Self-Storage State of the Industry 2011: Financing, Construction and Development
|Copyright 2014 by Virgo Publishing.|
|By: Amy Campbell|
|Posted on: 01/26/2011|
After two years of little to no activity in the self-storage financing market, 2011 may be the turnaround year for the industry. With more funds in the pipeline, will we see a resurgence of new development and construction?
In recent years, financing has been a challenge, both for existing self-storage owners looking to refinance their loans as well as those wishing to build new projects. Developers who were ready to build suddenly found their funding resources dry up. In addition, a decade-long rapid-build phase had led to overbuilt markets, giving lenders yet another reason to pull the plug on self-storage lending.
However, there are still underserved markets around the country and available land ripe for self-storage development. Plus, the recession left behind hundreds of empty commercial buildings that are ideal for conversions. This year, lenders are returning their focus to proven borrowers with solid backing, and once again considering loans for an industry that has proven to be resilient.
One of the brightest rays of hope is the industry’s new eligibility status for Small Business Administration (SBA) loans. While it’s too soon to evaluate what affect this will have on the overall market, the announcement alone has the industry buzzing. CMBS (commercial mortgage-backed securities) loans are also creeping back into the self-storage lending arena. Real estate investment trust Extra Space Storage recently obtained an $82.2 million CMBS loan from Bank of America/Merrill Lynch.
In this second of a three-part series, Inside Self-Storage asked experts in industry finance, construction and development for their insight to today’s market. Our panel discusses new lending options, how the economy has impacted construction and development, refinancing, and what’s on the horizon. Our experts are:
What’s the state of today’s self-storage financing environment?
Hill: The financing market has improved throughout 2010 and should only continue to improve with time. Lenders are trying to close out their 2010 deals and starting to turn their attention to 2011, and there’s excitement and rumblings about new loan programs and capital sources that should be coming (back) into the market over the next year.
A lot of the lenders who came back into the market in 2010 were mainly focused on larger transactions and cleaning up their books. The expectation is that over time, loan amounts will come down and loan-to-value (LTV) will begin to creep up as competition for deals increases.
There’s also a lot of excitement, obviously, about SBA coming into the storage market. We expect to see more meaningful volume in this sector as lenders and the SBA start to figure that out. We’re not completely out of the woods yet as there are still bank failures expected in 2011, but things are markedly improved from this time two years and really even one year ago.
Ragsdale: The state of financing for self-storage has stabilized considerably after the deterioration, which continued into the middle of 2009. The state of general availability for funds remains heavily dependent on large and regional commercial banks, and some credit unions. Banks that don’t have a strong knowledge of self-storage still tend to shy away from making these loans. Some limited insurance portfolio lending is coming back online, which is attractive to corporate borrowers with stable class-A properties with low leverage.
Banks are still relying upon a “global cash flow” analysis when they look at a borrower, and favor borrowers with multiple sources of repayment and income. Interest rates remain low and generally attractive despite the lower leverage. Generally, a borrower can expect 65 percent LTV, 20- to 25-year amortization, and interest rates from 6 percent to 7 percent, with some opportunity for lower rates.
Sonne: The lending environment has improved significantly for self-storage in 2010. The year started off with limited capital available and has improved steadily. Now, banks and life insurance companies are lending at some of the lowest rates in years. There are even CMBS lenders back in the game. Interest rates range from 5 percent to 6 percent—great, low rates—and LTV is typically at 65 percent, up to 72 percent.
However good this is for the industry, it does not universally apply. Sponsorship (or the lender) must be very strong with a solid balance sheet, and this financing mostly applies to properties that have a stable operating history.
How will the new SBA loans change lending for this industry?
Hill: As of the time of this writing in December, the SBA programs for storage are pretty new, and the players involved are mostly trying to get their arms around the nuances of these transactions. The expectation is this will happen in the first half of 2011. At that point, these programs should become a viable source of capital for smaller (less than $5 million) transactions.
By nature, the SBA favors deals where the owner is heavily involved in the business, so this should be a great source of capital for transactions where the business is the borrower’s primary source of income. This is an area that has been somewhat undeserved by banks during the recovery because often times the risk in these deals is perceived to be higher.
Finally, in deals where there’s strong cash flow, but maybe a bit of an LTV mismatch relative to many lenders stated requirements (i.e.: a maximum 70 percent LTV), the SBA programs should present a good fit as they will allow some flexibility to climb up the leverage ladder.
