The Misunderstood Money Maker Most Investors Overlook

Dave:
Hey everyone. Welcome to On the Market. I’m your host, Dave Meyer. Joined today by James Dainard. James, what’s going on?

James:
Just hanging in there with the confusion in life. I feel like I’m constantly confused right now.

Dave:
Right before we turned the recording on, I asked James if he had seen that GDP actually went up in Q3 of 2022. I think I’ve scrambled Jim’s brain.

James:
I felt like I just got smacked in the head. I was like, wait, what? When you’re blank out for a second. I’m going to go digging deep now and figuring out what’s going on, because that I would not expect that this morning.

Dave:
No, I was not expecting it at all. And just for context for anyone listening to this, GDP, just a measure of the total output of the US economy, it went down in the first two quarters of 2022, mostly driven by inflation because the economy is growing but not enough to overcome inflation basically. And that definition, two consecutive declines of GDP is, some people consider to be the traditional definition of a recession. It’s not. I’ve done a show all about this, the way a recession is defined is super complicated by the National Bureau of Economic Research. And they do it retroactively. They’re not even trying to do it in real time. But it’s funny because a lot of people, myself included, when you see two quarters of GDP growth, you’re like, this is a recession or something. But now nothing’s really changed in the economy. It still feels as daunting as it has for the last six months. But now we’re seeing GDP growth. It’s super confusing.

James:
Tomorrow they’re going to come out and say rates fell two points. I don’t know. Every morning I’m like, what’s going on?

Dave:
You know when you’re a kid and you have opposite day and you just start doing everything the opposite of what you’re supposed to be doing.

James:
Yes.

Dave:
I feel like that’s where we’re at right now. My partner Jane was asking me something about what I thought was going to happen and I was like, well, this is what I actually think, but since nothing makes any sense anymore, I’m just going to go with the complete opposite and just start betting against myself because nothing makes sense.

James:
Everything’s going against the predictions. Nothing logically makes sense right now. It’s like opposite day and Groundhogs day every day. You’re like, wait, what happened this morning? Does it make sense?

Dave:
Well, I wish we had more to tell you about why this was going on, but this news just dropped and we’re just confounded by it. With that, let’s get into our guest today. AJ Osborne, who’s a good friend of yours I know and is one of the premier self storage investors in the entire country. He just dropped some knowledge. I really enjoyed this conversation. What did you learn about on this one and what do you think people should be listening out for?

James:
Well, I learned that there is an oversupply of self storage coming just like everything else. With all the upzoning and the need for all the stuff that people bought over the last two years, I thought that was going to keep going up. But just like everything, everything got overbuilt and it could come backwards. But very interesting conversation, I love AJ, me and him to work long hours and live off energy drinks. He’s like the-

Dave:
Kindred spirits.

James:
The fix and flip in multi and he’s self storage. But we’re very, very similar.

Dave:
Awesome. Well we’re going to take a quick break, but after that we will bring on AJ Osborne to talk about self storage. AJ Osborne, welcome to On the Market. Thank you for being here.

AJ:
Thanks for having me guys. I’m excited. This is going to be fun.

Dave:
It’s going to be a great time. Well, for those people who haven’t heard you, I know you’re a regular on the real estate podcast Circuit. But for people who haven’t heard you before, can you give us a little background about your investing experience?

AJ:
100%. I got started a long time ago, pre 08, and I was in insurance sales. So we managed companies, health benefits, dollars. We would do work with self-funding, things like that. But it was like sales. We were out selling corporate clients like B2B sales, and that meant we had really unstable incomes. I got paid only by, I didn’t have a base income. I got paid on commissions. It was good gig, but we were taxed at the highest rate and we also had wildly fluctuating income. We were making good money, but we had to live on very little. Me and my wife had to literally live on 30% of our income because we didn’t know what it was. That was life that we were living at the time and it was like, we got to offset this. We got to do something here.
I guess I thought this is financial freedom because I was in control of my time and everything else, but it really turned out to be more of a slave because I had all these bosses. And so we were just trying to get out of that rat race and try to protect my family with actually steady income. We needed some tax benefits because we were hit at the highest rate you could possibly imagine of anybody. We started to get into real estate. When we were looking at real estate, everything I did, because we were on commission basis, was cash flow. It was just all cash flow basis. I didn’t understand anything about this real estate world and equity. When we started looking at deals, we were looking at single family homes, multifamily. I didn’t understand how people were buying them. It didn’t make sense to me how people were making money when I’m like, I haven’t seen one deal that cash flows.

Dave:
And what year was that?

AJ:
This was 2005.

Dave:
Okay. Yeah.

