Planning for the Unpredictable:
Managing Volatile Costs and Unforeseen Events in the Self-Storage
Development Process
By Dave Cook, CEO, Tech-Fast Metal Systems, Inc.
Part I:
Unexpected Costs
Not Just Steel Cost Increases
A lot has been written and said about the recent escalating price
and reduced availability of steel. As a supplier and erector of
steel self-storage buildings, these are issues that affect Tech-Fast
and our customers on a daily basis. But, as we help our customers
deal with these issues, we are taking another look at the fact that
not only do self-storage developers need to manage the impacts of
recent dynamics in the steel industry, they must also expect, plan
for, and manage other unpredictable events that can occur during the
development process in order to mitigate their effects on the
project's schedule and budget, as well as their return on
investment.
Traditionally, planning for unexpected costs has been handled as a
percent to the construction budget-a contingency factor that's
usually 5 to 10 percent of the construction budget and designated
for allowable cost overruns. Such costs might occur due to
unforeseen site costs, fire flow impacts, underground utilities and
quite often, weather conditions during construction.
If you reflect on what it is like to plan and develop a self-storage
facility today as opposed to what it was five years ago, everything
has gone up in cost. Unpredictability is more commonplace now, so
prudent developers need to manage around the fact that such events
will occur.
Zoning and Other Regulatory Issues
Notably, government oversight on land use and zoning has significant
impact on the developer being able to fully utilize a property to
fit their business needs. Zoning and planning committees are in
place to create cohesiveness within the community. Their
requirements add another level of difficulty when you are building
several facilities in different communities and are trying to create
a strong identity, yet still have to cater to each local
jurisdiction. Areas that could be impacted include site utilization,
height restrictions, aesthetic treatments, and signage, all of which
can greatly restrict your ability to maximize the potential revenue
of a site. Modifications can mean not only significant impacts to
your budget, but lost time and reduced opportunity to get your
business open in a timely manner. And time is the one
non-recoverable cost in developing your property and starting your
business.
This is just one example of how working with an experienced,
organized and professional construction management team becomes a
critical element of revenue gain in the development of your project.
This team of representatives from architectural, engineering,
entitlement and zoning, general contracting, and building supply
organizations translates to speed and ease of development and
implementation, which will save time and money.
Site Selection Considerations
Today's development costs, as compared to those of years past, have
also increased due to the type of land now being selected for
self-storage businesses. It wasn't that long ago that developers
would build a facility on a flat piece of land, visible and
accessible from a major highway or arterial, with plenty of area to
build single-story buildings where customers would simply drive up
to their unit. Today, however, site selection has been complicated
by the realization that the more beneficial sites for
self-storage-those that better serve the needs of customers and are
more conveniently located to them-are located on more expensive and
sought-after parcels. Self-storage businesses are now more often
located on parcels that are difficult to develop and are impacted by
numerous restrictions managed via jurisdictional oversight.
Additionally, the cost of construction is impacted by developing a
more expensive piece of land and the nature of the construction
qualities needed to distinguish the facility from that of
competitors'. Such qualities include security, architectural
treatments, or services such as climate controlled units.
This change from simply looking for "cheap" land to identifying the
best location-likely more expensive and more difficult to develop,
but bringing a more ideal service and product to the marketplace-is
sometimes referred to as a "barrier to entry". Simply put, the more
expensive and more difficult the property may be to develop creates
a barrier to a competitor to duplicate. For competitors to enter the
market and compete with your location and level of service, they'll
need to spend as much or more than you and take as long or longer to
bring online. Thus, you've created a desirable effect, or "barrier",
to the next developer coming in and competing with your business.
Part II:
Steel Costs
Why Steel Costs Have Risen and What's Next
We've all been concerned with the dynamics of volatile and
unprecedented steel cost increases and supply challenges since the
beginning of the calendar year and we're no strangers to the
unpredictability of this event. To understand the causes, of which
there are more than one, let's revisit the worldwide circumstances
that brought the steel market to this point, then take a look down
the road and try to forecast how events might unfold.
First, we need to remind ourselves that at the beginning of 2004, no
one predicted the cost of steel rising in such a dramatic fashion.
Light gauge framing members, the skeleton of self-storage design,
have nearly doubled in cost since the end of December 2003. The
costs of roofing, wall sheeting, partition panels, and doors and
corridor panels have increased in the area of 40 to 50 percent. Even
with this occurring, few were (and still are not) predicting how
supply and cost increases will play out over the next several
months. I will, however, weigh in on a prediction later in this
section.
