Welcome to the Self-Storage University Podcast, where you will learn the correct way to identify, evaluate, negotiate, perform due diligence on, renegotiate, finance, turn-around and operate self-storage facilities. And your host is a partner in one of the largest real estate portfolios in the U.S. with nearly $1 billion of holdings, Frank Rolfe.
We all know what a mousetrap is and we know how it functions. You pull back the spring, you sit up the trigger, you put the piece of cheese on the portion of the metal that triggers the spring, and you place it where the mouse might be, and you sit back and you wait. And if you leave it overnight in your house in an area that you think there are mice, typically you'll go back the next day and, yes, you've caught the mouse in the mousetrap. Now, the problem with the concept of the mousetrap is sometimes the self storage facility buyer becomes the mouse and the seller becomes you, the person who sets the trap. This is Frank Rolfe with the Self Storage University Podcast. We're going to talk all about traps and how to avoid them. Traps that come from sellers who know full well what they're doing is probably not good for you, but may very well be great for them. Now, there's several kinds of storage-buyer mousetraps out there, and let's look at each one of those and figure out how to diffuse it.
So one common trap, and this is not always a trap, caused by the seller. This can also be caused by the buyer. And that's when you have this theory, this mindset that you're going to go ahead and buy something for cash and refinance it later. And the problem is when you do that, you sidestep typical banking due diligence. Now, you may think that it's a good thing. You say, "Well, I'm going to go ahead. I don't want to have to be at the mercy of the bank doing their due diligence." And we've had deals over the years, we got in trouble in the bank's diligence, and they were right. There were things that we missed about the property, the survey, the streets, who knows what. But thank heavens that they caught it, because if we had bought that property and we didn't do what the bank found, we could have regretted it. But the bank shut us down from doing it. That's the inherent danger when you buy things for cash. So that's not really a seller trap, but yet it is kind of a seller trap. Sometimes a seller wants to make ridiculous expectations of timing. They may say to you, "Yeah, I'll sell my property, but you got to close on it within 30 days."
Well, that's never going to happen. You're never going to get the due diligence done, you're never going to get the loan done, you're never going to get the loan finished up and completed and funded, typically within a 30-day window. And mom and pop know this, so they selected that date, because they know you'll never be able to make it. So instead they're looking for someone who wants to buy it for cash. And often they're doing that because they're hoping that there's some unsuspecting fool who will do that. And therefore you won't find that the thing is built on a toxic landfill or it has some kind of huge survey issue or title glitch. So whenever someone wants you to buy something for cash and tells you, "Oh, let's just buy it for cash and refinance it later," or you yourself are thinking about that, you better slow down and make sure you're not making a terrible mistake. That's one big scary item about buying properties at auction is typically you have to post 10% the day you win the auction and the other 90% within 30 days. So most people who buy at auction are going to buy it with the cash.
But the problem again is, did you do enough diligence or are you in fact walking into a trap? How do you get around that, you might say? Well, number one, make sure you did good due diligence, that's for sure. But also, you know, you might want to go ahead, you were going to buy for cash, but you might want to get a loan on it instead. There's a degree of comfort when you've already gone through the loan cycle one time, that you didn't make an error and that everything is going to work out to be fine. But it's a whole another deal when you already own the property and then try and get a loan, so they come back with a fatal flaw, there's not a thing you can do about it. You already own it. If they find the fatal flaw before you bought it, then you could always terminate the deal and walk away free from that mousetrap. Another type of mousetrap, and this one truly comes from the seller and they know what they're doing, is they give you a note on a seller finance note that's too short for you to get the property in the right condition to get refinanced.
Let's look at an example here. Let's assume that mom-and-pop Larry owned a self storage facility that they built from scratch, and they built it 20 years ago. However, they tell you they lost interest in it probably 10 years ago, and they stopped really managing it, and now the occupancy has fallen to like 50%. Now the bank isn't going to be able to make a loan on that deal. It's got declining occupancy, declining rents every year. It's only 50% full. So their plan is they'll go ahead and carry the financing while you turn it around. But they want to give you this insanely short fuse to turn it around. They might say, "Yeah, I'll carry the paper for two years or three years." Let's think about this for a minute. For you to get another loan, you probably need to allocate at least six months to a year, so that you can find a lender, get everything done, not be in a terrible rush, maybe even sell the property if you guessed wrong on the valuations and stuff of it. So we better tack a year on that thing. So suddenly that two-year seller note isn't really two year, it's one year.
