What's Up With Permanent Financing?
|Copyright 2014 by Virgo Publishing.|
|By: David Smyle|
|Posted on: 11/01/2004|
“Unbelievable” is the only word to describe continued financing opportunities for self-storage and most other commercial-property types. To illustrate, the following chart shows a sample of long- and short-term index rates over the last 10 years.
Today’s rates are still near the historical lows of 2002-2003, but they are creeping up. Even so, overall rates for adjustable loans are still generally in the 4 percent to 6 percent range, with five-year fixed rates in the 5 percent to 6.25 percent range and 10-year fixed rates in the 5.5 percent to 7 percent range. The lowest rates are still being offered by the conduit and insurance-company lending market, with banks, savings and loans (S&Ls) and credit unions (CUs) trailing by at least .5 percent, although offering more flexibility and lower costs.
This year continues to be an incredible time to buy or refinance properties. The Fed has raised rates twice in the last few months, and the short-term money indexes have increased as a result. But rates are not expected to increase significantly (more than 1 percent) in the next six to 12 months as we approach the election, and continue to reflect slow but steady improvement in the economy and job market. Those not looking to procure permanent financing for two to three years will likely see rates better than those from five to 10 years ago but higher than today’s.
The majority of self-storage financing continues to come from the traditional institutional lenders such as banks, with S&Ls and even CUs continuing to make inroads into the financing arena. The reason most borrowers choose their local bank is due to relationships, flexibility and lower costs. Many banks offer up to 80 percent loan-to-value (LTV), but may shorten the amortization to compensate. Additionally, they will often require only an appraisal and possibly an environmental report, but will have few if any other miscellaneous and legal fees, which are prevalent in the conduit- and insurance-lending market.
Banks are generally more accommodating with respect to prepayment-penalty language, acceptance of secondary financing, additional advances for expansion and quick closings. The main drawback to bank financing is the lack of available long-term fixed rates, especially with longer amortization periods. Most banks will only fix terms for up to five years but may offer a 10-year total term. Those that do offer longer fixed rates generally prefer a shorter amortization and are not as aggressive as their conduit competitors.
The newest players on the block are CUs, which continue to expand their commercial programs on a local, regional and national basis. These lenders not only offer up to 20-year fixed rates, some with no prepay penalty, but are also aggressive with LTVs (75 percent) and amortizations (up to 30 years).
Another unique factor involved with CUs is the availability of national funds for borrowers in areas where local CUs may not be lending. CUs without commercial-lending programs often buy participation in loans made by others that have the expertise. While the local CU does not directly originate the loan, it is still involved as the entity that qualifies the borrower for financing.
Charters usually require CUs to only lend funds to members who live, work or worship in the local area, or employees and alumni of various organizations, educational institutions or governmental agencies. Since a borrower may not qualify for membership in the CU actually funding the loan, especially if it is out of state, the local CU satisfies the relationship requirement and may buy a small or large piece of the loan being funded.
Savings and Loans
S&Ls can combine the best of banks and credit unions, in many cases by offering very competitive short- and long-term fixed rates with easier prepayment language than conduits and longer amortizations than banks. Many also offer nationwide lending programs and even nonrecourse loans for those concerned about personal liability. One of the national S&Ls offers up to 15-year fixed rates, upfront rate locksand adjustable rates below 5 percent. It even has programs that allow you to convert from an adjustable to a fixed rate during the loan term at no extra cost.
In today’s self-storage financing market, most of the long-term (10 years or longer), fixed-rate financing is provided by the Wall Street “conduit” market. These loans are pooled together, packaged and sold by Wall Street firms as commercial mortgage backed securities to investors. While they offer attractive rates (5.5 percent to 6.25 percent, depending on loan size, LTV and debt coverage), qualifying for these loans is often more difficult, especially for properties with less-than-stabilized occupancy and those coming out of construction.
