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.
Now, in classic negotiation, the seller would throw out a price, you would counter, and then you would try and work together to craft something that was successful, a win-win final price for both parties. But in today's crazy world, you can't always get there. This is Frank Rolfe, The Self Storage University podcast. We're going to talk about getting creative on negotiating price. Trying to come to a price that the seller will agree to, not using conventional methods. Now, we all know how negotiation works. One party has to throw out a price, the other typically winces, throws out their price, which is either lower or higher based on whether you're the buyer or the seller. And then that person throws out another price that is somewhat either lower or higher than what they originally threw out. And then ultimately you come to some conclusion. But what if your seller won't do that? What if the seller says, here's my price, take it or leave it? What if the seller is completely unrealistic on valuations? Now, we all know that interest rates have gone up the fastest as they ever have in the last 40 years, starting in Q2 of 2022. And as a result, a lot of sellers got caught off guard because they always thought of their self storage facility as being worth a certain cap rate. And then suddenly that cap rate is no longer the appropriate one.
So when you contact them about selling, of course, they threw out the price of how it was prior to Jerome Powell going crazy with the federal funds rate. And of course, it's old news. They're living in a bygone era. That ship is basically sailed. They can't get that price anymore, but you can't get it through their head that they can't. So what do you do when you have a seller who seems to be somewhat unreasonable in what they're asking on the price? How do you try and turn that around and get a deal with them? Well, the first thing you can do when you have people who are unrealistic and you don't seem to be getting anywhere in negotiation is just to flip it over and say, "look, what would I have to do to get this under contract?" Which basically means let's cut out all the BS. Some people are just not very good at negotiating. So when you throw out the price and the seller, he doesn't really know how to counter or what to do. Sometimes you can just cut through all of the mark and just say, "okay, what would I have to do to get this under contract?" Just to see if there's any chance of forging a deal. So if you say, "oh, I'll give you a half a million dollars. He wants, I want 900,000. Well, I'll give you 600. I want 899,000. Maybe he's just a bad negotiator.
So maybe you just need to say to him, "hey, what would I have to do to get this done?" Or another option would be to have an appraiser set the price. If you tell the person, well, here's a deal. I know you want the most money you can get, and I want to buy it at the lowest price I can get. And we can't seem to agree on what that price is that's correct for both of us. Maybe we should just get this thing appraised, right? We'll have to get a loan anyway. So if the appraisal doesn't come in, then we can't buy it. So let's go ahead and get an appraisal and let the appraisal set the price. This is a good idea because now it gets the third party involved. And if you both agree to go with whatever price the appraiser comes up with, then that kind of solves that issue. Now, of course, there's a problem with that. The appraisal may came in wildly too high, but that's the risk you run as the buyer. So if you want to try that angle, you can give it a shot. The other issue is the cost. Who pays for the appraisal? Sometimes you don't have to do a full appraisal to satisfy the seller. All you would have to do is just get an opinion of value, maybe from a broker whose opinion that they would trust. Now, another option is to make the price contingent on hitting certain NOI targets. You've probably been reading recently about the lawsuit that Warren Buffett has with another company.
I think it's Pilot Fuel Stop, I think. And what's at issue is they didn't get the entire chain for what they paid. There was 20% left over that they have to now negotiate what the correct price is for. So you can kind of do that with the Self Storage facility. You can say, "okay, well, I'll pay you X, but you got to hit these certain targets" and maybe hold part of the money back in escrow, assuming that you can hit that. And then if you can't hit that, the price would then be reduced pro rata by whatever you cannot hit that target with. This way, the property itself gets to set the price because its performance is what ties to what the final price might be. So that's another good option in many cases, particularly a property that's got lots of vacancy or declining rents or something wrong with it where the seller says, "oh, I know you can do better." Well, let's put your money where your mouth is. If you're so convinced this property can do better, then let's set up a pricing structure that's based on that performance. Another option you would have would be just to buy a portion of the deal and let the seller keep the other portion. So in that case, you would buy 51% of the Self Storage facility and the seller would retain 49%.
Now, why this is an unusual construction is that typically when you sell something, you're out of the picture. But in this case, you're only selling a part. You might say, why would a seller want to sell a part of a Self Storage facility? Well, maybe they want a liquidity event to get some cash. But at the same time, they don't really want to cash out. They still believe in the property. Or maybe they think the property will be worth more as interest rates decline. Or maybe rents go up or occupancy goes up. So they say, well, "Okay, I'm not selling all of it. I'm only selling half. So if the other half goes up in value enough, then I'll ultimately get to my target price." Now, if you want to go with that, remember, you're going to have to retain 51% to have control. That's item one. Item two, getting financing on that may be nearly impossible. So you're going to have to have a really, really good banking relationship or some strategy, including paying for cash to get to that level of ownership. And then also don't forget that you've taken on kind of a strange partner you don't really know. So as a result, we're not really, really sure if this was a good idea or not till we find out whether that partnership is something that you can handle. You may end up having just bought yourself into a partnership with a nutty person.
Finally, you can do a master lease with option agreement. Now, a master lease with option is just that you lease the entire property, lock, stock, and barrel. You take over. You start operating it. And you have a target price, which, of course, is the seller's price that they demanded on the front end. So if the seller says, "oh, well, I won't sell this for less than $1 million." Well, then that's your option price. You have the right to buy it at any moment for $1 million, up to typically three to five years into the future. But now you're going to try and make that happen by pushing the net income such that it is possible to get a loan on a deal that's a million dollars, which day one may only be worth $800,000. Now, the beauty of the master lease with option is you don't have to put your money where your mouth is until you've successfully gotten there. You could always do the master lease. Under the theory, you can increase occupancy or rents, and then later bail out, pull the rip cord when you find out you are unsuccessful, that the market just won't support that. But at the same time, you have the seller locked in where they must sell at that price, so there's really not much they can do about it.
Now, word of caution on the master lease with option idea. What's at issue there is that typically when you get the thing fixed, when you've raised the occupancy and raised the rent, the seller doesn't want to sell anymore. They'll come to you and say, "wow, this thing is looking great. I'm not going to sell it at that price anymore. I want more." So if you do a master lease with option construction, you have to make sure you have it completely in writing and that it is an absolute fail-safe bulletproof agreement. Every time we've ever done a master lease with option on any property, what ultimately happens is they don't want to close at that price. We've never had to go to court over it, but we have had many heated arguments with people who signed on to the deal, we took over, we fixed the property, and then when we're finally ready to close, now they've changed their mind. They demand more money or say, I don't want to go through. But the good news is we've always had very, very well-drafted documents and we have gotten the deals closed. The bottom line is when you reach the seller who is at a roadblock, doesn't seem to move much, can't seem to get them the price you want, don't give up. Don't get discouraged. Try out these methods and see if you can cut through all of that and still forge a good deal. This is Frank Rolfe, The Self Storage University podcast. Hope you enjoyed this. Talk to you again soon.