Ragsdale: SBA loans will have a favorable impact on the smaller borrowers who qualify for this type of funding. The program is just now getting off the ground, so in a few months everyone will know a great deal more about exactly what and what will not be approved for SBA. We can understand the guidelines, but the devil is in the details.
Bankers are also adjusting to this program. Some remain uncomfortable with the property type and don’t wish to include storage in their SBA portfolio, while others see this as an opportunity to write solid commercial property loans. This is a great help to smaller regional banks that can write a smaller loan for local storage operators with support from the SBA.
Sonne: It sounds exciting, but until some deals are actually completed, we will not know the impact.
What’s your advice for operators looking to refinance this year or next?
Hill: If you have a near-term refinance coming and don't want any surprises, start the process early and make sure you’re well-prepared. By talking to a few lenders or mortgage professionals, you can get a pretty good idea about how things are looking and what reaction you can expect from the market, and still have ample time to make adjustments or alternative arrangements if necessary.
It’s advisable to make sure your books are clean and orderly, and any deferred maintenance or other types of issues have been addressed at the property. Also, don't get greedy. If you’re presented with a deal that seems reasonable and brings a high level of certainty of execution, then execute and move on.
Ragsdale: Absolutely take a look at refinancing options while the rates are very low. That will have a big impact on cash flow.
Sonne: Make sure your balance sheet is strong. Lenders will look at the trailing 12 months of operating statements benchmarked to the trailing three years. If a sponsor doesn’t have a strong relationship with a lender, use a solid mortgage broker experienced in the self-storage asset class. Interest rates are low, but deals are not easy to complete.
What’s your advice for people seeking money for new development? Is it available, and how do they get it?
Hill: With few exceptions, this market remains challenged and the development financing climate is not favorable. There are many distressed opportunities out there that still need to be addressed, and lenders are going to be focused on solving these problems before they’re willing to talk about starting new projects.
The interesting thing about the development dilemma is the problem sort of solves itself. If a proposed transaction and the associated return make sense under an intensive equity scenario, which is essentially what you’ll need to succeed in this environment, then that deal probably makes sense and can get done. Alternatively, deals that would rely heavily on leveraged debt to make sense probably don't get done today. In that respect, you could say that the capital markets are self-policing the development situation.
Ragsdale: New development remains very challenging. Most banks have stopped making any commercial development loans unless an ironclad credit-tenant is in place to fully lease the property upon certificate of occupancy. Building storage remains especially difficult due to the longer leaseup time for the property. Many areas were overbuilt during the late 2000s and that’s still being absorbed.
The old adage holds regarding new development: Cash is king! Have plenty of it and seek a relationship with a local bank.
What does the future hold for self-storage financing?
Hill: The future for self-storage financing is bright and should only continue to improve. Self-storage has performed well throughout the downturn relative to other property types, and as lenders digest the performance, their appetite and willingness to lend in the sector should only grow with time. As more sources of capital come into the market, competition for deals will increase, and past history suggests this will lead to more competitive terms, which is great for borrowers.
Finally, until we see some very meaningful increases in jobs recovery, interest rates should remain low. The combination of these factors should lead to a nice lending window in the near term for borrowers.
Ragsdale: As CMBS loans come back online, albeit with a more practical loan product than we saw just before the financial collapse, it will take some pressure off of commercial lenders. SBA will also take a good deal of pressure off lenders and allow for common sense smaller loans with good rates.
The storage industry continues to improve in its sophistication thanks to the hard-working professionals in the industry, and this will continue to help lenders move funds into self-storage loans.
Sonne: Financing for assets will continue to improve in 2011 if interest rates hold steady. In general, the market for self-storage has improved in 2010 and the worst of the recession is over for this asset class.
What’s the state of self-storage new construction now?
Campbell: It’s primarily a financing problem. While there has been a loosening of available financing with the recent SBA’s loan program, particularly their SBA 7(a) loans for add-ons or refinancing, which offers 90 percent and up to $5 million, SBA 504 CDC loans for new construction and new sites will remain more difficult to acquire. So, until overall credit loosens, new construction loans will remain problematic. There’s also the factor of occupancies being stagnant or even dropping in some areas.