AJ:
It was right in the heart of it. The real estate world made no sense at all to me. We looked and thought, how can we get our, we were used to having an effect on income through sales. I understood that. I want to be able to effect revenue. But I also needed that passivity and everything of real estate. We found an asset class called self storage at the time. Nobody invested in storage. It was literally when we told people, we’re like, we’re buying these little storage facilities in these dinky towns on the middle of nowhere, people are like, you’re a slum lord? They were considered junkyards and banks didn’t like them. We did a lot of solar financing. It was although we were buying purely on cash flow. It needed to make us good cash on cash returns and we couldn’t use a lot of leverage.
We did that. We started in 04, then 07 we stopped and started back in 2010 and we kept going and we built a great portfolio. We were doing essentially a commercial BRRRR, which we call it the bird. I call it the bird because what we’re doing is we’re buying, we’re improving, but then we can do something you can’t do, unlike single family homes, and that’s, we can reduce risk in two forms. We can take our capital out. So the money that we put in, we go in, we buy it, we put 30% down. That’s what you have to do for self storage facilities. You take that leverage out, we get no prepayment penalties on it. We would then buy assets. We could affect the revenue through rate increases, marketing a whole bunch of other stuff that we were doing. We treated it like a business. We didn’t view it as an asset.
Lift that in income up. Three years later we’d refinance our money out of it. We’d get our capital back. It would still cash flow at the same debt ratio, so 30% equity. But we would then move that into a non-recourse loan. I would have my money out plus my profits and then I got that off my liability and we were non-recourse, which means we didn’t sign on the debt. So if it went under, they couldn’t take us. And then we would use that money and reinvest it back into another storage facility while still owning the one while not having the risk. We did this for a long period of time while I was selling insurance, me and my dad, I followed in my dad’s footsteps to sell insurance. He was born in extreme poverty, so he didn’t have running water, he had to poach for food. Literally he had an outhouse in the high rule deserts of Idaho that he’d have to walk to at negative 20 degrees. They were extreme poverty, no food.
And so he used sales to get out of it. We were both doing this. Right? It was great. I was with my dad. We were selling together, we’re doing everything. We were buying real estate, and we thought, man, we just hit it. Right? This is amazing. I get to work with my best friend, I get to do all this cool stuff. And we were doing really good in selling insurance. And out of the blue I became a quadriplegic, paralyzed from head to toe. I was taken to the hospital by my wife because one night my leg stopped working. I was put into a coma and they put me onto life support, hooked me to tubes. And when I woke up I was paralyzed from the eyes down and I was in extreme pain. I didn’t even get to say goodbye to my kids. It was like that. And then I laid there for months on life support, hooked up to tubes. I couldn’t eat, speak, drink, nothing. I communicated through blinking and these little plastic things and I was fired from my job in the hospital.
I worked for a big Fortune 500 company based out Chicago. I was let go and was. At the time I was literally, it was Christmas Eve and I’ll never, ever forget it because I was in the hospital looking outside. It was a rehab facility at the time. I went in there when it was warm and I’d moved from hospital to LTACH, long-term care. Then they finally moved me to a rehab facility. It was Christmas Eve, the snow was falling. I was going to get go home for the first time to see my kids. They were going to open up their presents. The hospital was letting me go with an escort home. And I was so excited and I was like, I know my wife’s spoiling my kids. I just knew it. I was like, she’s totally going to spoil. Dad’s been gone forever.
I thought, I’m not worried about losing my house. I’m not worried about my wife leaving our now four kids. We just had a baby, to go work while she has a paralyzed husband and someone else has to take care of our kids. That was all because of that real estate. It became something that was, it became my why. Then after that I said, I’m going to teach this. We’re going to allow other people to invest with us. I started the private equity side and we’ve been doing that for over five years now. That’s my story. That’s what I do and why I do it.

Dave:
It’s an incredible story AJ, I’ve heard you tell it once or twice before, but every time you do it’s just incredibly inspiring that you were able to overcome an incredibly challenging situation and are helping other people achieve the same level of financial freedom that you have achieved. Thanks for telling that story. I’m sure it’s somewhat of a painful memory but also you’re using it for good now.

AJ:
It was hard to talk about for the first few years but I think talking about it actually helps. And I wish people would talk more about that because that’s what people relate to. We’re all struggling, we’re all going through it. And honestly real estate is great. It is, but we’re all doing it for a reason. At the end of the day as much as I love storage and I do, I’m a total storage nerd. I know everything about it. I own tech companies in the storage space. Started founding member of the largest co-op in the world in self storage. I sit on boards. I have the largest communication platform including the book and the largest podcast in the self storage space. But at the end of the day they’re metal boxes that people rent. And so it’s really more of what this vehicle or this asset class does for us.
I know everybody fills that way and once you get that attachment to what the asset does for me and what the game is and how we’re playing the game, that’s when it becomes really, really fun and people really fall in love. That gets you over all the frustrating times, all the hard times, because it is, real estate is hard, it’s not easy. There’s things that come up and everybody likes to say how passive it is and you can make it passive if you’re investing with somebody else. But when you’re doing it on your own, it is not that passive. And building a real estate company is definitely not passive. So you got to understand it and love it and it’s got to have meaning.

Dave:
I love that. Absolutely. Doing what you both do is entrepreneurship. There’s no easy route to entrepreneurship. It is definitely a difficult business and hopefully you achieve at some point being able to invest with other people. But you both are actively working and hustling really hard. But yeah, like you said, that why and having a really solid reason to do it I’m sure helps you push through it. You’ve told us your incredible story. I’d love to hear you’re talking about how the game. Tell us what’s going on in the self storage game these days, what’s the landscape for self storage at this point in 2022?

