The AAA Storage Podcast

Welcome to the AAA storage podcast,
your integrated real estate and

development partner, exploring all
things, self storage investing to

bring you diversified success.

Let's dive in.

Brandon Giella: Hello and
welcome back to another episode

of the AAA Storage Podcast.

Today's episode is honestly gonna
be one of my favorites, and I

think one of the most powerful.

This is episode 24.

So we are gonna highlight some things
that we have talked before, but dive

right into the real value of ground-up
development for real estate allocations.

So before we get started, I have to say.

There is so much more that Paul is going
to, uh, uh, uh, explain on a webinar

coming up on October 27 and I want you
to register for that if you're listening

to this because there is way more
detail and way more important points

that we can't get to in this episode.

And there's gonna be a lot of,
um, of explanation around that.

And then.

Uh, time for questions to talk to Paul
and the team about some of these details.

And so please go to
aaastorage investments.com

where you'll see an events tab at the
top of the, the nav of the website.

And that will take you to register for
this webinar because like I said, there's

gonna be a ton of information there.

And I really want to make sure
you have everything you need to

understand why ground-up development
is so important when you're thinking

about investing in real estate.

So this episode we'll be talking
about, um, uh, the way that we're

gonna, all that, that a, a, a savvy,
sophisticated investors should allocate

their resources, uh, or their, their
real estate, estate investments

if you're an accredited investor.

And then within real estate, there are
some different ways that you can invest.

Uh, and, and why ground up really
is a, a very important part

of your allocation decision.

So, Paul, with all of that, tell us
about, if you're talking to investors

that are thinking about real estate,
why think about a development of

project, uh, a ground up in development?

Why is that so important, uh,
as a part of your overall mix?

Paul Bennett: Yeah, look.

Before I jump into that, Brandon, I
also wanna note we're gonna link the,

uh, the registration for the webinar
and the show notes for this episode.

So if you don't want to go to
aaa storage investments.com

or.

Whatever you can, you can just hit
the link in the show notes and, and

easily register for the webinar.

And I, I'm pretty excited about it.

We've spent a lot of time, we've
got a little bit more work to do.

We've still got a few weeks before
we, we, uh, do the live webinar.

But this is gonna be a, a powerful topic.

So let's, let's jump in.

You know me, I'm hopelessly
linear, so I kind of have to

start at the top of the funnel.

Um, and I wanna talk for a minute about.

Overall allocation to real estate in
an accredited investor's portfolio?

Um, I, I, I think there are a lot
of people out there, uh, that are

under allocated to real estate,
particularly those that are working

with registered investment advisors.

Not like Andy Jones, who we had on
our last episode, who really don't,

aren't familiar with, nor do they
recommend alternative investments

in a particular real estate to
their clients with any consistency.

Um, those guys wind up often over
allocated to the public markets

and, you know, ETFs and mutual funds
and, and, and stocks and bonds.

But the data will tell
you that a moderate.

To balance stance is to allocate
20 to 40% of your overall,

uh, portfolio to real estate.

Now they're, you, you, if you're super
conservative, that number might be 10 to

20% if you're more aggressive, 40 to 60%.

So the midpoint is 20 to 40%
of your, of your investible net

worth allocated to real estate.

Um, that means a $2 million
investor should have between

400,000 and $800,000 of their
portfolio allocated to real estate.

Um, and for most people who have
a $2 million portfolio, they

either own a business or they're a
professional and they don't have time

to manage real estate on their own.

Um, and second point is you can't really
buy a piece of commercial real estate

by yourself for 400 or $800,000 and.

You don't wanna manage it.

So it really pushes people towards
vehicles like ours, um, where they can

get professional management, a diversified
portfolio, um, and still allocate

within the range of their portfolio.

That, that makes good sense.

Um, within the real estate.

Asset sector, asset class.

Most people gravitate to
investing in existing assets.

They're investing in core or core plus
assets that are, that are, you know,

fairly stable, cashflow producing.

That's where most people are attracted.

Uh, in the real estate world, I, I
don't have a percentage at this point,

but I, I would guess a substantial
percentage of the capital allocated

to real estate by private investors
is, is, is allocated to existing

properties, and most people perceive
development as significantly more risky.

Brandon Giella: Mm-hmm.

Paul Bennett: Than
acquiring an existing asset.

