Episode 188: Mistake #2 – The Risks of Skipping the Inspection

Announcer (00:03):

This is the Self-Storage Podcast.

Scott Meyers (00:09):

Hello everyone and welcome back to the Self Storage Podcast. I’m your host Scott Meyers, and today we’re going to be continuing on in a series of the top mistakes that would be successful self storage investors make and how to avoid them. As you know, we’ve been at this for a number of years and we have made a lot of mistakes in the beginning of my investing career and I have been a party to and an observer and watched many folks out there commit to many mistakes. Now, fortunately, they aren’t the folks that we’ve come alongside in our mentoring programs, but there’s a whole lot of folks that made some mistakes along the way and then they finally decided that they were going to get educated to learn how to do it the right way. And that is so important as we’ve talked with so many investors that their first deal, they lost the battle and they lost the war.

(00:52):

That first deal that they did, they didn’t do proper due diligence and they didn’t understand the intricacies of their investment or of this asset class. And they be brazenly went out and just felt that this is the best performing asset class. And so what could go wrong? And well, they found out the hard way that there are many things that could go wrong. And so that’s what we’re aiming to do. And who knows, we may just write a book on this to make sure that folks have a roadmap to understand just exactly what the pitfalls and the mistakes are that they could make in this industry because it is just an easy set it and forget it, business that succeeds no matter what you do. So it all begins with proper planning. It all begins with education and understanding. Here are the steps but also what’s behind each and every step.

(01:33):

And so we’re going to be going through that in underwriting to market analysis to the overall deal analysis. But today what I’d like to focus on is the actual physical inspection, the actual site inspection when you’re looking at the physical aspects of a facility and understanding just what it is that you should be paying attention to and maybe some of the rocks that you didn’t know to look under to make sure that you do avoid any of these mistakes when it comes to the physical aspects of the property. Now, number one I would say is to come into this with a mindset is that you don’t know what you don’t know and not everybody is an expert in all aspects or especially the physical aspects of a facility. So you may be good at investing in single family houses and multifamily and you’ve seen a number of furnaces and air conditioners and you may know a thing or two about whether they’re at their useful life or not.

(02:23):

But what you may not recognize or understand when you head into self storage is what is the proper temperature and the proper tonnage and the type and the amount of HVAC units you should have at your temperature controlled cell storage facility in addition to its useful life and whether it’s been maintained well and what it looks like when it hasn’t and whether it’s at its useful life or not. And so as we enter into the physical inspection phase, which is part of your due diligence, it’s very important that we understand each and every one of these aspects because what this allows us to do is this gives us an opportunity to go back and negotiate these. So self storage is a little different if you’re coming from even the single family world where there is a disclosure statement and you just have to have an in-home and inspection and understand that some of these items should be taken care of.

(03:09):

But in commercial real estate and self storage, if you don’t find it on your own, there is no disclosure statement. So this is 100% on you that you have to perform your due diligence and your physical inspections because if you don’t find it, there is no disclosure in commercial real estate. And so essentially all of these contracts are as is is without a warranty, and if you don’t do your due diligence, then well then that’s on you afterwards. And so it’s very important to go through each and every one of these items and negotiate if there is an issue with any one of them. Let’s get back to talking about the HVAC units. Well, you can take a look at them when you’re out on site doing your first or your second initial physical inspection, but we don’t stop there and you’re going to hire somebody to come out and you’re going to hire an HVAC specialist to come out and take a look at the units.

(03:56):

Is there a service record? Is there a service record that is in place and kept in the file that the seller has? We would ask the broker or the seller for that first of all, and if they can’t produce it, then we know we definitely need to bring somebody out to be able to inspect the HVAC units to find out if they’re in need of service. We would hope that that would be the only thing that they need, but if they are at their useful life or if they need to be replaced or if they’re just not working, it’s a good thing, then we call them out to find that out because then we will go back to with this as well as any of these other items we’re going to talk about today, go back to the seller or the broker and say, well, it’s not listed in your listing here, and so you’re either going to have to repair this before we close on the property or give us a repair credit because this unit doesn’t work or this unit has maybe basically a year left or it needs to be serviced, whatever that dollar amount is because there is no disclosure.