AJ:
So self storage, it’s so weird, I really do love this asset class. And one of the reasons I think I love it so much is how misunderstood it is. A lot of people really don’t get self storage. They just don’t. It’s this weird asset class that people look at and they think it’s something but it’s not. And so it’s fun for me, because I get to educate and people are like, wow, this is incredible. This part of it, I didn’t even know this. And then also, oh wow, there’s a lot of misconceptions around it. I think some of the first things you have to think about storage is a lot of people think, it’s just because people are storing their junk. And that misconception led to a lot of people prior to 2008, nobody wanted to invest in it. There’s a lot of things that people perceived that it was risky.
Prior to 2008, self storage is the newest commercial real estate asset in the commercial real estate asset groups. It came about really in the 80s and started to take hold in the 90s and exploded after 2008. And what a lot of people don’t realize is prior to 2008, institutions did not play in self storage. Banks weren’t majorly involved in it, you didn’t have funds, you didn’t have any of those things that were in self storage. And one of the reasons why was, well not one, the two reasons why, was first, the inability to manage and operate them. Self storage is a business, it’s not a real estate asset. In fact it mirrors much closer to a retailer or a hotel than it does anything else. Why? We have short term contracts, we have lots of products, meaning units that have different people. There’s different reasons that people utilize it from businesses to everything else.
Operationally it looks super passive when you’re comparing it to an apartment complex because nobody’s living in it. But business operationally, it’s much more complicated. I look at apartment buildings and I’m like, wow, that is so passive. What do you do all day when you own one? Because it’s just we’re marketing, you have to do all this stuff all the time. So prior to 2008 there was no institutional grade, third party management. If I’m a fund and I want to put 100 million or a billion dollars into that asset class, what am I supposed to do with it? How do I manage it? And then second, it had never been through a debt cycle. It had never been through a major cycle, so the banks and institutions and funds, they couldn’t underwrite this asset class.
So during the 90s you had a boom in development of all the other commercial real estate assets. Everything from hotels to retail centers to the super Kmarts and Walmarts and you had all of it, right? Everything from housing in the late 90s, it all exploded and developed. Self storage didn’t. It didn’t go through a major development cycle. After 2008 you had companies like Extra Space, that’s a REIT. They developed institutional grade, third party management and it had now been through a real estate cycle. More importantly it was the best performing asset during the great recession. And all of a sudden everybody took notice, because it wasn’t just the best performing, it blew every other asset out of the water. As of right now, still to this day, 26 years later, it is the top performing and the lowest defaulting commercial real estate asset.
After 2008, everybody had just gotten slaughtered in all these asset classes. They went bankrupt. And they were like, we got to find somewhere to put it. I know real estate, I don’t know, where do we go? And self storage became the winner and the landscape changed. Once institutions came in, people started to realize you win this game through business and technology. Technology started to come in, big money came in and the self storage development boom started and that started in 2016. We went from the highest point ever on development, was about a billion dollars prior. Every single year after that it was five times that. We hit two, three billion, then we were hitting five billion a year. So since 2015 we’ve not even eclipse, we’ve blown out the development of any previous high ever known. And from there, self storage was changed forever.

James:
So prior to 2008, because that’s interesting that the banking became easier in 2008 and nine for this product considering what was going on in the banking market. The banks were melting down during that time. How were those deals? When you guys started looking at these in 2005, right? You guys were looking for asset classes to invest in, you wanted a higher yield, you ended up selecting self storage over even other things that could also be high yield. How were those things debted though? If it wasn’t big institution, was it all local banks, how did you take a deal down prior to 2008?

AJ:
Credit unions, local banks and seller financing is how we did it. We did a mixture of local banks, credit unions, seller financing, but it was really predicated on our income. Banks really viewed it like a home, not a commercial real estate asset. They were like, you got to pay this back, so we’re looking at your income, we want to see how much money you have. And that really changed what we could do. We had to go to cities that no one’s ever heard of. We went to, our first facility that we did was Bonners Ferry, Idaho, which is literally a population of 400, nobody’s ever heard of this place. There’s more grizzly bears than there are people there. Just out in the middle of nowhere so we could buy a cheap asset, we had to put a lot of money down and the banks looked at our assets.
I want to see your home, I want to see your bank account. Whereas today the banks don’t really look at our assets. And in commercial real estate, financing is viewed much more on the asset than it is the person. From there we’d go, but they’d cap us out. They didn’t want to lend a lot of money to us on storage where other real estate asset classes, like multi-family or whatnot, they didn’t care what your debt to income was. That was irrelevant, right? Storage it wasn’t at the time. So then we would have to go negotiate with sellers, do seller financing. But to give you an idea of how much people didn’t want this asset, we were sitting down on one of our deals prior to 08, and we were in negotiations with the lady that owned it and she’s like, I want a 10 cap.
And we’re like, we’ll pay you a 12 cap, and two you’re going to seller finance this and we’re not going to have recourse. It’s going to be at 3%. It was just like, we’re the only people here to buy this, there’s nobody else coming. And so we had all the ability to basically set what we were doing it. Those banking terms were like that. Think about this, we’re buying nine caps, 10 caps and banks didn’t want to lend money to it, but they were lending to homes, duplexes, multifamily at negative carry. And so crazy.

