Date: April 4, 2018
To: Self-Storage Property Owners
From: Heidi Henderson, Executive Vice President of Engineered Tax Services
Many real estate investors are unware of how the top industry professional utilize the tax code to their benefit. And most think that their tax professional is aware of every aspect of the existing code to advise them of any applicable credits or deductions they are eligible for. In reality, the tax code is complex and expecting your CPA to know every aspect of it, is like expecting your family doctor to be able to perform heart surgery!
I am a real estate investor myself and through many years in tax and accounting I have learned from the best on how to apply every aspect of the tax code to create the most tax efficient real estate portfolio, leading to continued success.
Recent tax changes under the Tax Cuts & Jobs Act expound on the benefits of real estate investing. Taxpayers can now capture immediate deductions for business related tangible property, your depreciation can be front loaded, and for energy efficient buildings the available credits and deductions were renewed in February of 2018 and assets removed during demolition can be written-off or donated for a charitable contribution on your tax return.
These are just a few of the complex tax code sections which can make the difference between a profitable business, and a losing proposition. Below is an article outlining 11 Frequently Asked Questions about Cost Segregation, which is one of the methods you can apply to your property.
We partner with business owners across the U.S. and have worked on thousands of self-storage properties nationally. Give me a call today for more information and to discuss the some of the tax strategies that might be applicable to your business or property. I can be reached at (801) 689-0325 or via email at email@example.com
11 Frequently Asked Questions about Cost Segregation for Self-Storage Properties
By: Heidi Henderson, Engineered Tax Services
Cost Segregation is the process of identifying personal property vs. real property, and individual building components for tax purposes, rather than treating a building purchase as one large asset. This determination allows a property owner to depreciate their assets over the useful life of each asset instead of assuming that the entire purchase amount applies to one long-term (39-year) asset.
All investment properties, including self-storage properties qualify for cost segregation. When a cost segregation study is applied, you are telling the IRS that you are simply choosing one acceptable method for depreciation (MACRS*) vs. another approved depreciation method (straight-line). Both are acceptable, however MACRS requires an analysis to identify the value of each individual asset you own, rather than looking at your property as one large asset.
Cost Segregation can be applied to a newly purchased building, a newly constructed building, or a building you have owned for around 15 years or less. If the property is not fully depreciated (39 years is the length of normal depreciation), then there is an opportunity to change the method with cost segregation. Although any property can be depreciated under MACRS, the costs of performing a cost segregation study may outweigh the benefits if the property was acquired for less than approximately $300,000.
Under straight-line depreciation a property’s total cost (less an allocation for land), is depreciated evenly over 39 years. Under MACRS the assets are identified and reclassified in 5-year, 15-year, and 39-year class lives depending on the IRS determination of its actual useful life. And whether the assets are used for your business use, or the basic function of the buildings use as a structure. Examples of 39-year property include; windows, walls, doors, roof, HVAC systems, plumbing, and electrical. Examples of 15-year property include exterior improvements such as; fencing, exterior signage, asphalt, curbs, landscaping, and exterior lighting. And examples of 5-year property are; carpet, appliances, specialty lighting, woodwork, unit partitions, individual unit locks and security, and business specific heating and ventilation systems.
Some property types will have a higher reallocation percentage than others. Interior, climate controlled self-storage properties will see a higher amount than a shed-row or boat and RV storage type. The allocations are based on actual assets and values or each of the components within the property.
Surprisingly, the information required to perform the study is limited. For a recent purchase, the closing statement or HUD is the only requirement. Blueprints are helpful but not necessary. New Construction projects require cost breakdowns and total costs for construction and development, but individual invoices are not required.
Choosing a reputable firm is a vital to ensuring that every aspect of the IRS requirements are met, and in the case of an audit the report is upheld without disallowances or associated interest and penalties. The IRS Audit Technique Guidelines dictate that a physical site visit is performed, the analysis is performed by a professional with cost-accounting or engineering expertise, and the method of determining asset value is an approved methodology. Make sure that audit defense is included in your study, and that the final report offers complete detail over every aspect of your property. Choosing a low-cost provide may be tempting, but the ultimate savings, detail and support of a reputable provider will far outweigh any additional costs. And finally, ask for references!