(04:44):

Well, if they didn’t list it that seven of the eight units are working but one isn’t, which I’m sure they wouldn’t, then it’s up to you to find it but then ask for it because it’s not disclosed. Hopefully that makes sense. So that’s what we’re going to be addressing as we go through each and every one of these items. That also goes for the physical structure. So we’re going to look at the walls and the roofs. Does it have an asphalt shingled roof? Is it at its useful life? Are there any leaks? Now with storage is difficult to find out if there are leaks because the units are locked and we don’t create a bailment. We can’t go in and inspect them like we can in a single family house or to a degree multifamily. And the only time we know is self storage facility owners either once we’re in it and now that we own it is if a client then says, Hey, there’s a leak in the roof.

(05:25):

Good news is it’s on us to just repair the roof. We don’t have to cover the contents like in other asset classes, however, we don’t know that there’s an issue until we get to that point. So having an inspector come out to take a look at, again, if it’s asphalt shingles, where is it in terms of the useful life or where are they? If there’s multiple roofs and multiple buildings and if it is at its useful life, then well, we’re going to ask for a discount because you didn’t state that this roof is at the place where it needs to be replaced. And who knows if they have seven roofs and they all need to be replaced, that could be the reason why this cellar is selling. And so we’re going to take a look at the roofs, we’re going to look at the decking underneath because that could be a significant CapEx capital expenditure that we would have to incur.

(06:07):

And again, that may be the reason why they’re selling. So we bring a roofer out to take a look at the asphalt shingles and if it is, if they’re all steel roofs, well that’s usually part of our industrial inspector’s normal protocol. They’re used to seeing all steel buildings with steel roofs and the normal rollup doors and they can inspect the building to determine again if the roof is in bad shape or if it was installed improperly standing. Same roof is put down with nails as they put down with screws and did they install it properly? And you most likely don’t know whether it has been installed properly or not. And I can tell you that I can’t. I’ve looked at a lot of ’em and I know for the most part whether it has or not, but it doesn’t matter. I’m going to get an inspector up there to look at each and every single one of these roofs because when they’re done with their inspection, not only are they going to point out anything that’s at its useful life, but many inspectors, you will pay them additional and they will give you a rough estimate or a quote of what it would cost in terms of a range that it would cost to be able to make these repairs.

(07:04):

And so what did we do with that when we’re done, just as I mentioned, then we take that back to the seller and say, here’s what we found at your facility. Not trying to beat you up, but these are real items that we found that we’re going to have to address either now or shortly after we close on it. And we were unaware of these things because again, it wasn’t included in the listing. It wasn’t disclosed, but here are some issues. And so then you had the ability to negotiate and ask for either a discount or ask for a repair credit at closing so that you can get these items repaired and replaced. Because again, if you don’t, then that’s all on you. It’s not up to them to just take care of that. Next, I’m going to make certain that the inspector, that the inspection company that I use, that they are also very well versed in drainage and they have the equipment, so they have the levels, they have the lasers to come out because as good as you may be, as good as we are looking at a piece of ground and determining where the water is going to go, if they don’t have a drainage system and the water is just expected to go between the buildings and to the left and out into the swale or out into the road or off the property, where does it exit?

(08:11):

If you can’t determine where that is and typically you won’t be able to do so with the naked eye, then we have to have a company come out to determine what that looks like. And they’re also going to be able to see a little better than you, not only with the naked eye but without with their tools. If there are areas that where water ponds and it collects, sometimes we can see this on the buildings or sometimes there are four units at the end of a building that haven’t been leased in two years, which is usually a telltale sign that there’s either a leaky roof or at least when it rains and they don’t rent those out. But either way, we want them to come out there and determine is there an issue here with a drainage and did they create and build this with the proper weather lips to keep not only rain from coming out, but if it blows sideways, is there a weather lip where the door goes in front of this lip, a little hunk of concrete that sticks up so that rain doesn’t go inside of the units as well?