James:
Is that because, because I remember in 2008 there was a lot of defaults going on in small storage facilities. To be honest I just blew it on a couple because it was hard to get debt on them. But do you think 2008 reset the market as far as, because what a lot of the operators back then were just mom and pop, small owners and they kept really poor books. It was like you couldn’t get leases, you didn’t know what it was. The rent rolls were all over the place. Do you think that’s when that all changed, 2008 the defaults went up and then the institutions and investors like you cleaned up the whole business and that’s why there’s more financing available? Because I remember, we look at things and people are like, we don’t have leases. The PNLs would be all over the place and we couldn’t get a loan for anything just because there was no substance. It was just like you said, a 10 box on a piece of land with no real true income. I almost feel like 2008 reset a lot of things.

AJ:
Mom and pop is an understatement. You’re exactly right. Seriously dude. And still we find these. I’m negotiating with a guy, get this, we’re negotiating with a guy with 500,000 net rentable square feet. Can you send us over your printout on your management summary? We keep it all by hand, by paper in the office. You have to come here to our location and go through the paper.

James:
Xerox it.

AJ:
Yeah. Because that’s what it was done prior to 2008. And one of the reasons that was done was because banks wouldn’t loan on it. So the people that were buying them and building them, it was almost all cash. One of the things that people don’t realize, self storage had such a low default rate. Well at the time, self storage debt to income or debt to value, it was like 30% debt. So they survived. They had no debt. So of course they survived. But the ones that did default were ones that couldn’t refinance and needed to, right? Because then like you were saying they have all this paper stuff, banks were gone and we couldn’t get bank financing for self storage for, it didn’t become easy until like 2014, 15. So it still took a while, because that’s when institutions came. After 2008 we had years where we couldn’t get financing.
And then you have all these people that either needed to refinance, they couldn’t or they had just developed storage and they were done. It was out. We bought a lot of those people up. And so yeah, it’s very important to recognize even though it was the lowest defaulting doesn’t mean there was not defaults. People get that confused. There was, and there were defaults at astronomically low debt. When we’re buying them, our whole business model, Jimmy, to your point is we’re going out and we’re buying these things that are ran like that and we’re turning them around, we’re updating them on technology. Our original business plan was this, we’re going to actually pick up the phone and we’re going to collect bills. That’s it. We’ll just pick up the phone and we’ll make people pay their rent. And that was a winning strategy in the space. It was very mom and pop.

Dave:
Who was even developing these things back in the 90s and early 2000s before some of the institutions got in?

AJ:
It was mostly home developers that were developing huge neighborhoods and they would have these pieces of land that they didn’t know what to do with and storage was really cheap. And so they’d be like, well we have this land, we’re developing this, so we’ll go throw these on. Or it had a few of the large players. There were handfuls of large players, but 90% of the industry when we got into it was mom and pop, single operator owned. Then 10% were large guys. That has dramatically changed now. Through this, everybody, what we’re all talking about here, what James, David and me are talking about is consolidation. Consolidation happened due to the change in financing the players and the leverage of operations and technology in the space. And that’s what we did. That’s why we got into it. We went into it to consolidate the space in the industry. That’s what we do.
We’re trying to buy them all up, turn them around, package them in. We’re in the top 70 self storage operators in the world. Our portfolio is that, we did it here yesterday, we actually had to line it up, at a five cap it’s over 300 million. We have 33% debt to equity on average and over 60% of them I own with my partner individually. And so when you look at the bigger players, which I don’t even consider myself one. Now if you went back to 2008, we would’ve been one of the biggest in the world, in the top 10 probably. But that changed fast.

Dave:
I’m curious about that because there’s a lot of fear in the single family and multifamily residential space about the entrance of technology and institutional investors and Wall Street. And it sounds like something similar has happened here, but are you afraid of that or do you see them as competition or how has that changed your business?

AJ:
I do see them as competition, but that just means we were innovative and that’s why I own a tech company. That’s why we started the tech company. That’s why we started the co-op. And it was to just combat with that. Now, I’m a lot more worried about that in storage than I am single family houses. The reason is branding and how you attract your customers. You should be concerned about institutional market consolidation when you’re in an industry like a hotel. So prior to the 80s, right? Hotels were outrageously fragmented. Now they’re all under five brands. And why? Because of customer acquisition. So self storage, 85% of our customers are acquired from online. That means if you win the online space and you can attract it, you own the market. So if you look at two self storage facilities on a street, they dramatically perform differently.
Even if they’re the exact same unit, same size, same location, the operators change the performance. You don’t have that kind of leverage and that change in single family homes. Consolidating single family homes, you change the buyers, right? That’s what you’re changing. Somebody is buying more than another person. But the person that’s buying more isn’t fundamentally changing the business model or the acquisition of customers or anything else that they can leverage and outperform their neighbor by leaps and bounds. Market rents are fairly set for us. We do things like dynamic pricing, meaning every day all my rates are changing. We’re acquiring different types of customers, we’re doing all this lead stuff, we’re generating, it’s a big machine that we can use and leverage data and we can actually beat our competitors.
That’s not really how that works in an asset like that. Storage, we were worried about it. We’ve invested a ton in it because we didn’t want to end up like hotels. But even Sam Zell tried to do that with apartments and it didn’t work.

Dave:
To brand them.

AJ:
Tried to brand. It didn’t work, right? Because nobody cared about those things. Where it’s different in certain types of asset classes.

