How to Shop Your Self-Storage Loan and Avoid Leaving Money on the Table
|Copyright 2014 by Virgo Publishing.|
|Posted on: 07/02/2013|
By Casey McGrath
So you have a relationship with Bob the Banker in town, and Bob’s agreed to finance your self-storage facility for five years at 5 percent. You know Bob, so you trust him; but the reality is he likely is not giving you the best rate and terms available in the market.
The hard truth is rate and terms matter. Your monthly loan payment is likely your largest expense, and it greatly affects the cash going into your pocket when all the bills are paid. So if you’re not shopping your loan, you’re giving a lot of extra cash to Bob and his boys down at the bank. Let’s explore why and how you can change this outcome.
Competition: Rates and the Amortization Period
If a banker knows he’s the only one touching your loan, he’s not nearly as motivated to lower his rate to what may be considered local market interest rates. One way to counter this is to put together a professional document with three years of property-level historical profit-and-loss statements or tax returns, an occupancy report, and a personal financial statement for all sponsors on the loan. This package can then be “shopped” to several local lenders.
Talk to three to five loan officers and you’re likely to get a wide variety of interest rates, amortization periods and loan fees. At the end of the day, it matters. Consider this example: You have a $1 million loan coming due. The banker with whom you have a relationship offers a five-year quote at 5 percent with a 20-year amortization. A competing lender offers a five-year loan at 4 percent with a 25-year amortization. Over the course of five years, that lender will save you nearly $80,000.
This is scalable, so shopping a $2 million loan would save you about $160,000 in this scenario. That’s real money by any standard. No wonder Bob the Banker has been so friendly.
Term: The Importance of 10-Year Money
Most local banks offer three- and five-year term loans, and occasionally they’ll go to seven and 10 years. There are several non-bank, non-retail lending outlets that consistently lend 10-year money, including commercial mortgage-backed security (CMBS) lenders and life-insurance companies.
Getting a 10-year loan is beneficial in several ways. First, it pushes your interest-rate risk out 10 years rather than just five. Given today’s rates, it’s hard to imagine rates going lower in five years. Because of inflationary pressures, the likely end of quantitative easing by the federal government, an improving economy and the demand for capital, it’s very conceivable that rates five years from now will be higher than today. A five-year loan exposes you to the market rates in five years, while a 10-year loan pushes that risk out to 10 years.
Second, there’s appraisal risk. Many self-storage owners experienced this firsthand as capitalization (cap) rates jumped in 2008 and 2009. Those looking to refinance were sometimes not able to get financing up to the outstanding loan balance due to depreciation in value, and therefore, had to inject additional equity into the deal at refinance. A 10-year loan offers more time for properties to regain their value should there be a market correction, diminishing the likelihood of a necessary capital injection.
Finally, there are financial and time costs associated with refinance. By locking in a loan for 10 years, you offset those costs for five additional years. Costs include lenders fees—likely one point—legal fees and additional third-party costs such as an appraisal, environmental reports, surveys, etc. There’s also a time commitment to gathering the information, shopping your loan, interfacing with the lender and closing the loan. Time is money, and the less time you spend on refinancing your loan, the more time you have to tend to day-to-day matters at your facility.
So consider shopping your loan to CMBS lenders and life-insurance companies. Unfortunately, many of these lenders are not available at the retail level and require an intermediary such as a mortgage broker to access these capital sources.
Recourse vs. Nonrecourse
The vast majority of local and regional banks require a personal guarantee on part or the entirety of the loan. If the loan is low-leverage in nature (less than 60 percent loan to value), this may not be much of a concern for borrowers. However, as lenders venture farther up the capital stack, the scenario whereby a borrower is financially responsible for any losses becomes more likely. Recourse loans allow lenders to go after your personal assets if they’re not made whole on their loan.
This is oftentimes the biggest benefit in pursuing non-bank financing. Both CMBS and life-insurance lenders lend on a nonrecourse basis. This means if the local factory shuts down and half of your tenants vacate, you lose the real estate and nothing more. They cannot come after your personal assets. Because of this, CMBS and life companies put more effort into understanding the real estate during the due diligence process and less emphasis on underwriting the borrower. This is beneficial for borrowers who, for example, have a history of givebacks. If the property has a record of strong cash flow, CMBS and life-company lenders can move past the givebacks and lend at near market rates and terms.
The Cost of Comfort
There’s a certain level of comfort that comes with dealing with your local lender. You can sit down face to face over lunch and discuss your loan. You can shake his hand and look him in the eye and trust that he’s giving you his best rate. The reality is you pay for that comfort.
In today’s world, there are a diverse set of lenders that have very different motivations for lending. Some lenders have large fixed costs and are volume-driven. These lenders are less concerned with maximizing profit margins on each loan. Others want to diversify their geographic concentration of loans and look to other states for opportunities to lend. The point is, if you focus exclusively on one or two local lenders, you’re likely leaving a lot of money on the table.
Some of the non-retail lenders, such as CMBS lenders and life-insurance companies, are not available on a direct basis. They work through mortgage brokers to filter out loans that don’t fit into their “box” and, therefore, save time and money by only dealing with real estate in which they can lend. For example, these lenders generally have a loan floor of $1.5 million and generally only lend on real estate in primary and secondary markets. Some will get aggressive on leverage while others are more risk-averse but offer lower rates. For this reason, it may be worth working through a mortgage broker to ensure you’re getting the very best rates and terms in the market, all the while freeing up your time to focus on your job—operating your self-storage facility.
Casey McGrath is an associate vice president with The BSC Group, where he provides anal ytical support and mortgage brokerage solutions for a diverse set of self-storage clients. To reach him, call 312.878.7561; email firstname.lastname@example.org ; visit www.thebscgroup.com .