Finding Self-Storage Construction Lending
Copyright 2014 by Virgo Publishing.
By: Richard Hill Adams
Posted on: 11/09/2008



 

Today, the fastest and safest answer from your friendly banker is, “No.”

No, you don’t have enough equity in the deal.

No, we don’t care how long you owned the land; the entitlements you secured are not worth what they were worth last year, and other people are selling similar types of property at significant discounts to your alleged value.

No, you need a larger financial statement with a greater amount of liquidity to cover any potential cost overruns in your new project.

The lending community—from national to local banks, savings and loans to credit companies and other providers of credit—has serious concerns about today’s real estate market. Regulators are struggling with the worst credit market we’ve seen in decades amid serious questions about the soundness of the financial institutions in the United States.

How do we change a no to a yes? The answer is by understanding what the lender needs to make your transaction work. Currently, construction lenders are few and far between. Many are out of the market temporarily; some will be out longer. Construction loan transactions need to be underwritten and documented to comply with what the lender is going to need, not what the borrower wants.

Interest Rates

We see construction lenders that are still in the market and transactions based on interest rates floating over Wall Street Journal Prime, or alternatively, interest rates floating over LIBOR (London Inter Bank Offered Rate). The margins over the index range from prime plus .50 basis points to 30 day LIBOR plus 350 basis points. This provides an interest rate for your construction loan at 5.5 percent, based on prime plus a half of one percent and 5.9 percent based on LIBOR plus 350 base points.

Underwriting the Risk

Underwriting is considerably more conservative; lenders want more skin in the game. The loan-to-value would be a maximum of 75 percent of the future value based on a stabilized project. The loan to cost would be in the range of 75 percent, which requires the developer to invest 25 percent of the total project cost in hard cash. Lenders do not take into account imputed equity in new construction financing.

The real determination in the construction lender’s opinion is when the loan matures will there be permanent loans available for this project? Or will the construction lender provide a mini-perm for a one- to three-year term? This facet of the underwriting is very subjective in the current market.

Construction lenders are looking at their own internal mini-perm rates at 7 to 7.5 percent, using a 1.35:1 debt-coverage ratio based on a 25- to 30-year amortization schedule to underwrite the amount of money the project is capable of supporting for a permanent mortgage. This permanent loan amount would also be the maximum construction loan offered.

While this sounds good, when you take a look at the real estate market for storage facilities, the cap rates for existing storage facilities sold in the last 12 months may be 6 percent in any given market. The lender is adding 100 basis points to the cap rate and calculating value from net operating income based upon a 7 percent cap rate, even though the current market might reflect a 6 percent cap rate. The lenders are concerned the Federal Reserve Board will increase interest rates at some point next year. Cap rates will also increase for all classes of income-producing real estate assets.

Support Your Loan Request

No matter how good you think your project is, the lender cannot see it through your eyes. You need to supply as much support as possible to convince your lender to deliver an acceptable construction loan. A professional feasibility study from a well-recognized company in the industry will be beneficial to show the lender your project has merit. This feasibility study should cover your market area, potential rental rates, existing competition and projected competition. This information can be obtained from the city and county planning departments. These proposed projects could conceivably compete with your venture, if and when they are built.

For the most part, appraisals are ordered by the construction lender processing your construction loan. Most construction-loan borrowers do not invest the money to have an appraisal completed prior to going to the bank. A solid appraisal from a recognized appraisal company would provide a significant amount of information to your lender. It can help the lender underwrite your transaction, and could make the difference between you receiving a letter of intent for your construction loan or not.

Build the Right Team

In the storage industry, there are the behemoth publicly traded companies, which are national in scope, and then the rest of the owners, which are not as large. In today’s market, the construction lender is very concerned about the track record of the developer and the builder of the project. Lenders want developers with solid track records, successful development experience and long histories of self-storage property management. So, if this is not you, what do you do? You build a team.

Align yourself with a successful builder who has experience building this product, has excellent references and a solid financial statement. The lenders want to know your builder is substantial and can afford to run operations and pay employees during construction while waiting for the loan draws to be advanced to pay his invoices on your project.

The marketing and management for your project can be undertaken by a professional management company that can assist you in taking your new project from construction completion to full occupancy in the shortest amount of time.

If you are not comfortable presenting your business plan and financial package to the lender, you would be well advised to seek professional assistance from a loan broker who has strong relationships with the lending community. These are the people who know who is in the market and can assist you in the professional presentation of you loan request. Think about this: You can hire better qualified talent in five minutes than you can become in the next five years.

Permanent Lending

Permanent loans are typically written with 65 to75 percent loan-to-value ratios, with debt coverage ratios of 1.25:1 to 1.35:1, and will use the lenders capitalization rate, which may be 75 to 100 basis points higher than the prevailing cap rate on existing projects sold in the current market. Permanent lenders are focused on the management of your facility. The credit committees are concerned about the experience of your management.

Permanent lenders want you to have skin in the game and a minimum of 15 percent, hard cash equity left in your project after you’ve refinanced your construction loan. They’re looking for stabilized properties—12 to 24 months of trailing income and expense information—proving this project is successful, profitable and well-managed. To stabilize your property you need to operate at a 90 percent occupancy level over this time period.

The permanent lenders will underwrite the cash flow of your property, and in the case of life insurance companies, can provide you with non-recourse financing. Interest rates vary dependent upon the term of the loan requested. Currently, we have lenders providing 6.25 percent interest rates for three-year loan terms, 6.5 percent for five years, 6.75 for seven years and 7.25 percent for 10-year loans. These are fixed rates with the majority having either a prepayment penalty or a yield-maintenance requirement, as is the case for the life insurance industry. There are some lenders that will provide long-term fixed-rate financing without prepayment penalties.

Face to Face

Identify the best potential construction lenders in your market, find the highest ranking bank officer in the real estate lending group you can meet with and arrange a meeting to present your transaction. A loan transaction, properly packaged with the required documentation for the lender, including site and aerial photographs and a good narrative description of your transaction will allow you the best opportunity to make a good first impression. Although the Internet is good for e-mail and sending additional information to your lender, it should not be the medium of choice for submitting your loan.

Remember lenders are people who operate in a very stressful environment. Everything you can do to provide a well-documented transaction will make life easier for the lender and, hopefully, faster for you to receive an approval for your new construction loan.

Richard Hill Adams is chairman & CEO of American Realty Capital Advisors Inc., a Laguna Hills, Calif., company providing financing for land acquisition, debt and equity loans and construction loans for self-storage and mixed-use projects. To reach him, call 949.455.4100; visit www.arca-money.com.