And what we're gonna talk about today
is I'm gonna show you why that's not

true and why your al, your allocation
to real estate should include both

existing properties and ground up
development to achieve the best balance

and overall return profile in your real
estate portfolio, in your real estate

allocation within your larger portfolio.

So that's what we're
we're gonna aim for today.

Uh, hopefully we'll have a little
bit of fun along the way, but let's,

let's switch gears now and talk
very practically about what drives

incremental value in real estate.

There are only two things, right?

Um, it's NOI growth or net
operating income growth.

It's the cash flow that the property
produces, which is either driven by one

of two things, rent growth, which is
basic market supply and demand driven.

Right or lower expenses,
which aren't likely, right?

Expenses usually don't go down.

Um, uh, and, and the other
thing that drives value in real

estate is cap rate compression.

So if cap rates in a given
market move from 6% to 5.5%,

those properties become more valuable.

Um, and two things drive cap
rates, supply and demand for

properties in a given market.

And interest rates.

And I think that the, the thing that
you have to think about as it applies

to increases in value for existing real
estate is, I just named four things.

Rent, growth, lower expenses, supply and
demand for properties and interest rates.

Three of those four you don't control.

And most people, no, all people
cannot predict accurately.

So they are wild cards in the equation.

And if you catch the right cycle
in a given real estate market,

you might get rent growth and cap
rate compression great for you.

If you get caught in the wrong
cycle, you could, and we'll talk

about an example in a few minutes
where they both go the other way.

So you, you, your invest, your, your
ability to create incremental value in

existing real estate, um, is, is really.

Driven by factors that you can't really
control and you can't really predict

expense growth or expense declines.

In theory you can control, but like
I said, they're really not likely.

Um, but here's the key.

There's a third value driver.

But it only exists in
the world of development.

It, it exists to a much smaller degree in
a value add project where you're buying

a, an apartment project that's sort of a
Class C and investing a lot of additional

capital to turn it into a b plus.

Um, and the same thing would
apply if you buy, you know.

Uh, a self storage facility that
has excess land and you, you

build, you know, another 200 units.

Those are value add plays.

They're sort of a blend of existing
and, and development, if you will, but

we're, we're not gonna complicate it
with that sort of hybrid concept today.

But the third value that only applies
to development is the spread between

what it costs to build a property.

And the ultimate value of the cash
flow stream that that property

generates once it's stabilized.

And we've talked about this on other
podcast episodes, it's really driven by

yield on cost and development spread.

Um, and to give you an example, today
we underwrite our storage facilities

that we're developing at a 9.5%

yield on cost, which is a 9.5%

yield on the cost to build that project.

The market for cap rates in self storage
today is about, it is between 5.5

and 6 I use 6 all the
time to be conservative.

So there's a 350 basis 0.3

3.5

percentage point spread between the
yield we're getting when we develop a

property and, and the what that yield
is worth, once the property stabilized.

And if you're buying existing self storage
facilities today, you're paying a 6 cap.

There's no spread.

You're, you're paying the market
value of that cash flow stream.

So this third component is
the value creation that occurs

in the development process.

Um, and it's, it's critical
because it does several things.

It, it, it provides real growth
for your capital and it also

provides a downside buffer.

In the event you get caught in a
market that conditions that aren't

ideal, where either rent growth
slows or goes negative, uh, or.

Cap rates expand instead of contract.

Um, you're really not as dependent
on those outside factors that you

can't control in order, um, to drive
acceptable returns in a development deal.

Now, I, I will say this, the, the
advantage that existing properties

have is they produce current cash
flow, if they're structured, right?

Right.

And, and so if you're an income
oriented investor, if you're.

80 years old and you're sort of
out of the risk window, you're,

you're not taking any risk and you
need current income 'cause you're

retired and you're no longer working.

Um, and you still wanna
allocate to real estate.

Buying, investing in existing
real estate makes perfect sense.

But if you're 45, 50, 55, even
60 or 65, and your portfolio's

objective, still includes some real
growth above the level of inflation.

Combining existing real estate
and ground-up development in your

real estate allocation will result
in the best balanced outcome.

I'll stop and take a breath.

If I said anything that wasn't
clear, didn't make sense,

or you got any questions.

Brandon Giella: that was great.

That was great.

I know that there are gonna be some
listeners that are like, okay, there's

no free lunch, and so you, you don't
get more return without more risk.

So I want to talk about
the risk discussion.