James:
What AJ’s talking about right there is so important as investors try to scale and get into bigger projects, running the business side, because a lot of people think of real estate is just an asset you buy, you manage it and you collect cash flow. But the business side is where your whole portfolio can change and what AJ’s talking about, running self storage I think is so unique because you really do have to operate your business well not just by the real estate, but as you scale up with apartments, apartments have gotten in that same categories. Well as we’re going out and getting debt on these large sites, we’re buying an 80 unit building. The bank is going through all of our websites. They want to see that we are an actual business though, that we are not just real estate investors.
And that is really, really key and important for people to realize as we go into some sort of recessionary market, it’s so important that you actually build the business because the bank will give you more leverage, they’ll give you better terms and they will actually, they’ll commit to you more if you do run professional websites, managed it well. For us we’re building a master website right now for all of our apartments. They all tie in together and it shows the infrastructure behind it and that’s where the whole leverage game changes and that’s why that changed 2008. As people get more professional there’s more money available. But self storage or apartments, if you want to scale, you need to invest in the infrastructure.

Dave:
It’s a totally different skill. It’s not the same as going out and finding an underwriting deals like customer acquisition, marketing, following up. Collecting rent. Like you said, it’s a different business and you need to find, I assume you have a whole team AJ, of people who are helping you building this marketing engine that you’re required.

AJ:
I have over 80 employees. When we look at this on just that self storage side, that’s not the tech companies, anything else, that’s my, we would call direct reports. What you guys are talking about, what Jimmy’s talking about is really important. When people are like, well is it easy to get debt? Would that bank want self storage? Would they want to lend to self storage? I’m like, I don’t know if the bank would want to lend to self storage but the bank would want to lend to me. And it’s not because of my financial stance, It’s not because they go you have a lot of money in the bank. That’s not it at all. It’s because of what Jimmy said. They’re looking and say you have the infrastructure to pull it off. That’s the difference.

Dave:
So they’re looking at your customer acquisition cost?

AJ:
Yes. They don’t ask, hey AJ, how much money do you have in a bank? Now we’re going to loan you. No. They say, what’s your site look like? What’s your customer acquisition process look like? What’s going to happen if we are in a high vacancy area? They’re looking at the execution on commercial assets. That’s what they want to see. It’s not nearly about, you could have somebody that has way more money than I have, way more money in the bank, and they went to get a loan on a self storage and the bank’s going to be a lot more hesitant to give them money if at all than they would be for me. Or anybody else that creates a plan to really execute and has the right business partners, has the right business associated with them to get this done. The better you can showcase how you are professional, what you’re doing to build a business, how you look, create a business plan, that is going to help you infinitely in getting loans.

Dave:
That’s incredible advice. I think that’s something people truly overlook all the time. It’s sort of like the operational piece. Everyone wants to go out and just find the deal because it’s fun. It’s definitely fun doing that. But you have to back that up with operational excellence, especially if you’re trying to get the debt you’re looking at. You said something… Yeah, go ahead.

AJ:
I want to make sure it’s very clear. People are like, well if I don’t have that, that doesn’t mean I can’t get the loan. That’s not what we’re saying. There are third party management companies, there are ways that you can set up. Do you have an LLC? Do you have a website? Do you have a professional looking presence? Do you have a presentation and a business plan full of partners, abilities, strategy that you’re going to execute that you can explain? That’s what I’m talking about. Going in and saying this is a good deal and I want money for it. They go, okay, I’m a bank. I don’t know if it’s a good deal. I don’t know anything about storage. Is it a good deal? I have to know that you know, you’re going to show me why it’s a good deal and what you’re going to do to make sure it’s safe and profitable.
The more that you can teach me as the bank and explain to me your business plan in a professional manner, the more trust I gain for you to execute on something that I don’t know. It doesn’t matter if you have zero employees, it doesn’t matter if you have any experience, you need to be able to show them you have a plan. And a lot of people treat it like they’re buying their personal residence, and it’s like, well here’s my income, what will you give me as a loan? It’s not how this works. And people need to, whether you’re buying a duplex, a single family, you got to start changing your mind about how you talk to banks, what your value proposition is to banks. A lot of people don’t realize that and they don’t understand why banks don’t want to give them money but they’re giving Bob down the street money and you’re like, I make more money than Bob. Why are you giving him money? Right?
Well it’s because Bob has it together. He’s got a business plan, he has an execution strategy, he’s partnered up with so and so. He knows what he’s talking about or at least looks like he does.

Dave:
That’s great advice. I want to ask you about something you said where you said that two different storage spaces on the same street will perform really differently largely based on brand. I’ve just noticed this in Denver where I used to live that the self storage facilities we’re building in I would think higher and higher priced places. And I was always curious about that in urban infill instead of on the outskirts. I was just curious, what is it about or how location dependent is storage and why would they be willing to pay that high price for the dirt when seemingly you can put them anywhere?

AJ:
Self storage left the industrial parks, they left the back alleys and they went to the corners. Self storage is now being considered more infrastructure. It’s also now being considered more key type real estate assets. But in order for cities to recognize that, which has taken them a long time, you had to show and you’ve probably noticed and a lot of people have, they look different today.

Dave:
They’re swanky now. They’re nice.

AJ:
They’re swanky. They’ve got lights.

Dave:
Expecting like a cocktail bar in the self storage facility.

