Cash Flow and Equity; Which is Better?
Generally speaking, there are two primary ways to make money in self storage; cash flow (on a month to month basis) and equity (realized on the back end). Neither is inherently better or worse than the other but the investment strategy you choose should reflect the “type” of profit that best achieves your financial goals. Put blunty, I'm a value-add guy. If forced to choose between cash flow or equity, I prefer the equity on the back end. Don't get me wrong; I certainly enjoy spending the cash-flow when its there. It’s just that I believe that the quickest way to change your life through self-storage is to target properties that have the greatest potential to add value.
Think of cash flow and equity existing on opposite ends of the same spectrum. There’s a trade off between the two. As you move up or down the spectrum you will be trading cash flow for equity or vice versa.
At one end of the spectrum are the “equity heavy” deals; the ones that won’t cash flow all that well, if at all when you first buy them. Let’s look at a quick example. If you were to increase the value of a property from $500,000 to a million dollars in two or three years, that's a half a million dollars in profit (in the form of equity) over a relatively short period of time. To achieve equity swings like that, you will likely have to endure miniscule or even negative cash flow in the early stages of your investment. Once stabilized though, you have not only created half a million dollars in equity but because you paid 50 cents on the dollar relative to its current value, the property will ultimately produce sizable cash. With this strategy you are tapping into the best of both worlds; huge equity creation as well as significant cash flows once you get the property turned around. To realize these benefits though, you have to delay gratification and essentially “work for free” for the first 12-24 months of the deal.
The other end of the spectrum would be when you buy a turn key property that does not need any work to maximize its value. If you buy it right, it's going to produce cash flow from day one. Yet, you cannot readily increase the cash flow beyond what it is currently bringing in because turn key properties like this have (by definition) already been optimized. You can still make decent money but to me, this strategy takes too long to produce the kind of life changing money that I am after when I buy a storage facility. If you own the property long enough and pay down the debt, you will eventually own it free and clear and that would be an accomplishment in and of itself. I personally don’t have that kind of patience. Tomorrow isn’t promised to any of us! And so why play a 30 year game in hopes that you’ll still be around to enjoy the fruits of your labor?
While I don’t personally have the patience to wait 30 years for a property to achieve maximal profitability, I do understand and (dare I say, preach) the benefits of delaying gratification. This analogy is a little bit of an aside, but I'll share it with you as It relates closely to our discussion of cash flow and equity. If you think about it, stereotypically speaking, white-collar workers, doctors, and attorneys in the white-collar realm are going to get paid every two weeks. They are paid, generally speaking, better than blue-collar workers. Again, an overgeneralization, but blue-collar workers get paid weekly, and they make X amount of dollars; less than a white collar worker but more than a day laborer (who gets paid on a daily basis).
Drilling down a bit further, look at folks who are not willing to delay gratification at all. Let's say they receive a paycheck, but they are not in a financial position to wait for the check to clear. Please know that I am not passing judgment. I’m just illustrating the costs associated with being unable to delay gratification and conversely, the inherent benefits of delaying gratification that alluded to above. Take somebody who gets paid on Friday, but they are not in a financial situation to deposit that check and wait until Monday or Tuesday when the check clears to spend the money. They go to a check-cashing business and quite literally hand over a $500 check to receive only $425 to $450 in cash because they cannot wait three days to get their hands on the money. If you think about that, they're giving up 10-15% of their salary to get their hands on the money 3 days sooner.
Simply put, I believe our ability (and willingness) to delay gratification plays a critical role in how quickly we can amass wealth. The longer the delay, the more dramatically you can improve your financial situation. This is one of the primary reasons why I focus solely on the value-add investments rather than turn key properties. The other big factor is the risk mitigation that comes along with buying value add properties but that is a discussion for another week.
All that said, I completely understand that foregoing cash flow for extended periods of time is not always a realistic option for folks as they get started in this investing niche. It’s not easy or even a possibility to endure negative cash flow (this is true both physically and psychologically) and so in those cases, I would suggest that the best thing to do would be to find a middle ground, a sweet spot, where there is some cash flow up front (enough to meet immediate needs) while simultaneously retaining as much upside potential as possible.
My hope is that this article has at least got your wheels turning relative to what type of storage investments will best meet your needs. I further hope that you are finding some value in my storage musings and would love it if you'd post comments or questions below. And please be sure to subscribe so you don't miss out when the next post goes live!