This unprecedented situation has been called a "perfect storm" by
several observers in the industry. It is a collision of several
events in the world economic environment of steel supply and demand
which has never before been seen. I've been buying and selling steel
in various forms for over 25 years and have never seen such dramatic
events occur at the same time. In fact, steel framing, cladding and
roofing products have been stable or lessening in price throughout
my career. In that context, this "correction", as some may call it,
could easily be viewed as justifiable and as a long time in coming
for steel manufacturers.
A major contributing factor to the current situation is the
worldwide demand for steel, with China clearly leading the charge.
They are currently consuming approximately one-third of the world
supply of steel. As they emerge into the world marketplace, they
must first develop their infrastructure in the form of power plants,
roads, bridges, and an industrial and manufacturing base. Beyond
that, they are preparing for hosting the Olympic games of 2008.
Their appetite for steel and the raw materials and scrap it takes to
produce it is out-pacing the need by Western countries and is also
being chased by those of South Korea, Japan and Russia.
Secondly, the value of Asian and Euro dollars as compared to the
weaker U.S. dollar is creating a pull of natural resources as well
as finished steel goods which gain higher value in these currencies.
Thirdly, the availability of iron ore and coke, both used to produce
steel products, is in ever lessening supply, while scrap steel is
gobbled up at record high volumes and prices. Additionally, domestic
steel production capacity has decreased over the last decade due to
mill closures and bankruptcies within the manufacturing sector,
resulting in reduced supply. Finally, higher fuel and transportation
costs and a lack of available ocean carrying vessels increases the
shipping costs of delivering raw coil to the manufacturers. All of
these dynamics create a supply-push which results in higher costs
coupled with a demand-pull which results in increasing prices.
Looking forward to the remainder of 2004, we are currently seeing
some "minor" upward adjustments in the price of steel, in the
neighborhood of 4 to 5 percent. For the near term, I expect costs to
level out or plateau through the fourth quarter of 2004. No one,
including myself, would predict a pull-back or lowering of prices as
long as the demand-pull exists on the reduced supply. Simple
economics would suggest that industry manufacturers, having been
successful in realizing the increased value of their product, will
be extremely reluctant to give any of it back. If such is the case,
we will see only modest reductions in price, at best.
Reduced Availability May Be Bigger Issue
Currently, the biggest concern for self-storage developers may not
be how much you pay for your steel building, but whether or not
steel is available. Several suppliers are allocating consumption to
prior year purchases, which limits the supply to current demand
levels. However, there are numerous supply options as you expand
your vendor options and with such, we will see a shifting of market
share in the building supply market. Clearly, we see the strengths
and weaknesses of businesses when stresses of this nature occurs.
It's to your benefit that in a free market system, and worldwide at
that, you have options to consider when choosing development and
construction partners.
Part III:
Planning and Managing for the Unpredictable
Better Planning Can Mitigate Effects
To better plan for unpredictable events, first and foremost you need
to start with the basics of income-producing real estate investment,
and that is still location. As I stated earlier, the type of sites
used for self-storage facilities has been changing. The current
construction cost fluctuation only serves to further emphasize the
importance of having a sound location from which to serve your
market. As a developer, you need to look for a site which works best
for your business, rather than look for a business that works for
the site. We all need to recognize this as a maturation of our
industry. No longer can you buy a cheap piece of land and build a
mini-storage that customers will come to, for your competitor will
buy and build on a more desirable property that is more convenient
to the end-user and provide a facility that is better run based on
market demographics. Your competitor will provide better service and
value while the value of your business goes down.
It speaks consistently to what we've been coaching our clients to do
for a number of years: do your homework. It comes off as a cliché,
but researching your market and profiling your client as part of
your business planning is now mandatory, not a choice. Before you
select a site and go forward with your self-storage development, you
need to understand the needs of your marketplace. You need to know
whether or not you have created a barrier to entry to your
competitor.
Dealing with the Realities of Rising Costs
If you are currently developing a site and have committed to the
property, what do your options look like in the face of escalating
steel costs? In some cases, tens of thousands of dollars and several
years of effort have already been invested. You may be now looking
at a lower and/or slower return than you planned for. I would
suggest to you that in nearly all cases, you should continue
forward. If, during your initial planning, you felt that your
market, your timing and your location were all appropriate, then the
project is still worthwhile even in consideration of increased
costs.
In talking with our clients, they are concluding that self-storage
is still the highest and best use for income-producing property,
with better creation of value and return on investment than any
other type of commercial development.
If you're considering building a business other than self-storage,
such as offices, a strip mall or other retail, construction costs
for all types of buildings have increased in price as well. The
value of self-storage remains strong compared to these other options
of development. So all of the strength and rationale behind
developing self-storage remains in play versus these other options.