(09:00):

And some of these first generation properties, well, they just weren’t engineered for that. And some of the general contractors, they skimped or the concrete guys didn’t know to do this for self storage. So these are all things that we want to take a look at because if we have issues every time it rains and our clients are leaving as a result of it, then we want to know that as well. Some of this will be reflected in the management records and the tenancy records, but you should be looking at this from a physical standpoint first to avoid any of those issues once you own it. Same goes for gates and the gate software as well as the mechanism. Most of us won’t know whether the gate software is operating properly or whether the actual driver itself that drives the chain. If it is driven by a chain or a belt, if it’s had its useful life or it has been maintained very well, if it works right now that’s great, doesn’t have a rusty chain and components, well, it still may have five years left handed, 10 years, or they may have a couple of months and they’re milking it along.

(09:55):

Either way, I’m going to leave that to the inspector to give his best judgment. And then again, if it is in its useful life, then he will provide a quote and arrange of price to be able to replace or repair the unit if it indeed it needs anything. Next we’re going to look at the cameras, the security system. Do they have cameras and do they have a system in place already? Are the cameras operating correctly? We’re going to go to the room where the multiplexer is and the actual screen itself and take a look. Are they clear? Can we actually see through them? Are they old? Are they dated? Are there black holes in the multiplexer on the screen, meaning some of those cameras are out or did they just not have coverage or did they just not program it correctly? But either way, we’re going to dig into the system, find out how many hours it has on the hard drive.

(10:41):

Is it motion activated? Is it on all the time? Does it need more space on the hard drive or is it just the whole thing too antiquated and we need to replace it all together because this, a very important selling point of our facilities is clean, safe, and secure and easily accessible. And so if you don’t have the security piece down that you can point to because you’re going to market it on your website is one of the top three things that you pride yourself on. And then they get there and they realize that, well, you really don’t have this place covered very well. And they will see that when they walk into the office and they take a look at your camera system that is right up on your screen because you’re going to show that right behind the counter in which they will come in and talk to somebody about leasing a unit subway.

(11:22):

We pay very close attention to that system and it’s also a significant cost to replace it. So we want to know upfront if this is going to be another capital expenditure or not. Also, as part of the physical inspection, they’re going to look at the electrical systems and just make sure everything is grounded correctly if there are any bare wires, junction boxes, anything else that needs to be done. If there’s some wire that doesn’t meet code, some wiring that doesn’t meet code, we want to know that as well and make sure that anything and everything has been identified and taken care of before we close on the property. Same goes for plumbing. And many of these facilities, they may operate without an office and so there may not be any type of a plumbing system at all into the site. And others, depending upon where you’re at, if you’re in a secondary or tertiary market, we may have city water or we may have well water and we may have a septic if there is an office and a bathroom.

(12:10):

So having these inspected as well as you can imagine, if they have not been maintained very well, including a septic, well, we’re not going to talk about that on air right now, but that could be a whole different issue and a big, stinky, smelly expensive mess. And so we want to determine if that has been maintained well or if it does need to be pumped out or if there are any leaks. If there are, there’s any problems with the bed, the leach bed that needs to be addressed. Once again, that is a very expensive repair to either fix or replace an entire septic system and a well system and a well pump. So we want to make sure that those are in good operations as well. And now we’re going to talk about a phase one environmental report, and that’s really not part of the inspection.