I know we're gonna get there, but I
just wanna pause and say, I know there's

people thinking like, okay, great, this
sounds awesome, but what's the catch?

You know, so we'll get
there in a second, but

Paul Bennett: There, there, there
is no doubt there is a risk element

in, in development that doesn't
exist in existing properties.

And you're right, we will, we'll
talk about it in a minute, but there

are also different degrees of risk
in different types of projects and

different assets within the real estate.

Universe.

And I think that's a point that
will, again, we'll make intermittent.

Before we do, I wanna, I wanna
give you a quick example.

This is gonna be a lot of numbers.

If you come to the webinar, we'll
dive deeper on this and we'll actually

have some charts and graphs and
it'll be a little easier to follow.

Um, but I'm gonna give you two examples.

One in which you invest in an
existing multi-family project, and

another in which you invest in the
development of a self storage facility.

It.

So on the multifamily side, let's say
that you're different scenarios, but

let's just say that you, you buy a
property at a five cap and you sell

the same property at the same cap rate.

In other words, there's no movement in
cap rates over the six years that you own

the property, but you get a 4% growth.

Year over year, compounded
on the net operating income.

So the, the, there's no change
in the demand for properties,

but there is positive dynamics
in the demand for rent by renter.

So you're able to grow your NOI if
you, under that scenario, if you hold

that property for six years and sell
it at a five cap, you get a 10.7%

internal rate of return.

Better than a sharp stick in
the eye, but not mind blowing.

Right.

Um, now let's play with
sensitivity a little bit.

Um, oh, by the way, in that model,
you actually are receiving 2.5

to 4.5%

cash on cash returns on
your equity each year.

So you're getting some income.

Good thing.

That's a good thing.

Some checks in the mailbox.

Uh, but okay, so now let's
say, well wait a minute.

Not 4%, but 6% in our live growth.

Your return goes up to 13.5%

IRR.

And by the way, I don't look at returns
that aren't time valued because.

There is a time value to money.

A dollar you get back today
is more valuable than a

dollar you get back tomorrow.

And so everything we look
at is on time, value basis.

Um, so now let's, let's leave the four,
the 4% NOI growth in place and say you

get a 50 basis point or half a percentage
point compression and cap rates.

So they go from five, you buy it at
five and you sell it at four and a half.

Now you're getting a 13.39%

return, IRR.

And lastly, if it goes the other
way, you get your 4% NLI growth.

But for whatever reason, cap
rates, maybe interest rates go up.

And so cap rates go up.

Um, so you get a 50 basis point
increase in cap rates not good.

Brandon Giella: Hmm.

Paul Bennett: Your return
over six years is a 4.46

internal rate of return.

That one factor.

Basically destroyed, you've
kept pace with inflation.

Um, but like we said, when we were sort
of getting ready to get started here.

A tie's like kissing your sister.

Um, I, I don't, I'm not in
this, I'm not in this game to,

to stay even with inflation.

I want to outpace infl.

I want to grow the value of my capital.

So that just gives you an example
of a existing multifamily deal and

it's, this is a made up scenario, but
I, I built the model and ran out the

number so I could do the sensitivity.

And it may not be perfectly
accurate, but it's darn close.

Now let's look at a self
storage development.

So we developed to a 9.5%

yield on cost.

So let's assume that we're building
a self storage facility and we've

underwritten it to a nine and a half
percent cost, and we are projecting a

2% NOI growth and we're buying it and,
and we're gonna sell it at a six cap.

So we underwrote.

To a nine and a half
percent yield on cost.

That's the yield on what it costs
it to build it, but the market will

value it at a six yield, because
that's the market cap rates today.

Sell that same property in six years.

It's a 24.6%

internal rate of return

Brandon Giella: Hmm,

Paul Bennett: versus 10.7

in the purchase of an existing facility.

I didn't do as much sensitivity analysis.

Um, but let's just say you get a 50
basis point compression in cap rate.

So we, we, we built at a nine
and a half percent yield on cost.

When we get ready to sell in six years,
cap rates are five point a half, not six.

Your return goes up to 28%.

I irr.

So now what happens if it
goes the other way on you?

You get a 50 basis point increase
in cap rates, so they're not

six, they're six and a half.

When you exit, darn, your
returns reduced to 21.49%

internal rate of return.

Brandon Giella: Hmm.

Paul Bennett: So that buffer,
that, that, that value, incremental

value that's creating created
in the development process.

