’s really challenging to get your equity out if you create it, and expensive, you know. The fees and yield maintenance, there’s a lot of penalties that basically preclude you from going and accessing that.

Andy: Sorry. So if I understand correctly, so even after, like, a successful value-add, like in Month 36, after that acquisition, you’re not able to do a recap, or it’s too expensive to, it’s not worthwhile to?

Kris: Well, with the wrong debt product, that’s what I’m saying.

Andy: Oh, I see.

Kris: Some of the longer term debts, you know, 7 to 10-year. If we go out and get a CMBS note, which is commercial mortgage-backed securities, right, these are securitized notes that are very aggressive, right, very aggressive on the LTV, very aggressive on their pricing, but they lock you in. And to refinance that or to sell your property, let’s say somebody offers you a wheelbarrow full of money and you want to sell it, it’s going to cost you a fair amount of money to get out of it, because what they’re betting on is that consistent yield for 7 to 10 years.

So if you’re going to get out of the loan, they’re going to charge you for it. So, generally, we’re shooting for smaller regional banks, three to five-year bridge type funding with very low prepayment penalties. And what’s happened, Andy, with us in particular, at least the last, you know, let’s call it five years is generally around three-ish where we would think about refinancing to pull some of that equity out, we’ve seen values go up so much in the time we’ve had them that we’ve just traded.

We’ve sold them or recapitalized them because, you know, we’re getting values that we had projected in Year 10 and we’re getting them in Year 3. We’re going to take that every day.

Andy: Might as well take the wind in your sails, right? I mean…

Kris: It’s not going to be here forever, right?

Andy: Right.

Kris: It’s funny, Andy, Jimmy, like, you guys know this in the alt space especially, right? It had a shelf life of maybe 10 years on the institutional side, right? I mean, some of the early guys, like the Yale endowment, I can’t remember his name, but the guy who started the Yale…

Andy: David Swensen.

Kris: Yes, Swensen. He just passed away not too long ago, right?

Andy: Yup.

Kris: But he was one of the first guys that really was starting to place capital in these alts. And since, you know, 2010, all they’ve done is this, right? They’ve only won, and that’s not going to happen forever. There is going to be a correction, and it will be very interesting to see, you know, kind of what the correction is and where people have these weaknesses.

Maybe, you know, my argument will always be it’s probably going to be on the debt side. They’re over leveraged. Let me give you something to think about right now. So interest rates are rising, right? And this is all asset classes, but we’ll use self-storage as an example. For you passive investors out there, think of this. So if I was a developer three years ago, I was underwriting probably, let’s say, in self-storage, probably 3.5%, 4% interest rates.

And that’s what my construction loan is at. Well, those loans come due in three years, and then they have to go out and get permanent financing, right? They have to go finance the construction loan. That bank says, “All right, you guys are done. Pay us off. Go get a new loan.” Well, if they didn’t underwrite kind of a five, we’re looking at kind of fives right now, five-and-a-half, maybe by the time they’re done, six, you know, they’re going to be in trouble.

Those loans come due, and now the bank says, “Hey, pay us off,” and they may not have the value they thought they had in the project. That’s where it’s going to start to be interesting. I’m not saying blood in the streets, but it is going to be interesting over the next 18 months or so as a lot of these development projects come to fruition. Where do they end up?

And back to your original point, it’s all debt, right? If you got the wrong debt product, it can be really painful.

Andy: So you’re saying the tide is going to come in, and then we’re going to find out who’s been wearing their swimsuit?

Kris: Time will tell. Time will tell.

Andy: What do you think, Jimmy?

Jimmy: Well, it kind of reminds me of an article I read in the Journal, I don’t know, a week or two or three ago about how we’re entering a period of negative leverage, right, with cap rates compressing like they are, and then interest rates going up. Is that a serious concern within the self-storage sector as well, Kris? It sounds like it is given your last thought there.

Kris: Well, this is the key part of it, right? And let’s go back to multifamily for a second. I’m seeing deals where guys are buying, you know, let’s say a four cap, and they’re getting a loan at four-and-a-half. So they have to grow NOI just to break even, just to get debt service coverage. And if their NOI growth plan is just pure rental rate growth, not a true value-add where maybe they’re going to do it at a heavy value-add, boy, those deals make me nervous.

And this goes back to our philosophy of, if we’re growing NOI, generally, you’re going to be okay. If we can grow Net Operating Income year over year, you’re probably going to be okay. And that negative leverage situation, to your point, Jimmy, I think some people are going to be exposed with that as we move forward.

But, again, I don’t like to look at the doom and gloom side. I think it’s just kind of a realistic opportunity that may exist in the future.

Jimmy: No, for sure, it is. And, you know, it’s always a good thing for investors to keep their eye on those trends and how they can benefit from them or at least cover themselves from any negative trends. Well, Kris, it’s been a pleasure speaking with you today. I don’t want to go too much longer here.

We’ve kind of run out of time. But before we go, maybe you can tell our listeners and our viewers where they can go if they want to learn more about your Fund 3 or just your Reliant Real Estate Management in general.

Kris: Yeah. I think if you Google Reliant Real Estate Management, you’ll find us. Our website is reliant-mgmt.com, so the abbreviation of management. On there you can find a bunch about our team and track record and our most recent investment opportunities. Fund 3 is on there.

You can download the investment summary if you’re interested. Certainly reach out to our team. There’s Contact Us buttons, Invest Now buttons all over the website. And get in touch with me or our investor relations team, schedule a call. One thing I would leave you with, Jimmy and Andy, because, you know, we talk to a lot of passive investors. And people are like, “Well, if I don’t know a lot, like, what should I focus on,” right? Because it’s hard.

You can’t be an expert on everything. And I’m going to go back, you guys said I could step on a soapbox, this is my soapbox. So, look, it’s really hard to predict the future, right? When people say, “Hey, tell me what your returns are going to be?” I look at them and say, “If you bought a share of Amazon stock, would Jeff Bezos tell you what it’s going to be worth in six years?” Nope.

But in real estate, we do, and it’s made up, right? I don’t know what cap rates are going to be in six years, either do you or Jimmy or Andy, because if you did, you wouldn’t be doing a podcast. I can tell you that much. So from our perspective, we look and make assumptions in our models that are huge assumptions.

And what I think, as investors, you should think about is this is where team and track record matters so much, because ultimately that’s what you’re betting on. You’re betting on people, you know, and those people to make good decisions with your capital. So I’ll leave it at that. I won’t go full soapbox on you, just a little taste. If you want more, you can reach out on our website.

I’d be happy to spend an hour or two talking about how all assumptions are basically made up.

Andy: I love it.

Jimmy: Great. Watch it, because I think some of our viewers and listeners may take you up on that. Oh, by the way, I looked up a few minutes ago, it is quaternary is the word we were looking for. Primary, secondary, tertiary, quaternary, which I hadn’t actually come across that term before, but fun fact for everybody.

Kris: Andy, is Holland, Michigan a quaternary market?

Andy: I’d say it’s tertiary, you know. I’m a little possessive. I like my hometown so, you know. Anyways, Jimmy, we don’t like foul language on the show, so let’s…

Jimmy: We’ll wrap it up. Fantastic. Well, for our viewers and listeners, if you want links to all of the resources we discussed on today’s episode, you can access the show notes at altsdb.com/podcast. And don’t forget to subscribe to the show on YouTube and on your favorite podcast listening platform so you’ll be sure to receive new episodes as we release them.

Kris, again, it’s been a pleasure speaking with you today. Thanks so much for being here with us.

Kris: My pleasure. Appreciate it, guys. Hope you have a good rest of the day.