Cost Segregation is not a “trigger” for audit. The IRS issued automatic consent for deprecation whether applying a change from straight-line to MACRS at the time of purchase or retroactive for a property you bought 10 years ago. This means that taxpayers are allowed to make this change with the approved forms offered by reputable cost segregation firms. However, in the rare case of an IRS review, rest assured that a detail report with the proper IRS approved methods and audit support will affectively defend your tax filing position.
The cost is usually based upon the type and use of the building, size, and location of the property. Beware of cost segregation providers who charge a percentage of the tax savings. The tax savings is relative to the entity type, number of owners, the year of acquisition and other factors, so the actual cash benefit can vary. Most providers will offer a quote along with projected tax savings, so you and your CPA have the information necessary to make an educated decision.
The tax savings realized with a cost segregation can vary depending on the type of building, your total acquisition cost, and length of ownership. Self-storage properties vary in type and size and may see reclassification percentages from 15% to as high as 40%. Request a detailed benefit analysis from a qualified and experienced firm who has a history with self-storage properties.
The Trump administration passed the TCJA which is the largest tax reform bill passed in over 30 years. There are significant changes that offer tax cuts for real estate investors. The largest change being the adoption of 100% bonus depreciation for tangible personal property acquired after September 27, 2017. Tangible personal property is defined as assets with a useful life of 5, 7 or 15 years. Therefore, when cost segregation is performed to identify the personal property (5, 7 15-year property) apart from real property (39-year assets), it allows the property owner to capture bonus depreciation on those reclassified property and immediately expense the entire value in the year purchased!
*MACRS: Modified Accelerated Class Recovery System
There is an art and a science to presenting auto-pay to the self-storage customer but there is a tremendous value for both the customer and the self-storage facility.
The presentation of auto-pay is everything, how you say it, how you deliver it and the sub-conscious triggers the customer reads all work as a synergy to optimize your auto-pay program. With Storage Authority Franchising we have the system in place for you to maximize your revenue and streamline the process.
We love customers on auto pay because they save us time (for marketing) Typically only the few who put themselves on auto pay get on auto pay. Even if asked if they want to go on auto pay say no because most yes or no questions naturally end up with as a no. This one is a no-brainer. It just takes learning the script and techniques mandatory and one hour of training and the proper lease. Because people stay 2 extra months if they are on auto pay an extra 10 auto pays a month is worth $30,000 a year.
When presenting the hard copy lease, Storage Authority may be the only one who has this option on the front page of a lease making it easy to present and get a yes at just the right time. And no extra paperwork like every other facility. Of course, we had to pay a self-storage attorney to set it up to make sure we met the law, but well worth the investment.
As self-storage evolves, and we make the paperless transition the very wording on how you start the lease presentation will be critical to your success, ” All I need is your ID and the debit card you would like to keep on file.” As you swipe the debit card (debit cards carry less merchant service fees than credit cards) into the software you remind the customer their card will be debited on whichever date their move-in date every month and we will send an email confirmation. You automatically put them on auto-pay by just assuming they want the value of the program. Remember they are also reading your late fee schedule that is on your counter (*See Below example) as your working through the lease presentation. It’s expensive to be late in self-storage there is an immense value to the customer to automate their payment process.
For self-storage owners & operators, auto-pay is, undoubtedly, their best source for obtaining on-time payments. It helps lighten many of the biggest hassles that go along with operating a storage facility—namely delinquent payments, collection calls and lien sales. In addition, too, customers on auto-pay generally don’t think about paying that bill every month or scrutinize the dollar amount they’re paying too closely. Because it becomes just part of their monthly budget many will also stay an additional two months or more as noted earlier. Adding a rental increase also becomes streamlined and more acceptable for tenants enrolled in an automatic-payment system.
Take advantage of the “no late-fee guarantee” program use your tool on the counter to help educate the customer if there is any hesitation. Tell the customer how convenient it is to enroll. Also, be sure to ease their fears about any risks of keeping the card on file by letting them know your software program meets Payment Card Industry Data Security Standards (PCI DSS) and compliance. Customers cards are stored on an encrypted level where managers can only see the last four of the card.
Ultimately, the service should reduce your collection calls and lien sales, as customers on auto-pay will always make their payments on time. Plus, it’s another great service and valuable convenience you can offer your tenants.
Auto Pay Program + Late Fee Schedule
These should be outlined on a single laminated sheet and displayed on the counter or positioned in a plexiglass 8×11 frame very visible on the counter for the customer to read. Many self-storage operators fail to realize how valuable this is. Too often we forget to tell customers about our late fee schedule, or how they are guaranteed no late fees by enrolling in our simple, automatic, debit/credit-card payment plan.