For the risk.

There's, it's a risk premium, right?

Um, not only provides much more attractive
returns, but it helps absorb any negative

impact that comes from market dynamics
that impact value that you can't control.

Brandon Giella: That's right.

Paul Bennett: Um, we've just been
through a period from late 2021 to

the end of 2024, where, um, we're.

R advertise rates decline
for 28 months in a row.

Brandon Giella: Hmm.

Paul Bennett: I think I'm getting in
front of myself here in terms of my

notes, but, um, if you bought an existing
facility in early 2022, the value of

that facility today is probably 20 to
30% less than what you paid for it.

Brandon Giella: Hmm.

Paul Bennett: Because we've seen
negative rent growth and we've seen

a small expansion in cap rates.

Brandon Giella: Hmm.

Paul Bennett: Now you'll come out of it.

Uh, I think self storage is a
great asset and it's like every

other kind of real estate.

The markets are cyclical and you
hold it through that cycle and

up the other side of the curve.

But what happens to your internal
rates of return when you have to hold

a property for 10 years instead of the
five or six that you originally set out?

It, your internal, your
time value returns go down.

So it, it, it's a, so, um.

I, I, now, I'm gonna flip to the risk side
of the equation because there is no doubt

that that development has risk in it.

That you know that buying an
existing property with existing

cash flows, um, don't have.

Um,

but, but here's why.

The risk, particularly in self
storage and small bay industrial is

not as great as people perceive it.

I'm gonna give you some more data.

The cost to build a multi-family apartment
project a 200 unit apartment project

in Austin, Texas today is somewhere
between 250 and $300 a square foot.

That property rents for about $19, 19 $20
a square foot, and produces a gross yield.

On the per square foot cost of about 8%.

Brandon Giella: Hmm.

Paul Bennett: We build a self
storage facility before between

a $100 and $110 a square foot.

And guess what?

We're getting in rents $18 a foot.

So think about that.

You wanna bill something if you're
gonna get a a 18 or $19 revenue.

Would you rather pay $250 for
what produces that revenue or a

$100 And where is there more risk?

Um, the, the, the other part of this
equation is that lower cost per square

foot result in lower carry cost.

So in an environment where you build
an apartment project and you blow

your lease up projections by a year.

The cost of that added year, the
additional working capital that it took to

feed the bank and pay operating expenses.

'cause you didn't have the
revenue, um, can destroy a project.

It can absolutely destroy returns
and sometimes it winds up in the, the

keys going back to the bank or, or
more commonly the investors getting

capital calls because the venture
needs more capital to pay those

expenses because it's, it's, it's
not met, it's lease up projection.

You

Brandon Giella: Hmm.

Paul Bennett: when you're building at
a hundred dollars a square foot, those

carry costs are one and a half times less.

Right?

And, and, and so nobody wants an
extended lease up period where the

market's slower than you thought it was.

Um, but they're survivable.

In the self storage world, um, because
they don't involve as many dollars.

So it still dilutes returns.

It's still not a positive outcome,
but the risk, so my my point is

there's overall incremental risk in
development, but you have to, you have

to think about the difference in risk
between multifamily, retail, office

self storage, small bay industrial.

By the way, we're building
small Bay Industrial at.

At 80 to $90 a square foot and
getting $18 a foot in rent.

So it very much like self storage.

So although there is incremental risk,
the risk in self storage and small bay

industrial, um, is significantly less
and therefore makes them the ideal.

If you're, if you're a little
bit risk averse, but you buy into

the concept that that combining.

Investing in existing assets and doing
ground up development will provide a more

balanced risk profile and overall return.

Um, self-storage and, and small
bay industrial are the perfect fit.

Along with go do a go do an existing
multi-family deal and then invest

in growth fund two, which is small
bay development of small bay and

self storage and is diversified
across four different markets.

F 11 different projects and
two different property types.

And I think the resulting the growth that
will, will be created on the development

side, um, will help balance out some of
the sort of less than impressive return

numbers that you can get from existing.

But you've got the security of a little
bit of cash flow and a stable asset.

And I, I just think it
makes a, a, a great blend.

Brandon Giella: Hmm.

What I'm hearing is, I'm gonna
summarize, I'm gonna break this down.

If you're an investor.

Real estate has got to be a significant
portion of your overall portfolio, but

within real estate, there are different
ways that you can invest in real estate.