Fuhlman: Based on several 2010 publications, self-storage construction is estimated to be down 65 percent to 75 percent over the last two years. This lack of new, ground-up construction has been attributable primarily to restricted financing and the dramatic reduction in residential and multi-family development in most markets. There has been an uptick in conversions as a number of infill locations have a significant amount of properly located and zoned vacant existing space available.
Wright: New construction remains quite slow. However, over the past couple of months we have noticed a bit more interest, mostly from potential clients who own their land outright. These folks have a much stronger ability to maneuver through the very difficult task of obtaining financing.
What challenges do developers and builders face?
Campbell: The first challenge is finding the right location on which to build, particularly one that is underserved or has pent-up demand. The next biggest challenge continues to be finding available and adequate financing. Developers and builders still fall under the real estate umbrella and until the economy improves in this area, growth will continue to be stunted. This is why self-storage owners are looking at expansion of existing facilities, conversions and refurbishing as interim strategies until things improve with lending institutions.
Fuhlman: Developers continue to at least face the restricted financing and limited market growth issues. In addition, properly zoned and located self-storage vacant land has become more difficult to find. A number of developers have chosen to watch from the sidelines as messages from the federal government and general economy trends have been mixed at best.
Wright: The biggest challenge still remains the ability to obtain financing. That being said, the SBA recently changed its loan guidelines allowing self-storage business as an eligible business type. This has created a buzz in our industry and time will tell what impact it will really have.
Will green building and LEED play a bigger role in the future?
Campbell: No question about it. Most businesses across the board are becoming more aware that improving the environment is good business. For example, there are pre-painted building components that are a part of the Energy Star program, which means they’re covered with cool-metal coatings. In effect, these paints can help reduce energy costs because their surfaces can reflect up to 70 percent of solar heat, as opposed to only 20 percent reflected from surfaces with standard pigmentations and reduce interior temperatures as much as 46 degrees.
Fuhlman: Green building and LEED certification are always a positive aspect of any development. Unfortunately, significant subsidies are still generally required to make the additional expenses pencil out. I would expect green building to play a more significant role in the construction process as the technology improves, subsidies increase or utility costs increase.
What role will conversions play this year? What are the challenges?
Campbell: Once again, the lack of reasonable financing for new construction is forcing owners to look elsewhere to build their storage business. One of the alternatives is converting existing buildings into self-storage. Conversions have advantages that many new construction projects don’t have in terms of good retail locations, easy access and, in many cases, a larger customer base―as well as less money needed than with new construction, so long as the property is already acquired.
In some cases, one can get into the business faster by developing a conversion. The challenge is to make sure the upfitting doesn’t become cost-prohibitive, as a result of trying to convert a building that requires too many reparations that are too expensive.
Fuhlman: There’s a national trend toward the conversion of vacant infill buildings to self-storage. This trend is expected to continue. The speed of the overall economic recovery and the recovery of the specific asset classes will determine how much conversion activity takes place in the near future.
Wright: Conversions will remain to play a big role in our industry. With so many commercial and industrial building vacancies, conversions of existing buildings may be pencil out to be a good play within the marketplace. Pointing out the obvious, the construction costs in most cases will be less expensive—given that the slab and shell are already in place. In most cases, fire sprinklers and mechanical equipment also are in place.
What does the future hold for self-storage development this year?
Campbell: Recovery will be sluggish, but probably better than this time last year because other businesses are slowly starting to come back; and the duration of any recession has to do, in large part, with overall confidence on the part of businesses and consumers. Because of the poor economy in recent years, we’ve had to become more creative with our product line, with our marketing and with our overall approach to remaining competitive and successful. This will help us as well as others in the business going ahead as the economy improves.
Fuhlman: Ground-up development is expected to at least maintain its current pace in 2011. Many industry experts predict a significant increase in conversions as vacancies in many asset classes continue into 2011.
Wright: The future of self-storage still remains healthy. It’s safe to say that the market needed a correction, and a correction it got. Many current operators reading this would agree. That being said, self-storage development still continued in these very difficult economic times. That’s quite amazing when you think about it. This industry has proven its resilience, and life conditions dictate that people will continue to use self-storage.
Without a doubt, you need to do proper due diligence when thinking about developing a project. Be smart and consult with industry experts. Construction costs remain low; if you have the right site, this may be your time to take advantage of those low construction costs.
To learn more about the state of the self-storage industry, attend the Inside Self-Storage World Expo in Las Vegas, March 14-16. To register, visit www.insideselfstorageworldexpo.com.