Insuring Profits

Tenant Insurance Flows New Revenue Stream To Bottom Line

As self-storage occupancy reaches all-time highs nationwide, operators are eagerly fishing for new revenue streams that can boost profitability. If you’re lucky enough to have the space and permits to accommodate a cell phone tower or advertising billboard, you’ve reeled in a big catch.

However, only a small percentage of storage operators can qualify for high impact revenue streams such as these. Nevertheless, many other channels still remain open to operators such as offering the traditional boxes and packing materials or even overlooked items such as lifting straps, trailer lock kits, dust covers, and mattress bags. Some operators find truck rentals very profitable, but the overhead for equipment and insurance can be costly.

A growing number of operators large and small have discovered a largely untapped revenue source that is evolving into a new profit center: tenant insurance. Depending on state laws, operators can earn administrative fees or commissions that can generate a significant return on investment (ROI).

“In some cases, the revenue earned through tenant insurance at a facility has become the second largest revenue stream after unit rentals, exceeding boxes, moving supplies, and rental trucks,” says Keith McConnell, vice president of business development for MiniCo Insurance Agency, which markets tenant insurance programs. Phoenix-based MiniCo offers TenantOne Direct insurance and a Pay-With-Rent plan that allows the customer to pay the monthly premium with the rent payment.

The key to building this level of revenue is the rate of participation of tenants at a facility. Most top operators now require new tenants to have insurance coverage on stored goods since the owner only provides rented space and not the care, custody, and control of items. This can be satisfied through a homeowner’s or renter’s policy or by purchasing specialized coverage.

“Our lease requires the tenant to have insurance and give us proof of that insurance coverage. If it’s worth storing, it’s worth insuring—it’s got value,” says Ken Nitzberg, CEO of Devon Self Storage in Emeryville, Calif. “It’s like any other commercial lease where there’s always an insurance clause where the tenant has to pledge certain coverages to protect the landlord.”

There are other reasons operators require insurance coverage for stored goods. In addition to covering the value of tenants’ belongings, insurance also offers a level of protection for facility owners.

“We do it to protect ourselves because whenever there’s a burglary, fire, flood, or hurricane, one of the first things tenants tend to do is come in the office saying, ‘you’ve got to make me whole—you’re responsible.’ We’re simply renting space. You store at your own risk and that’s why we require insurance coverage. We protect ourselves from frivolous lawsuits,” Nitzberg says.

Most insurance programs provide a method to document that customers were offered insurance. If the tenant declines the coverage, that documentation is a valuable asset should a customer later file a small claims court case. And operators who have weathered a natural disaster, criminal acts, or other calamities have learned firsthand the value of making sure customers have tenant insurance. Tenants with insurance who experience losses tend to seek relief from an insurance company rather than the manager’s office.

Nitzberg says approximately 70 percent of Devon’s tenants participate in the insurance program. That percentage mirrors the penetration rate other operators experience when insurance is required at their facilities.

“When a facility opts to include a requirement in their lease that all tenants must have insurance on their belongings, the insured tenants at the location can reach 50 percent to 70 percent,” McConnell confirms.

While operators with an insurance requirement tend to generate a higher percentage of tenant participation, even modest rates of involvement can add up to a significant return. MiniCo provides operators with an illustration of benefits showing how a penetration rate as low as 21 percent at a 500-unit facility can earn enough to offset the cost of the owner’s commercial insurance by generating more than $5,000 annually. When employees are trained to routinely offer the insurance at lease signing, the program can generate annual revenue of $20,000 or more per facility.

A Lure To Portfolio Buyers

A vibrant insurance program can have a dramatic effect on ROI, especially at facilities in locales that don’t command the highest rents.

“Where we really see an impact is if you’re in a $12 to $13 a square foot rental market; you can increase the bottom line on a percentage basis quite a bit with a protection plan or tenant insurance program,” says Aaron Swerdlin, executive managing director of the NGKF Capital Markets Self Storage Group in Houston.

Swerdlin notes that in some brokerage deals, an established insurance program can be a valuable asset to buyers with experience running programs at their existing facilities. The buyers stand to generate a lucrative new revenue stream when the seller owns a property with a limited insurance offering, or none at all.

“When your buyer is in a joint venture where you’ve got a REIT operator and a private equity investor, it can be very profitable for both because it expands an existing program for the REIT or institutional operator,” Swerdlin says. “It gives the operator partner of the joint venture an opportunity to throw a significant number of properties into a tenant insurance program or tenant protection plan, increasing profits to that profit center. It gives the institutional partner quite a bit of additional revenue because they can negotiate sharing of the profits of the insurance, especially when you find a portfolio that doesn’t have much tenant insurance to offer. That can become very valuable.”

For example, when Michigan-based Storage Pros Management sold 37 properties to a joint venture involving CubeSmart for $242.5 million last year, the properties’ existing tenant insurance program became an attractive asset to the buyers.

“When we sold to CubeSmart, we were able to get all that premium capitalized as part of the purchase price,” says Ian Burnstein, a Storage Pros principal. “It was a very significant number. Those 37 stores had 14,000 policies.”

Burnstein adds that the properties generally averaged 80 percent tenant participation in the insurance program.

“If you have 300 policies at a store and $5 of that policy is going to the bottom line, that’s $1,500 a month,” Burnstein says. “If you sell at a six cap, you just added $300,000 on your purchase price by selling 300 policies. So it’s a very real number. That’s why we focus on insurance.”