And what you're advocating for is for
sure take on existing properties and,

and look at, you know, what is already
built can be very, uh, good, attractive.

There's reasons for that, like income,
like you suggest, but consider.

ground-up development development
projects because the fundamental

math makes it more attractive,
especially in a risk adjusted return.

Like if you're thinking about cap
rates, thinking about NOI and different

things that are out of your control,
the risk adjusted returns are better in

general, in your, in your experience.

But then even within development,
there are also different markets, of

course, like we've talked about before.

And then there's different property
types, like you're saying, there's

self storage or small bay industrial
that all have their, their different

costs associated with them and their
yields as a result associated with them.

And so the way that you guys are
approaching investing in real estate and

advocating for folks, investing their
assets in this type of property, it just

flat makes sense on the math, the risk.

And, and then the overall kind of
mix of their portfolio and what

an investor's trying to achieve.

Is that roughly, did I summarize roughly
what, what we're talking about here?

Paul Bennett: I think you summarize it.

Great.

And, and to be clear, I
am not saying don't exist.

Don't invest in existing assets.

And I'm also not saying don't invest
in multifamily, um, development.

Um.

I, I think it, how big is your allocation?

How, how many, how many, how
many times can you cut that pie?

You know, if your allocation is, you know,
60% and you're worth $10 million, um, so

you've got a $6 million allocation to, to.

To real estate.

I think there's room for multifamily
development, multifamily,

existing, industrial, existing.

I mean, I think you, you, you know,
you, you can design it however you want

and where your comfort level is, but
I'm really not saying stay away from

any of of them on either the existing
or the, the ground up development side.

But at the end of the day, if you include
existing assets for incomings to build.

And development for growth and
downside return protections.

I think that's the approach that
delivers the most balanced performance

in a real estate portfolio.

Um, and, uh, and, you know, I, it.

Again, like you said,
the math makes sense.

Um, I don't think the risk and
development particularly in storage

in small bay industrial is as
great as many people think it is.

And hopefully we've, we've exposed that
a little bit and what we've done today,

we'll go a lot deeper and have a lot
more fun with it, um, in the webinar.

Um, but, uh, but yeah, hopefully we've,
you know, at least got some people

thinking with what we talked about today.

Brandon Giella: Yes.

Yeah.

What I was gonna say is, so we're, this is
the 24th episode that we've done together.

I like to say I have an MBA in finance.

I get some of these things, but I'm not
a sophisticated real estate investor.

I don't invest in, in real
estate, uh, by myself.

But you explaining it in this way is,
I've said before, is like a masterclass

because you're able to get to the heart
of why this is such a great investment.

And it's very helpful for me at least
the way that you've explained it.

And I know for our, our listeners
as well that breaking it down in

this way, it makes so much sense.

To in invest in this kind of property,
the way that you guys structure these

deals and look at these properties.

And it's really amazing that
you break it down this way.

And I would encourage listeners to go
back to episode six where we talk about

cap rates and we talk about some of
the, the, the technical, mathematical,

um, components of some of these
investments, because that paired with

this episode is, is extremely helpful.

So thank you for, for
breaking it down like that.

Paul Bennett: Ah, it's, it's always fun
and I, I would encourage people, if this

was fun at all, if it's been a fun 25
or so minutes for you, um, go to AAA

storage or a a a storage investments.com.

Uh, go to the events tab.

Register for the webinar
on the 27th of October.

Um, and like I said, hopefully, I
think we'll get the, the registration

link, um, down in the show notes
for this episode of the podcast.

So you can just go there.

Uh, but, but check out our website
as Brandon said, check out some of

our other podcast episodes, which
are all there on the website as well.

So go find episode six and, uh.

And use it as a reference
point for some of the terms and

concepts we talked about today.

But it's been fun as always, my friend.

And, uh, thanks for for,
thanks for the opportunity.

Brandon Giella: That's right.

Thanks for being on.

Yeah, do check us out on
Spotify, apple Podcasts, YouTube,

wherever you get your podcasts.

And sign up for our newsletter as well,
because that way you'll get a lot of

more information coming to you on a
weekly basis and, uh, and it'll help

kind of orient you to different things.

And, and please as always,
reach out to the team.

As you know, there's great experts
behind the AAA investments team, and

so I am excited for y'all to get to
know each other on the webinar on

the 27th, and we'll see you then.