AJ:
Oh yeah. We put a lot of money into those things. I’m developing a $40 million storage facility right now and it’s when we’re working with cities, when we’re working with county commissioners and residents, you’re showing them something that looks better than the office buildings and everything around. So self storage has changed and what you find is customers really care about, first of all how it looks, how it feels, safety and security, convenience. You’re not going to drive past three facilities to get to a storage facility. That’s not how it works. Convenience trumps everything. And self storage is outrageously sensitive to supply and demand. The more that you can get with the people, that is your target market that will pay the right places and generate that product offering, self storage is competitive, right? You will stop all those customers from going down to the other facility or the ones you want.
So in self storage we have three different types of customers. You have customers that care about price, you have customers that care about location and you have customers that care about quality. The price driven ones, I don’t want. Those can go to the infill, the junkyard, everything else. They can go to the industrial and they can drive to pay that $5 difference or whatever it is. That’s actually I think the smallest class of people. That’s a very small one. Most people care about location and quality. Over 60% of all of the decision makers on renting a storage unit are female. Now they may not be the ones that are doing it, but they’re the ones that have the end say on, I’m not renting there because I’m not going to go drive in there. I don’t feel safe.
That really changed the way and when you look at a model that is driven on operations and you can leverage it and different product offering and types to different types of people, it changed the way we look at where they should be. It changed the way once they started building nice ones that looked like hotels and office buildings, it changed the way the city accepted and would allow them to be as part of the community. Now, generally speaking, cities don’t like storage for a few reasons. The first reason is they are the lowest tax basis of any commercial asset. No one’s living there. You have no businesses that are there. As far as a per square foot basis, it is astronomically low tax revenue to the city and it doesn’t hire anybody.
Cities don’t generally like it because of that reason. But it is now in most places considered infrastructure and cities know they need to have them, they need to have them somewhere and they’re working with them.

James:
There’s also the human nature starts to evolve. In 1990s we had had a lot of big mansions getting built, big homes, big lots, oversized. And then over the last 20 years, I just saw that California came out with something where you can actually go, you can condominiumize any lot, single family lot in all of California and it doesn’t even matter if you have an HOA and the HOA says you can’t do it, it supersedes it. So now affordable housing and these little cottages are popping up everywhere. I know in Seattle we’re building a bunch, we had Thomas James Homes on not too long ago and they’re building a lot of cottages and they’re maximizing the ratio of what you can cover on these lots.
And so a property that had one house on it now can have three to four, but the space is also substantially smaller. Also Washington, the governments are going through the trouble of making sure these big houses aren’t built anymore. They’ve maximized the far coverage to where if we have a 5,000 square foot lot in Seattle, we can only build a 2,500 square foot house where we used to be able to build a 4,000. And so it’s shrinking the structure of these buildings. I also think that’s why the trend is you’re seeing these storage units come more infill. Because before it was for toys and random junk in the middle of nowhere. Now it’s at a necessity. If you have an 800 square foot, two bedroom, one bath house, you’re going to need space to stick your stuff. Because a lot of these also don’t have garages either.
And so with that transition going on and we’re seeing this evolve, where’s the forecasting at for that with all this affordable, condominiumize small lot housing? It almost feels like the hedge funds might have known about this prior because I started seeing all these structures go up everywhere in Seattle and they weren’t getting filled and now they’re in high demand. I was actually really confused when I saw them going up everywhere. I’m like, why are these things going up everywhere? There’s no demand. And then all of a sudden they start filling in. Well, what’s the forecast for that? Because people are going to need to put their stuff somewhere. Either they’re not going to buy stuff or they’re going to need to put it somewhere.