How much of a collections issue would you have if most of your customers were on auto-pay? Quit asking new tenants if they want to sign up for it. Instead, make it part of the lease and sales presentation. For example, you can say, “Our customers love the convenience of our auto-pay program. All I need is your ID and debit card to get started?” More auto-pay customers mean fewer past-due customers and more streamlined revenue for the facility.
Money in the bank following the Storage Authority Franchising system.
Sample Development Budget & Proforma.
You will do multiple budgets proformas for yourself along the way to a final one for your bank. The first is one based on several assumptions and estimates so you can have some initial discussions with your banker. The second, one after you have a site plan, so you can provide a proforma based upon your actual design plans, including the exact number and size of units to be rented to get an updated pre-approval. And the final application with real construction cost from contractor bids and expenses from your feasibility report and other investigations, for the final loan approval. Your loan request will include several items in addition to the proforma. This information will help your banker make a positive decision on your application. It will provide valuable information about yourself, your business plan and your expertise and an executive summary which help your banker quickly understand your project and find the major data they need without looking everywhere for it. It is one more item to let the bank know you are a professional day one. Self storage is loan friendly because self storage loans have one of the lowest failure rates for real estate development. But part of loan decisions are based directly on you and how you present yourself, your project and your team.
There are no one size fits all standard construction cost, expenses or profits for self storage. Typically, the first semi accurate development and operational cost and profits come after you have found land, obtained a conceptual plan and obtained a feasibility study by a self storage expert. But it is important to understand the basic general magnitude of construction, operating expenses, rental rates and various financial information to determine if self-storage makes sense for you. The concept budget below is based upon assumed costs & expenses that may vary greatly. Be cautious as it would be easy to tweak one or several factors to eliminate the profits or double them. Many items and details are not included in this example such as carrying cost to get from empty to break even.
This is an example for educational purposes only and should not be used to make any final self-storage investments or development decisions.
CONCEPT BUDGET & PERFORMA*
50,000 Square Foot New Single Story Construction
TYPICAL LAND REQUIREMENTS*
Single Story Self Storage: Typically, 5 +_ usable acres when storm water detention is required and or subject to certain zoning restrictions. Land requirements can vary on local zoning requirements and land quality.
Typical Construction Cost vary on many factors from design, amenities, locations, land quality and more and must be determined by actual construction bids. Cost below have been assumed and will vary.
PRELIMINARY DEVELOPMENT COST* – 50,000 SF Single Story
Land $800,000 + –
Construction: $3,250,000 +_ $65/sf x 50,000 sf
Unusual land etc.**. $0 if none
Unusual City regs. ** $0 if none
Soft cost $400,000+_
Carrying costs $300,000+_
Total $4,750,000+_ Single story 1 phase
Phase 1 -25,000 sf $3,300,000+_ Note land/office/soft carrying costs in phase 1
Loan Equity $1,155,000 Phase 1 owners’ equity required
Loan Equity $412,500 Phase 1 owners’ equity required
As you can see there is a vast difference in equity required between a traditional bank loan and a SBA loan.
Typically, when phase one occupancy reaches 70% it is time to get started on phase 2. Most of the time you will use the same bank for both phases so you do not have to pay a prepayment penalty. Often your equity in phase one will be enough for most if not all of the loan equity required for phase 2. You should have these discussion with your bank when you apply for the phase one loan as this is not the case for every lender.
STORAGE RENTAL INCOME* FOR A 50,000 NET RENTABLE SPACE
Rental income varies upon many factors and are very dependent on location, unit mix, managers experience, marketing and several other factors. The SSA reported the 2015 national average rental rate for Q4 2014 was $1.18/sf for a 10’ x 10’ non climate control unit and $1.51/sf for a 10’ x 10” climate control unit. It is important to get data from your local area.
Typically, we consider 90% rented at premium rental rates full. For this example, 90% Rented at an assumed average rate of $1.35/sf is used.
50,000 sf x .9 x $1.35/sf = $60,750 monthly income = $729,000 Annual income
PRELIMINARY OPERATION COST*
Operation cost vary on many factors. Often, they range between $5 to $6 a sf.
Use $5.75/sf for this example.
