Become a professional borrower by using financing to your advantage. How? Properly leverage your existing asset, using the current property value to receive the highest return on equity. In doing so, you can maximize your investment and create additional value.
Leverage is the key to maximizing return. Think about a car jack: This simple tool provides the leverage you need to lift your car, an almost impossible feat to achieve on your own. Similarly, you can use your existing capital to finance a self-storage or other investment. You can certainly use cash to acquire, build or expand a property, but thats like lifting a car without a jackpossible but extremely difficult. In essence, financing is like the jack. It enables you to get more out of your assets.
By using financing as a leveraging tool, you can tap into existing equity and put it to better use on other investments, building wealth. You accomplish this by obtaining a loan worth 75 percent to 80 percent of the value of the property.
The value of a self-storage facility is determined by the net operating income (NOI) derived from the property, or rather, how much someone is willing to pay for that income. NOI is simply the total income minus total expenses (excluding principal and interest payments, depreciation and amortization).
If the facilitys net income is $150,000 and the buyer pays $1.5 million, the buyer receives a 10 percent return on his investment (also known as paying a 10 capitalization rate for the property). Cap rates vary for reasons such as regional economics, property types, location, occupancy level and age of the property. You want to increase the value of your property by increasing revenue and lowering expenses, creating a higher NOI.
The equity growth in a property is derived from the pay down of the loan balance and the increase in net income. The latter is a function of increased rental rates or occupancy, which gives you higher revenue. As the equity in the property increases, the return on equity actually decreases. This is because you have more money invested in the property and, therefore, more money at risk (i.e., initial cash investment plus added value in investment equals current equity in investment).
After a facility reaches a stabilized occupancy level (somewhere between 80 percent and 90 percent), theres a significant amount of equity just sitting there trapped in the property. This equity can be used to fund expansions, purchase another property or pay for large capital improvements. You want to limit the amount of equity in any one project to a range of 20 percent to 25 percent of the property value. To do this, youll refinance the property, pulling out the excess trapped equity.
Back to Leverage
Leverage the value of the property to maximize the return on equity. When shopping for financing options, look for the following:
- A low fixed-rate loan
- A 25- or 30-year amortization period
- A 10-year balloon term
- Financing that is secured by the property only and not your personal assets (non-recourse)
- A loan that will allow you to pull cash out when refinancing up to 80 percent of the value of the property
When refinancing a self-storage facility or any commercial real estate, evaluate all of the financing options available. This is the easiest way for you, as a professional borrower, to prevent cash-flow loss and create value.
Matt Lexow-Gray is a senior loan originator with S&W Capital and Realty, a boutique commercial mortgage-brokerage firm that strives to find solutions for borrowers financing needs. For more information, call 888.525.9081; e-mail [email protected]; visit www.sandwcapital.com.