As a general rule, the conduit market underwrites loans to a maximum 75 percent LTV, using the last trailing six to 12 months of cash flow—less late fees, interest income and RV income, in some cases. A property in lease-up may have stabilized occupancy (85 percent to 95 percent) but not enough cash flow over the last 12 months to qualify for higher LTV requests.
In addition to offering the lowest long-term, fixed rates around, the attraction of conduit loans is the “nonrecourse” nature of most programs. Nonrecourse means the lender can only go after a property in the event of default and foreclosure, protecting the borrower’s personal assets. These loans typically have stiff prepayment penalties tied to “yield maintenance” or “defeasance,” which can easily run six figures in the wrong interest-rate environment. They also impound for taxes, insurance and future-replacement reserves ($.15 per square foot per year) and require higher insurance coverage.
The costs to obtain conduit loans runs between $10,000 to $30,000, depending on the lender and whether you choose the “large” ($3 million-plus) or “small” ($500,000 to $3 million) loan program. These costs do not include the usual 1 percent loan-origination fee at closing.
Most conduit lenders charge a $2,500 to $5,000, upfront, nonrefundable application fee in addition to the third-party report deposit (for the appraisal, phase-I environmental site assessment, property-condition report, etc.), usually around $15,000. Lenders require an ALTA survey as well, which can run between $5,000 and $7,000. Under the large-loan program, you also incur lender’s legal fees between $7,000 and $10,000. The fees tend to be less under the small-loan program, typically capped at around $10,000 to $12,000, not including the survey but including legal.
All this being said, a 10-, 15- or 20-year term at fixed rates lower than 6 percent can be worth the upfront costs for long-term property holders. Ten-year loans carry up to a 25- to 30-year amortization, while periods exceeding 10 years are generally self-amortizing (e.g., 15-year fixed rate with 15-year amortization). Many lenders limit the amortization on metal buildings to 20 years vs. 25, but not in all cases.
Most conduit lenders prefer stabilized, well-located properties in metropolitan or high-traffic areas and construction of concrete block, brick or wood frame. Two-story facilities are generally not preferred unless drive-up access is provided. It takes about 60 days to close a conduit loan. Understand the loan terms, closing requirements (insurance, title endorsements, etc.) and informationchecklists, and try to get a sample copy of the conduit lender’s loan documents prior to laying out any upfront cash.
There are probably a dozen or more active conduit lenders, all with their own requirements. One may not have any legal fees and, in some cases, no need for a survey, but may be more conservative in loan dollars. Another may be more expensive but stretch the loan dollars. The key is to find the lender that most closely matches your investment strategy. Your mortgage banker/broker can be helpful in this area.
While borrowers can go directly to many of the conduit lenders to originate a loan without the use of a banker or broker, the process can be a difficult one, with lots of paperwork and red tape. An experienced professional can guide you through the process and let you know what to expect before you get started and along the way. His services will not necessarily cost additional funds, as most lenders will offer PAR or wholesale pricing to its broker/mortgage banker network.
Insurance-company lending is similar to conduit lending and rates but with easier underwriting criteria and paperwork requirements. However, it is much more conservative in loan dollars, preferring to be around 65 percent to 70 percent maximum LTV. Properties must usually be well-occupied, newer, well-located and of nonmetal construction. In effect, these lenders will cherry-pick and prefer shorter self-amortizing loans. Insurance companies also typically offer upfront rate-lock features.
Be proactive in your financing search by starting early. Lenders are very busy in the current interest-rate environment and closing times are lengthening. Don’t wait until 60 days prior to current loan maturity. Give yourself at least 90 days to search for and fund the loan program best suited to your needs. Lenders are flush with money to lend so get it while it’s hot.
David Smyle, president of La Mesa, Calif.-based Benchmark Financial, is a mortgage banker and 20-year veteran of the commercial-banking industry. His company offers financing solutions for self-storage, apartment and commercial properties nationwide through its direct-lending relationship with bond street capital as well as other institutional financing sources. For more information, call 877.862.7916, ext. 201;