Pondering Property Performance

Posted by msmessenger on Nov 1, 2017 12:00:00 AM

How To Use Occupancy And Vacancy Rates As Gauges 

Most self-storage operators understand the three principal metrics used to determine how well a facility is performing: physical vacancy by units, physical vacancy by square footage (sometimes called “area”), and economic vacancy. Indeed, almost any management software program will produce these numbers with the push of a button.

The problem is, as standalone numbers, these metrics don’t mean a great deal. For example, if the physical vacancy is 100 percent, you might want to go out and celebrate. On the other hand, if you rented every unit for $1, than you’ll probably be bankrupt fairly quickly.

Let’s review these metrics. Unit occupancy is easy; if you have 200 units and 190 are occupied, that’s 95 percent occupied (190 divided by 200). A more meaningful physical occupancy is square footage occupancy, or total square feet rented versus total square footage of the property. If you have a 25,000-square-foot vacancy and 20,000 is rented, that’s a 90 percent occupancy (20,000 divided by 25,000).

By divining a little harder, those numbers can be more useful. Generally, unit and square footage occupancy should be close, but, if it’s not, such as the prior example, it may indicate the larger units are not competitive in the market and thus are empty, says Kate Spencer, a managing director and Practice Group Leader of Self Storage Valuation & Advisory at Cushman & Wakefield in Dallas. “That’s an important thing to analyze, just to make sure that you cover all the bases to address your vacancy.”

Finally, there is economic occupancy, which can be seen as total possible income. Take the monthly rent for every unit, add it up, and deduct vacancy loss and discounts. Let’s say the property has the potential to earn $35,000 when filled with renters paying market prices, but total income is just $32,000; then you have a 91 percent economic vacancy ($32,000 divided by $35,000).

These metrics can be used as indicators, massaged by further mathematics to produce a more meaningful equation or can be comparatively analyzed.

Charlie Fritts, chief operating officer of Storage Investment Management Inc. in East Amherst, N.Y., uses this example: Let’s say you have 20 percent physical square footage vacancy and you take those units that make up the 20 percent and divide by the square footage. In the result, you’ll find out the average size of your vacant units. If you do the same for your occupied units, it can help you to understand which units are renting better allowing you to consider how to make the vacant units more desirable. Often, the solution may be in converting less desirable sizes. With those averages, you will know if you need to create additional larger or smaller units to match demand. 

“That information gives you an idea of what is renting at this moment,” he says, “and gives you some idea of where your focus should be. Managers sometimes want to discount rates because the units are not full, but if your square footage occupancy tends to be the smaller stuff and you are in the dead of summer when you see a lot more families moving and using larger units, I wouldn’t get real excited about that. You just don’t have the demand right now for smaller and making it cheaper doesn’t mean that you are going to rent it.”

Economic Occupancy Comparisons
For a wider sense of how the facility is performing, a lot of managers do economic occupancy comparisons. Economic occupancy is the relationship between the actual revenue collected and the gross potential income, which is based on market rental rates. “Managers need to make sure rents are reflecting the market to ensure that revenue is being maximized,” says Spencer.

That’s not the only comparison that needs to be made; economic occupancy should be made against physical occupancy. Typically, economic occupancy should mirror physical occupancy. Spencer adds, “There may be reasons why your economic vacancy is higher or lower such as a recent surge in physical occupancy or a softening of market rental rates due to new supply. As a manager, analyzing these figures will assist in managing and maximizing the revenue at the property.”

Owners have historically been wrongly obsessed in tracking square footage occupancy and economic occupancy, says Steve Mirabito, president of StoragePRO Management Co. in Walnut Creek, Calif. “Plus or minus one to six percent of each other is what owners have always desired as optimal.”

From a broker’s point view, equilibrium smells like opportunity.

“If you are at equilibrium between physical and economic, your street rates are too low,” says Aaron Swerdlin, a vice chairman with Newmark Knight Frank in Houston. “You always should raise rents on the units that are full or leasing well. If you have 100 10-by-10s and you have three vacancies, you need to raise your street rates. If you are 90 percent economic and 90 percent physical, you street rates are too low.”