Swerdlin recounts a transaction where the portfolio of properties had virtually no tenant insurance offering, but the parties assumed the new operator would institute a program. “We put an artificial number in our proforma that is highly likely to be achieved. For the buyer of that portfolio, that [tenant insurance] is probably the single biggest piece of upside because they know based on their experience with their current portfolio they’re going to get a level of penetration at a decent clip,” he says.

Swerdlin adds that most buyers will underwrite some level of tenant insurance penetration in their profit model. In most transactions, NGKF’s due diligence looks back at a trailing three years of a property’s performance. However, because tenant insurance is still in its evolution, looking back at this particular income stream may not be meaningful. Instead, he reviews the REITs’ quarterly and annual reports to determine their penetration rates and overall experience with tenant insurance.

“We pay close attention to their trends and we try to extrapolate things that make sense for our purposes,” Swerdlin says. “Tenant insurance is only going to increase and it’s more than just incremental for the next couple years. Once it gets to a stabilized level, then it will become something that you look at trailing and you get a good idea of whether it will generate more data.”

Adding Value From NOI

Revenue from tenant insurance increases the net operating income of a facility, which can add to the overall value of the property. The additional income stream can potentially increase an asset’s perceived market value and allow it to qualify for additional loan proceeds as well.

“It’s become enough of a significant factor in the industry that lenders, buyers, and sellers now look at that income stream as being fairly predictable and basically as good as rental from units in terms of calculating the value,” Nitzberg says. “If you’re generating $1,000 a month net of insurance revenue to the site—that’s what the store gets in an administration fee or commission from the insurance agency—that’s $12,000 a year. If you value that store at a six cap, that’s the equivalent of an additional $200,000 of value. It’s become a significant number.”

Using a formula that divides net operating income by the cap rate, operators can determine how the insurance income potentially adds to the value of a property.

Besides the boost in property values, income from ancillary products such as tenant insurance can qualify facility owners for higher loan proceeds for refinancing a mortgage or other uses.

Lenders look at the property’s debt service coverage ratio (DSCR) to determine the cash flow available to pay current debt obligations. If the facility is generating an extra $1,000 a month of revenue and the lender has placed a DSCR of 1.5 on the loan, that means an extra $500 of revenue potentially can be applied to the borrower’s loan amount.

“It ups the amount of proceeds you can get on a loan because you have more cash coming in to service the debt on that loan,” Nitzberg explains. “Any auxiliary income that comes in, whether it be from tenant insurance or the sale of boxes or locks or a cell tower, as long as it is reasonably predictable to be consistent, the lender will include that in the total revenue that you collect.”

Consistency is the key. The capital markets value ancillary income by examining its sustainability and how long the income stream has been in place. If an owner can demonstrate that the income stream is sustainable based on historical analysis and that there is strong potential for this income to grow, the lender will assign value to the income and lend on the full amount instead of discounting the worth of the ancillary business.

“Is the likelihood that it continues very high, very low, or is it likely that it increases? I’m trying to figure out what I pay for that income stream,” Swerdlin says. “The single most important thing is how reliable is that revenue stream going forward?”

Low Cost Administration

With any product offering, the operator must consider the cost to implement it. Typically, the expense involved in adding a tenant insurance program to a business is minimal. Tenant insurance is a low-cost, or virtually no-cost, program to administer. Initial training is advised to learn about the product, its benefits, and how to offer it to customers. Once managers and staff start to offer the product consistently to every tenant, the time involvement usually takes less than two minutes.

“There’s really no cost to generate it,” Swerdlin says. “If you have $20,000 at the top line, it’s probably not going to cost you more than eight percent to administer that additional revenue. You’re talking about a $1,600 expense to bring in $18,400 worth of income. That’s going to be significant.”

Insurance agencies typically provide free training and marketing materials to support their programs. “The factors that increase or decrease these results are the training the site managers receive and the direct supervision and oversight by the facility’s owner,” MiniCo’s McConnell says.

MiniCo conducts online webinars with facilities to teach managers and their staffs about the policy coverage, how to offer the program, and overcoming common objections or misconceptions customers might have. Customers can even contact a company representative right at the facility to get additional details and answer questions.

The marketing collateral helps to reinforce the need for insurance in customers’ minds. Wall posters and other marketing materials emphasize the message about the need for insurance.

Although many storage customers’ homeowner’s or renter’s policies may cover items stored away from home, some tenants still opt for the tenant insurance offered at the store. The chief reason is because there is no deductible on policies offered by MiniCo and others, whereas, a homeowner’s or renter’s policy may have a deductible of $500 or more. If the customer has a homeowner’s policy with a high deductible, the tenant is unlikely to file a claim for a small amount.

With tenant insurance, no matter how small the loss is, a claim can be filed without impacting their homeowners’ rates. Some customers who file small claims against their homeowner’s or renter’s policies sometimes find the insurance company will raise their premiums or possibly drop the coverage entirely. This claim history may follow the customer for years, even if they attempt to change insurance companies.

New sources of revenue originating from ancillary sales can have a positive effect on the cash flow and NOI of a property. Ancillary income including tenant insurance generally adds between three percent and five percent to a property’s gross income, although some facility managers have reported it can add as much as 20 percent.

Self-storage operators looking to diversify their businesses can cast a wider net into new revenue streams with ancillary products and services to expand their earning potential. Tenant insurance adds another income tool to a diversified set of products that has gained acceptance with more and more customers. It’s a product that helps to differentiate operators from competitors and promises to reel in additional profits going forward.

David Lucas is a freelance writer based in Phoenix, Arizona. He is a frequent contributor to all of MiniCo’s publications.