You may want to consider building material options other than steel.
If so, consider that recent material price fluctuations in lumber,
OSB, plywood and concrete have kept pace with all building material
costs. Such volatility, in fact, is commonplace in these commodities
and can be expected to remain so, whereas steel costs have
historically been stable and are likely to stabilize again. Looking
down the road, you have to envision what the value of the building
and the business will be. From the early times of self-storage
development, buildings built with steel hold a greater value than
those built from other products and will outlast and outperform
other designs. Reduced maintenance costs of steel buildings must
also factor into the long-term financial picture.
Another option might be to wait and see if steel costs come down. As
I mentioned earlier, it is still somewhat unpredictable to determine
where steel costs will be in the future, but it is highly unlikely
that manufacturers will give back the gains they've made. And for
that matter, most would predict the demand for steel to continue
throughout the remainder of the decade. Therefore, anticipating a
cost reduction would not be prudent.
The Rising Cost of Money
Regardless of the fluctuation in steel costs, the other pitfall to
waiting to develop might likely be the increasing cost of money
compared to today's rates. No one is predicting that interest rates
will be coming down, and in fact, they'll surely rise. The
availability and affordability of money is very opportunistic at
this time. Even if you could anticipate a reduction in material
costs, your savings would be nominal when measured against the costs
of higher interest rates and the loss of revenue you would incur by
delaying the opening of your business.
An important consideration when you're thinking of delaying or
postponing a project is the cost of the lost time. Often, we at
Tech-Fast talk with our clients about how a delay is measured not
only in the loss of revenue in the first few weeks of rent-up, but
the more costly delay of the start of an income stream based on
fully sustained occupancy. If you delay the start of your project,
you will achieve full occupancy later, and that time and those
revenues can never be recaptured.
Plan for the Future Now
The decision to go forward or not then goes back to how sound your
initial investment analysis was. It is not whether it costs you more
to build or whether your return will take a little longer to
realize, but whether it is the right business in the right location
at the right time. I would certainly recognize that there is a point
at which costs exceed the practicality of investment, but I don't
believe the cost increases we have seen have taken us to that point.
Out of the many projects that we expect to build this year across
the country, no one is saying they won't continue to build. Some
certainly have indicated they may step or phase construction, and I
personally see some worthwhile consideration of this strategy if for
no other reason than to better know the needs of the market. Still,
with the current affordability of money, this approach needs to be
considered carefully.
So much to consider, and there is still the question of how to best
mitigate your circumstances. I believe you will benefit from working
openly with your vendors and creating a team of professional
construction experts who will help you negotiate through stormy
events. Form this team early in the development process, even before
site selection occurs. Rely on their knowledge and experience to
guide you through the process and plan for-and manage-unexpected
costs and unforeseen events.
I also recommend you include your bank in the development process.
Although contingencies are allowed for, it is prudent to be
forthright with lending groups (you should talk to several) about
dynamics in the building supply industry so contingencies are
sufficient and appropriate.
Conclusion
As the self-storage industry continues to mature and become more
sophisticated, challenges to the development and operations of your
business will increase and become more difficult in nature. But, as
in any other business endeavor, good planning, thorough research,
and attentive management practices will mitigate the effects of
unexpected events on your business plans and success. The current
challenge to your self-storage business plans is the rising cost and
reduced availability of steel and other construction products. While
the severity of these cost increases is certainly unusual,
developers who plan and manage their businesses well can understand
and deal with this issue, just as they deal with more commonplace
issues such as zoning and regulatory glitches and additional site
development costs.
So while your heart may have skipped a beat when you were first
faced with this unanticipated event, and an honest assessment of
your situation is certainly called for, if you've planned well and
surrounded yourself with a team of experts that can help you manage
for and mitigate the effects of any cost increases, you will
succeed. Again, if you believe you're building the right business in
the right location at the right time, then your project is still
worthwhile even in consideration of increased costs.
The biggest danger is in indecision and delay. Remember that the
cost of a delay is measured not just in the loss of revenue in the
first days of start-up, but in the delay in achieving full occupancy
and the income realized from that success. Additional expenses, such
as rising interest costs, may further degrade your long-term
profitability.
So, even in the face of increased challenges to profitability, I
believe self-storage is still one of the best uses for
income-producing property. The key is in how you plan and manage
your business. The more sophisticated and educated you are about
your marketplace, the more research you've done on the needs of your
customers, and the more experienced your team of experts, the
greater the likelihood that your investment in self-storage will
continue to be a great decision that brings life-long benefits.
Now you have experience and success on your side. Contact us today to put our experts to work on your next project.