AJ:
When I said a lot of people don’t understand storage, this is the thing that is the most misunderstood part of storage, is demand. And the reason being is most people view storage as a product of excess. It’s because we’re hoarders. Everybody in America just spends lots of money and they just buy tons of crap. Which it’s partially true, it’s not like that’s totally not true, but actually that’s not the main driver. It is an economic as well as a regulatory function that is creating demand. So as you said, people are downsizing, people are going into smaller areas, but also the homes, even the McMansions. When you’re in a McMansion today, you have an HOA. That HOA doesn’t let you put an RV out front. When you want to go build a shop on the side, you can’t do that.
We are more regulated over our real estate than we’ve ever been. Back in the 80s when my dad wanted to buy a bunch of stuff, he went and built a shed out in the backyard and we would put our bikes in there, we’d put everything else in there, he can’t do that. Or Bob would work out of his backyard. Bob ran a plumbing company and he would take his truck in the backyard, in the shed and go, you can’t do any of that anymore. Space is regulated and it’s downsizing and it’s expensive. The price per square foot to build on the equivalent of a 10 by 20 for the average American makes no sense, especially at debt levels like this. Now all of a sudden it’s cheaper to go rent a 10 by 20. Then you also have the fact you have regulatory issues, you have building constraints and cost. You have more densely living people, but you have utilization.
In America, at the same time that price of real estate has skyrocketed, our ability to consume has dropped dramatically and the way that we consume has changed. Instead of localizing goods, services and products, we have now fragmented that distribution process through the internet where we know we don’t need to go to set locations to do that type of service. This fragmentation of supply chains and the way that customers interact creates last mile problems. We’ve seen a surge in business utilization, not only in industrial but also self storage. And also now people can consume at a whim, they can buy what they want. I know that I can live and I can have cheaper rent in an apartment because I live by myself, but I can still have my motorcycle, my skis and everything else. So now why wouldn’t I?
Now in the 80s you couldn’t, where were you going to put it? That wasn’t even an option. And two, your price per unit on anything, a motorcycle, anything else was astronomically higher in comparison to your relative income. Businesses now, they know that if I’m renting an office, I have my office here, right? Why in the world would I take up an office space that as an individual that is a revenue generating and producing individual to store files? That makes no business sense whatsoever because that space is so expensive and I can utilize that space to generate revenue from a worker or whatever it is. I use a storage unit, we stash all our files, everything else over there. This economic change, this supply change, this consumer change and business, that has fueled self storage. Right? Now, self storage is probably overdone at this point.
It just is. Everyone’s noticed it. It’s been the talk over the last three, four years, right? They’re everywhere. Everywhere. Now that is correlated with a rise in utilization, but it’s about a point. On average we’ve remained about nine, 9.5% utilization of storage in the general population, that’s gone up to 10.5. But a lot of that increase was due to COVID. I call it the COVID bump. On average right now, for the last three years we’ve seen 96% occupancy rates. The next previous high ever was 86%. That’s an abnormality that is not, I think consistent with long term use trends and demand for self storage. There’s a lot of people that are going to get burned by that because they all rushed into high, high growth markets. They were building it up. But that infill and that utilization and demand was being driven from growth.
And once that growth is gone, you have vacancies. I think that will hit certain markets hard because it was just overdone, it was overbuilt. I think we will have a disparity in the coming years in performance and self storage. And that is going to be something, I think that’ll happen in a lot of asset classes. Right? But I think it’ll happen in storage in a way that it hasn’t happened before, principally because we didn’t go through our development cycle. We never went through a development boom in self storage until after 2015. We are on the tail end of a development boom that had never been seen before. Well, of course that creates excess and supply. I think storage is incredible. People get it. We have 40% margins. It’s low capital, expense intensity, all the wonderful things that people already know about it and say these things are cash cows.
But then you also have the downside of that, that demand surged from investors. They’re easy to build, they have lower barriers of entry than most commercial assets of that size. If you had, let’s say a multi-family unit. So let’s say James, you’re going to like, okay, I’m going to go build a multifamily unit that has 500 doors, right? What’s that going to cost you in Washington?

James:
That big of a project is like five to 600 a foot. That’s because that’s commercial. That’s an expensive build out.

AJ:
You’re like six, seven times what it would cost me. I could build something like that for under 10 million and have 500 doors. A lot of people, and I don’t need plumbing, I don’t have all the issues, all that stuff. A lot of people turned to self storage and said this is easy to develop, it’s in high demand and it will fill up. And the market bailed people out. Meaning as the market went up, people could over build and they were okay, that’s not normal. Right? Now, it may have had to do something with the $3 trillion the government spent, I’m not sure, but it’s probably something to do with that. And so that not normal market cycle encouraged bad behavior because people were rewarded for it. And that’s across all asset classes. But storage, I think it’s going to be new because people didn’t get previously burned in storage.
So housing was constrained because people were scarred from it, housing is still constrained. There is an actual delta from houses needed to houses on the market. We don’t have that in storage. When everybody else was burned from housing or whatever it was, retail, anything else prior, they weren’t burned from self storage. They just thought this is an easy asset and some of those markets are going to fill that, hey, when markets don’t go up, you don’t just get bailed out for bad decisions.

James:
You’re saying self storage is no different than every other asset class that has just been pumped in juice on the performance. I actually thought a little bit, I didn’t really think of it that way because I just thought it was more smaller class so it couldn’t get as pumped as much.

AJ:
No, it got juiced.

Dave:
AJ, do you recommend people who are listening to this get into self storage? And if so, what words of advice would you give anyone who is interested in this asset class?

AJ:
I think self storage is the best asset class for an individual to get into in commercial real estate. The reason being is this, even though it has all the same problems now that all the other real estate asset classes have, none of those go away. I think there was a common theme that self storage is recession proof, which is idiotic, but that’s what people said. I think they’re going to learn that that’s not true. And so all that means now is, does that mean that people shouldn’t get it? It just means it’s like every other asset and you need to be smart when you’re building and pick on demand. But what self storage has that a lot of real estate asset classes don’t have. The vast majority are mom and pop individual owned that are vastly underperforming their potential from decades of people owning these things that had no business in actual operating the facility, anything else like that.
It’s still over 50%. Compare that to multifamily, right? Well the vast majority, 80% of multifamily is owned by institutions. And two, self storage, they’re everywhere. There’s more self storage than there are McDonald’s, Starbucks combined plus some, right? The inventory, the ability for me as an individual to get into the self storage game and buy it from a person that is not institutional grade and do very little easy fill ups and fix up to massively improve that, I still think is better than any other commercial real estate asset class out there. You can buy them in markets where institutions aren’t there. You can get them and they cash flow great. You need to watch out for the downsides to self storage. I’m not here to simply prop up storage and say, yeah, everybody needs to get into it and it’s recession resistant and all the same crap you hear from everybody else talking about storage that’s just trying to get investors or somebody else.
That’s just not true and people are going to learn it. But if you understand what makes the downside in self storage, it’s easy to avoid. Don’t do stupid things. Don’t go into a city where they’re building 20% new inventory coming onto the market and think that you can understand demand and demand won’t change. As long as you understand the downsides and you can avoid them, which you can, it’s very easy to do, I think self storage is the greatest commercial asset for an individual to start out in and get into.

