State of the Self-Storage Industry 2010, Part II: Finance and Construction
|Copyright 2014 by Virgo Publishing.|
|By: Amy Campbell|
|Posted on: 01/19/2010|
New construction was one of the biggest victims of the recession. After several years of rapid development—commercial and residential—the financial crisis brought construction to an abrupt halt. As financing dried up, developers were unable to fund new projects. In addition, there was a surplus of new houses and commercial buildings. Many remain empty today.
The self-storage industry, which had been in a rapid-build phase for nearly a decade, was impacted by not only the lack of funding, but also by over building in some cities. Where once a handful of facilities dominated a particular market, there were now a dozen.
Yet there are still markets around the country that are under served, and available land ready for self-storage development. The biggest hurdle now is obtaining financing. New projects backed by solid investors in well-located areas are more likely to receive funding. Likewise, existing properties that have shown consistent occupancy numbers and good returns will also find more favor when refinancing.
In this second of a three-part series, Inside Self-Storage asked experts in real estate, finance and development for their insight to today’s market. Our panel discusses how the economy has impacted construction and development, refinancing and cap rates, and what’s on the horizon. Our finance experts are:
Weighing in on the construction side are:
What is the state of today's self-storage financing environment?
Adams: Self-storage financing is becoming more difficult, in part due to the increase in capitalization rates. To exacerbate the problem, many lenders categorize self-storage as a single-purpose loan. The banking regulators also provide lending constraints on this type of product, which limits the amount of capital available to the industry.
New-project permanent financing requires greater leaseup and longer stabilized income to provide cash flow that will support the higher debt-coverage ratios lenders are looking for in today’s market. As we have seen in many parts of the country, real estate projects are under stress. Rents are lower, and owners will reduce the rental rate to maintain a project’s occupancy. The good news is the tenants stay; the bad news is they pay less money and cash flow goes down.
In addition to underwriting the property fundamentals, lenders are also focused on the borrower's global cash flow, which includes an underwriting of any other properties the sponsor has an interest in to be sure those are performing as well. There is limited non-recourse capital available; most loans require at lease some level of personal guarantee.
Banks continue to ask for deposits at times to counter “naked lending” on commercial properties. Commercial mortgage-backed security (CMBS) loans remains out of reach. Some life-insurance companies are coming back online but tend to focus on other property types. Cap rates are still trending higher.
Adams: The old adage, “Do not put off until tomorrow what you can do today” applies to refinancing your project. If you have CMBS financing and have a loan coming due, you’d better be out there looking to replace that loan as expeditiously as possible. The lender that funded your last transaction probably doesn’t exist to fund the refinancing of your property.
The aberration we saw where the cap rates fell through the floor in 2005 and 2006 will not be repeated in the near future. Cap rates today are increasing across the board as investors demand a greater return for taking a real estate risk with their investments.
If you get a proposal in hand that works with a lender you can trust, execute the transaction. Do not get greedy. Certainty of execution is paramount, and trying to gamble on an unknown entity under the allure of a more aggressive deal, or to save a few basis points in interest rate, is simply not worth the risk.
Remember, we’re in a capital-constrained environment with many deals chasing the limited dollars available, and it all boils down to your basic beauty contest. Make sure you pull out all the stops to look as good as possible before the big show. If this is not something you feel you can accomplish by yourself, hire a qualified professional to assist you—it will save you time, money and, most likely, frustration in the long run.
Adams: New construction is at a virtual standstill in most markets. The only new-development financing available in the near future will be for projects that have excellent economics, which will be created by strong capital contributions from experienced operators with strong balance sheets.
While it’s not a federal banking requirement to have a feasibility study, smart lenders will require a more in-depth analysis of your project. Remember, the real estate lending debacle has not just been subprime home loan borrowers, but commercial real estate development providing more capacity than the market was capable of absorbing.
If you’re looking for new development-type returns but are having trouble finding a construction loan for a new project, consider shifting gears and looking for a distressed development deal that already exists. Under this scenario, you may be able to motivate the lender by acting in concert with them. You’ll assume some level of existing (likely modified) debt that’s already in place and contribute new equity to help “right size” the deal, creating an opportunity for yourself and helping the lender solve a problem at the same time.
Adams: As we move into 2010, the real estate market for new housing should begin to improve. Inventory levels are down, and home builders have built few new homes over the last several years. This improvement will have a positive impact on the self-storage market and significant benefits to the banks by helping to eliminate their real estate owned (REO) portfolios.
A significant number of banking institutions were poised to write off all the bad real estate in their portfolios by the end of 2009. Hopefully this internal cleaning of the books will allow new loan allocations, which will benefit the self-storage industry. Make no mistake about it―your project will have to be well-underwritten with significant equity contributions from the sponsors and strong balance sheets to get your project financed.
This year will likely be challenging for real estate financing, as the capital markets for securitized lending products attempt to regain some traction, and the major burden for real estate capital is placed on bank and insurance company balance sheets. Simply put, there’s just not enough capital available at the bank level to refinance all the upcoming maturities, not to mention the loans that have already matured this year and extended one or two years. Banks will likely become more aggressive in foreclosing on properties that are not performing and do not service debt if the sponsor cannot re-capitalize the deal.
The outlook for our industry in the long term is promising under the theory that self-storage loan performance will have, once again, proven itself during this recession. The lending community will gain additional comfort with the performance of the asset class as a result of this recession.
Campbell: Slow. People are either afraid to make the commitment due to the economy or, if they do want to build or expand, financing seems to be one of their biggest hurdles. If they’re able to get financing, the terms are favorable.
Campbell: Financing seems to be the biggest hurdle from the builders and developers we talk to.
Barry: There are many fully approved sites for self-storage on the market today. The lack of development financing has virtually closed this market for the time being. For the same reasons, we suspect fewer investors will begin the land-development process until some of this supply clears the market.
Buyers and sellers can also look to potentially softened hearts at the municipal level as well. As tax bases drop with declining values and development continues to be absent, cities and towns may become more open to development, which leads to employment, a property-tax base and, in some venues, gross-receipts taxes. Municipalities are cutting back on expenses like salaries to meet declining budgets, and eventually, that may equate to relaxing some restrictions on building and development as they look for ways to generate revenue.
Campbell: It will to a degree. There has to be a happy medium there, a return that’s acceptable. For example, solar panels are not cheap, so there has to be a realistic return on investment that will make it feasible for the builder. Insulation R-values and similar things will play a bigger role. Most everyone would like to be greener, but unless there’s a payback, most aren’t going to be green just for the sake of being green.
Barry: It’s typically less expensive to convert a building to self-storage than build from scratch, plus there will be plenty of properties that may be acquired at deep discounts. I would expect to see this segment be one of the first areas developers seek out when financing improves, especially in urban areas.
What does the future hold for self-storage development?
Campbell: That’s a great question. Between fears of the economy, lack of financing and steel prices that keep changing, it’s anybody’s guess. But we are being optimistic and doing everything we can to find and work with anyone who’s willing and able to build. The ones who build now will have a leg up once things turn around.
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