(12:51):

It’s kind of separate from that, but at the end of the day, we’re still talking about the physical site and that means first reaching out to have a phase one inspection done by an environmental company. And if you have a lender in place, if you’re putting a loan on this, they’re going to request and require that and they may recommend or require you to use a particular company or choose from one of three of their preferred vendors and they’re going to come out and well, even before they come out, they’re going to take a look online to see if there have been any issues with the EPA at this particular site. Was it built on top of an old gas station or is it near dry cleaners or collision shop or repair shop, anything that would cause any issues with the groundwater. And then looking at the air quality as well, depending upon where it is located, it may be next to something that is throwing off a lot of paint fumes or a dry cleaner that is exhaust is blowing chemicals onto your site, which could cause issues as well.

(13:41):

Either way, we want to determine if there’s any issues with the site itself because the bank wants to protect themselves to make sure that there aren’t any issues that wouldn’t be covered by insurance if it is an underground leaky storage tank or if there are chemicals in the ground because the dry cleaner is nearby and they’re dumping chemicals or a collision shop that has paint or other chemicals that have leaked out of a automobiles parked on the yard that could come over and get into the water table or onto your ground that could contaminate it, which in that case now contaminates your ground. And insurance wouldn’t cover it if it came from somewhere else, which could cause a huge issue to remediate and then could cause well cause harm and put the property at risk. So we are always going to, and whether you’re using a lender or not, you’re going to everybody say, yes, Scott, we will.

(14:26):

You’re going to contact an environmental agency to come out and perform at the very least of phase one reports. Now, if they find anything in the history of the facility, at least register with EPA or if they find anything on site, then they’ll go to a phase two, which means yes, an additional cost unfortunately, but also to find out if there’s any further action that needs to be taken with anything that they found on site just to make sure that once again, you are protected and you are covered and you have the ability to transact and close on this property when you sell it. So all of this is about awareness, making sure that you understand just exactly what you’re getting into and that you’re buying what you see. So expect what you inspect and inspect what you expect that means going through and that with a fine tooth comb looking at anything and everything with regards to the physical aspects of the property because once you get done, once you’re beyond your due diligence, and this is done with inside of your due diligence period.

(15:19):

Once you sign off on due diligence, which means that there are no more contingencies to close at this point. You’ve got your financing in place, you’re satisfied with your inspections at this point, if you pull out, you lose your earnest money or you could be sued for breach of contract. And if you find something afterwards, once you close on the facility, well again, that’s on you. That’s why we perform all these inspections. And yet you would be faced with paying for any consequences of not going through this. And folks, it should go without saying, but the reason why we’re covering this in such detail is because I have seen many instances where folks are transacting, they’re buying properties and maybe the bank didn’t require a level of detail that I just discussed or some of these reports, but that doesn’t mean that you shouldn’t be doing them.

(16:04):

Sure, it’s $2,000 for this report or 3000 for this one or 5,000 for that one. But this is all just part of your insurance policy going into it. It needs to be part of every single person that is listening. It needs to be part of your acquisitions package and part of your transition checklist to make sure that once you get under contract and you’re approaching transition, that you are performing all of these inspections and doing your absolute best to be the most thorough you can possibly be in your due diligence because the last thing you want is to have any surprises crop up afterwards. Because with self storage and commercial real estate, those surprises come with lots of commons and zeros. And we want to make sure that you not only keep what you got, but that you can go on and get a little more. So with that gang dedicated to making it you better dedicated to making the industry better. That is why we will continue on with this series of the top mistakes that I have seen investors make and how to avoid them stories. Nation, you’ve been spending time with me, Scott Myers, and I look forward to spending more time with you on the next podcast. We’ll see you all again. Take care everyone.

Announcer (17:07):

Hey gang. Wait three things before you leave. First, don’t forget to follow the Self-Storage Podcast and turn on your notification so you never miss another episode. And while you’re there, please leave us a five star review if you like the show. Second, be sure to share your favorite episodes and more via Instagram and don’t forget to tag us. And lastly, head to the links in the show description and hit follow on Twitter and Facebook to get a front row seat as we grow and scale our business and bring you along with us.