Dave:
All right. That is great advice AJ. I have about 20 more questions on my list I wanted to get to, but we do have to get out of here unfortunately. That was a great way to wrap up. Any last thoughts and can you tell us also where to find you if anyone is interested in learning more about you? I know you have a book and your own podcast. Where should people find you?

AJ:
Easiest way, you can go onto Instagram, AJ Osborne, self storage. We do all things related Self Storage Income, that’s the website, the podcast, you can go jump on there and we just do infinite free information. It’s all out there on YouTube. Everything else that you can go consume to learn more. You can message us, email us directly from Self Storage Income website and you can DM me on Instagram.

Dave:
Awesome. Well, AJ Osborne, thank you so much for joining us.

AJ:
Thank you for having me on. Appreciate it guys.

James:
Good to see you buddy.

AJ:
You too, man.

Dave:
That was so fun. I did not know a lot about self storage and I just learned so much. What did you think of all that? I know you know AJ pretty well, but what’d you think of what he was saying?

James:
I love AJ. Me and him go down the rabbit hole. When me and him hop on the phone, it’s usually a long conversation, hours in going down rabbit holes. But yeah, no, I learned a lot. That is an asset class that I’ve always been interested in. Those high yield, the mobile home parks, the self storage, and just really you do think about just going and buying this stuff, but you need to run it like a business. If you’re not geared up to manage it, then he reiterated that make sure you put all the pieces together before you just jump into any type of asset class. Because I was thinking about getting in, and like, I should buy one of these and see what it is, but I got a lot more work to do before I go down that road.

Dave:
Totally. It actually reminded me when I first started at BiggerPockets, my first job here was in growth marketing, which is a lot of what he is talking about. Using data to try and figure out how to acquire users, trying to find the right people who are interested in our stuff and communicating to them effectively. Doesn’t sound like a real estate business. It sounds like much more like a software business or an operational business where you need a very different skill set than I think you do just to purely buy residential.

James:
You know when you look at a multifamily deal and they give you the performa and then their answer is, well why is this a good deal? It’s poorly managed. That’s their number one broker con.

Dave:
Yes, exactly.

James:
Poorly managed. That is true in self storage and that’s what he reiterated. That’s maybe not always the case in apartments, that’s their excuse out. But if you do not run your business right, you’re not going to get money and it is not going to run correctly.

Dave:
I could totally see it. Right? I have this short term rental, it’s in the middle of nowhere, and the town probably is like, I don’t know, 15 structures in the whole town. And two of them are self storage facilities and they look like they’ve been there for like 200 years. I don’t even know how they got to that place. But they’re full. There’s always people going in and out of them and I’m just like, who manages that place? It has to be someone who’s lived on that property probably for 30 or 40 years and has probably not the best, I’m just making some judgments, but probably not the best operational skill set to actually be running that business.

James:
Oh yeah. I’ve looked under the hood a couple times on these deals and you’re like, I’ve seen some operators that are really just handshake. They’re like, well, they pay me cash every month. And you’re like, what? I can’t get financing on this. And so yeah, the operation is a big deal. Banks don’t like to see backdoor cash deals with no leases. It’s usually not a good way to get your financing.

Dave:
Totally. I was glad to hear him talk at the end about the oversaturation because that was my number one question going into this. You go to just even talk to people who are new to real estate and they’re buying self storage facilities, and that’s great, but it just seems like everyone’s been doing it over the last two or three years. It’s got insanely popular and I was worried about this overbuilding, but just like he said, and just like we talk about all the time on the show, it’s super market dependent. It sounds like there’s still, he said, what? 50% of the self storage units in the country are still owned by those mom and pops. It seems like there’s still opportunity, but just like with everything these days, you need to be a little bit cautious, especially in those oversaturated markets.

James:
Yes. Watch the supply and demand. It’s always supply and demand, whether you’re going to eat your metrics or not.

Dave:
All right, sweet James, thank you as always for being here. Where can people find you if they want to ask you anything?

James:
Best way to find me is on Instagram at jdainflips or our YouTube channel at ProjectRE. We do lots of free flip tips and you get to look at all the weird stuff we see on a daily basis. So check us out.

Dave:
You got a lot of weird stuff going on, man.

James:
Oh man. I think half the reason I’m a little bit sick is just from these houses. Like this one house I bought, it’s hung onto me for three weeks, I think.

Dave:
You got to start wearing a hazmat suit in some of those places. All right, sweet. Well thanks man. Appreciate you being here. If you want to reach out to me on Instagram at thedatadeli. We will see you all next time for On the Market. On The Market is Created by me, Dave Meyer, and Kailyn Bennett, produced by Kailyn Bennett, editing by Joel Esparza and Onyx Media, research by Pooja Jindal, and a big thanks to the entire BiggerPockets team. The content on the show On the Market are opinions only. All listeners should independently verify data points, opinions, and investment strategies.