But wait, we have another problem. We have to get this business solved and fixed and then we have to get it stabilized, and then we have to go ahead and let some time pass. The bank's going to want to see, you know, that that's been seasoned for a while, and now suddenly your two-year note is maybe a year short based on the property you have. And mom and pop know that, because what they're hoping is you will default. That's the plan. You're going to put down your down payment, you're going to default, they're going to take the property back away from you, and hey, what a great deal for them. They got your 20% down or 30% down, and yet they still got the property back. It's like the vending machine that you put the dollar bill in with a string, you get the candy bar, you pull the string and pull the dollar bill back out again. That is never good for the buyer, ever. So if someone wants to carry paper, it's a mousetrap, unless the paper is long enough. Now, how long is long enough? At least five years, preferably seven years. Best option, 10 years.
Well, when mom and pop want you to sign off on a seller note of less than five years, and particularly these really crazy short time frames like two years, you better walk away from that. That is not going to work for you. And that's why the seller is so adamant about it, you can say, "Hey, seller seems really short. I mean, you're going to carry it for two years, how about five?" And, of course, the answer is there's no reason he can't do five. He just doesn't want to do five. Every year he goes beyond the two, he runs the risk of you actually being able to come forward with the money and pay him off. He doesn't want to do that, he wants to get the property back and keep your money. So be very, very sure when you do deals that the seller note is of a sufficient time frame that without breaking a sweat, with a reasonable level of success, you can in fact get that replacement note, so he does not get the property back. Also, watch out for the mousetrap of when the seller wants to trade you some type of short-term performance for long-term debt.
Here's what I mean. Going back to the example of the guy who's 50% occupied, and yet he wants you to go ahead and get a note on it and stuff. But the bank says, "Heck, I can't make these numbers compute at the price you're paying." And he says, "Yeah, here's what I'll do. I'll go ahead and rent 60 of the vacant units. I'll pay you. I'll pay you the rent on the 60 for a year while you get them occupied." Well, that's great and everything, but what he's doing here is he's artificially inflating the value by having 60 occupied that really aren't. And then you're putting 30 years of debt on that or 25 years of debt on something that he's only guaranteeing for a year or two. Think about what a bad deal that is for you as the buyer. If someone wants to trade you 25-year mortgage debt, he needs to guarantee that little item for 25 years or so. That's always been a bad trap that sellers pull on unsuspecting buyers. So make sure there's no short-term promises here that are shorter than your debt. If he wants to really, really man up and cover it till the bitter end, well, that's one thing.
But otherwise, no, you're just walking right into a trap. And then finally, the worst trap of all is when you completely trust the seller on everything. You don't have any question in your mind. The seller tells you X and by heavens, that is the gospel truth. There's no greater mousetrap to walk into with the unscrupulous seller when they know that you trust them and will not check out what they're saying. You may remember under Ronald Reagan he had a famous quote, it was called "trust but verify". What it means is, yeah, you can trust the information, it's better than nothing, but you verify every piece of it, because you know it's in the best interest of the seller to lie to you. So the only way you can battle back from that is to verify it yourself, so that you know with 100% certainty that everything they told you is true. If they tell you, "Oh, I got the permit for that thing," I want to see it. If they say, "Oh, I'm not in the floodplain," I want to see it. Over the last 30 years, I've seen so many mind-numbing, unbelievable cases where what I thought was a nice seller turned out to be horrifically immoral.
It does happen. I mean, people you would never spot, they're a happy deacon in the church, but suddenly, when it comes to selling their storage facility, they become the devil incarnate. So make sure that you verify everything. Don't disregard what the seller tells you. Don't write it off as not being truthful in any way, it might be, but just verify every single issue, so you don't walk into that trap. The bottom line to it all is just as the mice prefer not to nibble at the cheese which springs the trap, you should also refuse to take the same steps. There are ways to make sure that you don't fall into those traps. You definitely should be doing them. This is Frank Rolfe with the Self Storage University Podcast. Hope you enjoyed this. Talk to you again soon.