
Structuring Investments for Long-Term Success
May 05, 2023Today, I want to talk about cash flow issues and predicaments that many business owners and investors face. Through my experience, I’ve learned a lot about the importance of cash flow management in this industry. I’ve picked up some helpful strategies and insights over the years and I want to share those to help others avoid some potential pitfalls and missteps.
Conservative Approach to Underwriting and Fees
First things first, let me share with you our approach to investing in real estate and self-storage opportunities. We are quite conservative in our underwriting, and we do not share actual numbers because that would be insane. We are also conservative in the way we act and buy. Our fees are half of what a lot of the industry is charging on property management, and we have been told repeatedly that our fees are too low. However, through our strategies, we’ve had a lot of success in doing what we do. So let’s take a closer look and see if what we have to offer is something that can help you.
Focus on Fundamentals
Many business owners get carried away by short-term wins and promises of growth and forget to focus on the fundamentals of cash flow management. They often neglect the importance of long-term sustainable cash flow and instead focus on one-time fees, debt, and quarterly discounts on expense ratios. This often masks the reality of their operations, and they end up believing they are experiencing growth when they are not. The fundamentals are fundamental for a reason. Always remember to focus on the fundamentals when approaching investment opportunities.
Investors Provide a Mask
Investors often provide a mask for business owners to cover up the reality of their operations. Investors provide money that masks the poor performance of the operations, and the business owners get confused, thinking they are running a good, profitable business.
However, the reality may be different. Many large storage operators are running at a loss, and unless they get upfront fees from new deals, they cannot pay their bills. This is a big problem because they end up buying deals at any cost, and the performance of the asset starts to matter very little.
Size of the Deal Matters
The bigger the deal, the more upfront money business owners can take in fees. So, they start doing bigger deals at any cost, and the performance of the asset starts to matter very little. This is because of the short-term wins and the need for cash flow.
Importance of Sustainable Cash Flow
It is scary to see business owners neglecting the importance of sustainable cash flow and instead focusing on short-term wins. Investors should look at the owner, operator, and operations and ask how it is funded, whether it is sustainable, and where the benefit is coming from. Investors should also ask if the operation is profitable or if it will become a downward spiral in operations.
The Greater Fool Mentality
One concept that I’ve learned is that of the Greater Fool Mentality. This concept is best described as: anytime investors justify their investments based on the belief that someone else will come along and pay a higher price for the property. This can lead to buying properties that are overpriced and running at a disadvantage. While this may work out in the short term, it can be risky in the long term, especially if the market changes or interest rates rise.
Many investors justify their investments based on the Internal Rate of Return (IRR), which can be easily manipulated. Instead, I focus on Cash-on-Cash Return and Cumulative Cash-on-Cash Return of the investment, which are more reliable indicators of investment success. I believe that the property should be good now, great in the future, and not dependent on a sale to someone who wants to buy it at a higher price.
Structuring Investments for Long-Term Success
At my investment firm, we structure our investments to get our investors' money back within three to five years through refinancing or other means, but we don't sell the property. This way, investors are in our deals forever, getting equity, wealth, and income, without a big liquidation event like a sale that has to justify all the numbers. This approach allows us to focus on the fundamentals and avoid the risks associated with the Greater Fool Mentality.
The Importance of Understanding Revenues and Expenses
It’s also important to understand revenues and expenses when investing in any type of real estate, including self-storage. Let me offer this example: a company was running off of short-term revenues and expense ratios, which made everything look appealing. However, at the end of the day, they were running negative every single month, and it wasn't until it was too late that they realized what was happening.
This is a lesson for all investors to be diligent in understanding the numbers behind any investment. It's important to look beyond short-term gains and understand the long-term financial health of the property. By doing so, investors can avoid the risks of financial wizardry and ensure long-term success.
Conclusion
The self-storage industry faces significant cash flow issues, and it is vital to focus on the fundamentals of cash flow management. It is essential to have sustainable cash flow rather than focusing on short-term wins. Investors should also look beyond the surface and ask questions about the business's cash flow, profitability, and sustainability. The bottom line is that people need to start looking at cash flow margin fundamentals and focus on sustainable growth.
The important takeaway of all this is to focus first on the fundamentals and not be seduced by short-term gains. Look at the long-term because that is where success and wealth is going to manifest. By implementing fundamental wisdom as an investment strategy, you set yourself up to succeed and prosper.