The big REITs shoot for a five percent to 10 percent difference between physical and economic occupancy, says Fritts. “That’s a decent equilibrium. If physical occupancy is 90 percent, owners are looking at economic occupancy of 85 percent. The objective here is to stay with your asking rates as sizes fill up. Simple supply and demand pricing. When I talk to my managers, I explain occupancy in terms of working in a shoe store. When they first get a case of shoes, they have all kinds of sizes. Then they sell the shoes and, in the end, they only have the really big ones or really small ones left; and that is how it ends up in storage. If we get to be 92 percent or 93 percent full, the only thing we have left is what we have in surplus sizes.”

The economic occupancy average you should be up there in the upper 80 or lower 90 percent range.

“The old real estate rule is if your building is fully rented, your rents are too low,” says Fritts. “You don’t want to be at 100 percent. If your property is full, you have no room to grow. When you start to fill up, you want to push your prices so that total possible income increases, that pushes your economic occupancy down. That’s what you want because that means you have some opportunity for growth.”

A manager should never get to 100 percent physical or economic occupancy; if they do, they are crazy, Fritts reiterates. “I would like to manage for them, because they are leaving a lot of money on the table, and I can certainly help them solve that problem.”

Relying On Physical Occupancy
The less sophisticated operators rely solely on physical occupancy. When operators do that they leave a lot of value behind.

“If you are not managing your physical occupancy with constant rental rate adjustments, then physical occupancy doesn’t mean anything,” notes Swerdlin. “When you don’t pay attention to physical and economic occupancy, then you might be 95 percent occupied but, if you have not raised rates on existing tenants for a couple of years or if you give discounts and never burn them off, you can be at 99 percent physical occupancy and 75 percent economic occupancy, but that could mean you have 24 percent worth of revenue you are leaving behind.”

Swerdlin adds, “95 percent leased but only at 75 percent economic occupancy; what does that tell you? When I see that, as a broker, it just screams to me there is an upside.”

Calculating Economic Occupancy
Almost all self-storage management software will do an economic occupancy calculus, but Swerdlin dismisses these programs.

“I wouldn’t rely solely on existing software for economic occupancy because it is going to be an accrual-based number, only booking the scheduled amount,” says Swerdlin. “It will show you your economic occupancy relative to what people are contracted for with their rental agreement. If someone has a rental rate of $100 when the current street rate is $107, the software will show their economic occupancy at 100 percent because that is what their contracted rate is—not what street rate is. That just shows you what is contracted for in the lease agreements.”

What Swerdlin thinks is important is whether every unit at the property is renting at the current street rate and what did the operator put in the bank last month. “That is true economic occupancy, because that takes into account discounts and dollars you didn’t collect because units went delinquent,” he says. “It’s money earned and collected in a given month divided by every unit that was rented as if they were rented at current street rate. That’s not what the summary reports are calculating.”

Mirabito believes the whole issue of occupancy data is absolutely archaic and useless in understanding the economics and health of a self-storage facility.

“The problem with using economic occupancy is that asking rates should dynamically adjust based upon daily demand of each individual unit size,” Mirabito says. “Our customer surveys suggest customers plan to stay for a period of three to four months despite a portfolio average occupancy of 15 months. Therefore, we utilize different pricing strategies based upon the season, market demand of each size category, and our targeted customer.”

He continues, “If rents are managed dynamically, revenue will be optimized, and the delta between economic and square foot occupancy could vary by double digits! Self-storage operators should focus on the total dollars deposited and the total rent charged on a month-over-month basis.”

Using economic occupancy makes one blind to what is really going on in the store’s operation, Mirabito maintains. “What you really want to be looking at the month-over-month changes in rents charged and total deposits collected. These data points are useful in all competitive markets. Total rents charged are more insightful in both strong and saturated markets as a barometer regarding the manager’s performance and market conditions.”

Economic occupancy was a simple ratio built into the original 1980 era DOS management software reports. Unfortunately, management software reports have not significantly improved despite the need for such, opines Mirabito. StoragePRO Management has invested over $150,000 into analytical software to enhance their data metrics.

Mirabito suggests smaller operators create their own metrics and analytical tools by utilizing spreadsheets and graphs with trend lines showing short-term and year-over-year occupancies, cash collected, and total rents charged performance.

“It is too expensive for smaller operators to invest in analytic tools,” Mirabito concludes, “but it is dangerously naïve for an owner to rely upon economic occupancy and think that is the end-all-be-all.”

Steve Bergsman is an author, journalist, and columnist. His stories have appeared in over 100 newspapers, magazines, newsletters, and wire services around the globe; and his most recent book is “The Death of Johnny Ace.”