This is part two of my interview with Nathan Worden, a friend of mine who runs Commonstock, and the first part of the interview is here. You can read a summarized transcript below, or listen to the podcast for full details. Make sure you’re on my email newsletter to get notified when these are happening in the future!
How can the average Joe present a value add over the competition in service businesses?
Twelve years ago everybody got an iPhone in their pocket, and that changed how business is done. People think that the whole world has caught on to this modern era, but you’d be shocked at how many businesses are still operating like it’s 2005 or even 1985. Look around at the service companies in your area making tons of cash but leaving money on the table by not growing with the times, your value add can be in modernization.
When we buy self-storage properties we don’t do much to the facility in terms of remodeling, but we gain an edge by allowing 24/7 online rentals and phone support, contactless entry, and online payments. This may seem rudimentary, but it’s pretty groundbreaking in certain industries.
You mentioned a 65% operating margin, is that number growing?
It grows with scale on an individual facility basis. As we buy bigger properties, these new properties have more revenue and therefore better operating margins. Some of our properties in the south have low taxes and no snow removal and are raking in over 70% margins.
How do you view cost of capital? what is the barrier to entry there?
We look for a 6% cash-on-cash yield in year one on equity, which equates to 40% of the purchase. Our goal is to have an 8-cap property in two years.
How has the conversation and dynamic changed as you’ve taken on outside capital?
Some LPs don’t like my approach, and I tell them real estate isn’t the right play for them right now. My job is to deploy capital and give an accurate picture of what they can expect in return, I’m not going to overpromise. The industry has seen cap rate compression and some deals simply look crazy, but we’ve been able to perform and the tailwinds in the business have been killer.
Is there concern that the tailwinds driven by COVID will eventually become headwinds?
Absolutely; my job isn’t to be a bull, my job is the protect the downside case. Thankfully e-commerce is up, people are buying things, people are downsizing their properties, and the last recession was led by real estate and a lot of people are still recovering. That might not be the case all the time, and there will be some tough years eventually, but I’m bullish on the long-term future of the space.
How do you navigate more bullish or aggressive investors?
It’s hard to compete with groups who are more bullish; the two things I can’t control on my side are the cost of debt and what others are able to offer. If I put the business in a position where there’s a timeline that I need to liquidate or refinance by, that creates risk for the business. The upside takes care of itself if you protect the downside and execute, so I don’t get caught getting overly aggressive in bidding wars.
What are telltale signs of an investor that you don’t want to work with?
Anybody who asks about IRR, or when they’ll get their money back, I tell them this may not be the right space for them. I try to talk investors out of self-storage deals by highlighting all the risks and seeing if they get scared. If we got through a 5-year bear market, I don’t want people nervous that an asset is underperforming. I don’t want to deal with anybody who has a short-term viewpoint and gets scared easily.
The fact that real estate is illiquid is a feature, not a bug. I may have sold in March of 2020 if I could have instantly done so at the push of a button, but it takes 6+ months and hundreds of thousands of dollars to transact, which makes it necessary to maintain a long-term view.
Do you ever worry that you’re boosting the competitive landscape by sharing your news and insights?
This is a conversation that I had early on with my partner, as I’m active on Twitter, my podcast, YouTube, and a consulting gig all focused around sharing what I know about self-storage. Of the 100 consulting deals that I’ve done, 10 or 15 of those people have closed on deals and 20 have become investors. The flywheel of influence does wonders for the firm–I’ve found deals, I’ve found LPs, and I’ve learned a lot by being an open book myself. The truth is most people don’t want to do the work or take the risk, even when you share everything you can with them.
What concerns you more? Growing supply or shrinking demand?
I have a hard time seeing a world where people stop buying things the way they’re buying things. Self-storage is competing with a dumpster at the end of the day. Supply makes me more nervous; units are affordable to build, coming right near replacement costs. If prices continue to explode, we may see new supply pop up even in the small markets that I’m positioned in.
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