Assume $5.75/sf x 50,000 sf = $287,500/ year or $23,958/month (Before Debt Service)
NET OPERATING INCOME* (Before Debt Service)
$60,759 – $23,958 = $36,729/month = $441,504/Year (Before Debt Service)
Assume 5 Cap rate – $8,830,080
Assume 6% Cap Rate = $7,358,400
Assume/use a 4,000,000 loan at 5.5%, 25-year amt. = $24,563 month (P & I)
CASH FLOW AFTER DEBT SERVICE*
$36,729 – $24,563 = $12,166 per month = $145,992 Per year cash flow before taxes.
Will this be your cash flow? Of course not. There are too many variables. Your land could cost more or less. You could put in more or less equity. Your rental rates may be higher or lower. Your expenses could be more or less. You could do more or less marketing and sales then the typical self storage.
The goal is to build a self storage that provides a six-figure income while you can still continue your career if you want to and down the road to have a retirement nest egg that many people could never even dream of. Once you have found a property that meets your initial review and requirements you will get a 3rd party feasibility study that will not only provide you with a demand review but also all the above financial information above based upon data to your specific location and facility size.
Disclaimers: This informational and example is for preliminary education and overview purposes only and should not be used for investment purposes. This is an over simplified financial review. Once a property is located a detailed feasibility study, site investigation, site designs, construction costs and regulatory investigation are required in order to determine the feasibility of a project and projected profits.
*Development cost can vary widely based upon location, zoning, standards, your experience and a variety of factors. You should consult with a local self storage expert for development cost in your area. This is an example and there is no representation these numbers will represent your development costs. Industry rental rates, income & expense can and do vary upon many factors including, competition, local property taxes, location and owners experience. Typical rent up periods for the industry are between 18 months and 3 years and can be longer.
** Unusual construction requirements such as ledge, significant cuts or fills, retaining walls, unusual zoning requirements, off-site improvements, local pricing etc. are not included and can significantly increase construction cost.
Multi story facility cost more and typically can’t be phased, so they require significantly more capitol and initial equity. This is why first time self storages developers typically build one story facilities. Many multi story self storages will even have a higher price tag because they are often in areas of higher populations and are larger to offset the development cost per unit, to get better returns.
A word of caution, never develop a parcel of land simple because you own it or the purchase price is low. It must have several important features including significant drive by traffic and enough unmet demand for self storage.
Now based upon your liquid assets you can start determine the best options for your needs and investigate land, design, regulatory and banking requirements in more detail. At this point you are either ready to charge forward or realize you don’t have the capital required. If you don’t have the capitol don’t give up. Finding a more aggressive lender and or finding a partner with either the land equity or cash equity may be a great option.
Working with an experienced self storage development expert can also help reduce the construction cost, operational expenses and increases profits. You can look at building a smaller facility but they tend to be significantly less profitable and more of a hobby than a business.
If you want to learn more about how you can start your own Storage Authority self storage Franchise send me an email. Marc@StorageAuthority.com
It is hard to come up with the $400K – $500 minimum cash equity required to get bank financing. Or maybe even if you have it you are not ready to spend your last dollar of savings. I know this because I was short on equity for my first self storage and took on a 50 – 50 partner. It was the best decision I ever made. This self storage made millions in profits and is still making me good money every month and I now own 2 more facilities. Not to mention the growing nest egg when we decide to sell it. It took me a couple of years of asking around to find a partner. To make it easier for you Storage Authority decided to help potential partners find each other via the Self Storage Partner Registry.
Storage Authority is excited to announce its first of a kind self storage developer match program. Everyday we hear from potential developers who are ready to move forward with their Storage Authority self storage but do not have the cash equity to get a loan. The Storage Authority Match program will put two individuals together to create a joint venture team who will have the typical cash equity required to qualify for a self storage loan and move forward with their joint venture Storage Authority facility. The program has just launched for the state of Texas and will launch for the rest of the US later this summer. Typically, it is for individuals who want to be 50 – 50 partners.
To qualify for the program, you must have a minimum of $200K cash equity you are ready to invest in a Storage Authority self storage and:
If you are an investor we also have multiple investment opportunities as well from investing in individual self storages or Storage Authority, LLC.
Parties Interested in the Storage Authority joint venture program or investing in Storage Authority, LLC can call or email Marc at 860-830-6764 firstname.lastname@example.org for more details.