Show Me the Money

R.K. Kliebenstein Comments
Posted in Articles, Finance
Show Me the Money

By R.K. Kliebenstein

Several types of loans and financing options exist for self-storage development. This article will outline a few of the most common types as well as offer some alternatives.

New Development Construction Loan

This is most easily issued by a local or regional lender with whom the developer is an existing client. These are often "relationship" loans. The strength of the deal depends greatly on the ability and performance (track record) of the borrower than on the property. Gerald "Jerry" Buck of Huntington Bank in Cleveland, Ohio, says the best place to look for construction financing is to start with your relationship bank. "If they are not interested in the loan, they can often tell you the banks in the market that are active in (self-storage) lending. And do not stop when you have one lender interested. A limited amount of competition is good." However, when too many lenders get involved, they become discouraged, and they spend their time pursuing easier transactions, he adds.

Permanent loans are now being offered to self-storage
owners at very aggressive interest rates, long loan
terms and long amortization periods.

Forward Commitment. Accord-ing to Eric Snyder of Belgravia Capital, "The self-storage industry is becoming increasingly competitive and lenders are requiring developers to engage in extensive research prior to providing forward commitments." This transaction commits the permanent lender to provide a "take-out" (see below) loan upon the achievement of an agreed-on criteria. The achievement of a specific occupancy (percentage) or level of Net Operating Income (dollar amount) predicts the take out. The risk level is very high if conditions for a take-out are not agreed upon.

The take-out loan will be highly speculative if the lender is willing to state the loan will close on a certain date. A forward commitment under those circumstances would likely be a relationship loan, as previously discussed. There is usually a 1 percent to 3 percent fee for this type of commitment.

Read the loan documentation carefully, paying attention to the terms and conditions agreed upon at the issue of the forward. A developer may be willing to make commitments to get the deal done that he would later regret, especially if market conditions change to the benefit of the lender.

Take-out Loan. This moderate- to high-risk vehicle for finance is prepared at the time the property has neared stabilization or a distinct trend has developed that the lender can underwrite. The loan pays off the construction or "mini-per," and is customarily referred to as a "perm" or "permanent loan." This credit facility is typically long term and contains prepayment penalties and/or yields maintenance. "These loans are based on the operating strength of the property," says Neal Gussis of First Security Commercial. "Many (borrowers) utilize this vehicle to achieve several objectives. Many construction lenders have limited funds available for a single borrower. Refinancing with another lender allows the construction lender to have the funding capacity for the next project."

"People also seek to replace the construction or mini-perm with a permanent loan to obtain some or all of their initial equity in the project," he continues. "A company can allow its clients to borrow in excess of the initial cost if the property's cash flow meets our required debt-service coverage. Many permanent loans also reduce the property owner's personal obligation (recourse). Because of the presence of national lenders specializing in self-storage, including First Security Commercial Mortgage, permanent loans are now being offered to self-storage owners at very aggressive interest rates, long loan terms and long amortization periods."

Mini-perm. This is often a combination of a construction loan and a take-out loan. The term varies from three to five years, but basically gives a developer enough time to complete construction and stabilize income. It can often "roll-over" into a permanent loan, and is commonly issued by regional banks.

Refinance Existing Property to Extract Equity. This is an excellent tool by which to develop new properties, if the option is available. By refinancing an existing property and taking out the equity, you may be able to pay for the new project without finance costs to the project. Make certain if you have differing entities for the new and old project that an equitable arrangement is made to pay for the access to capital. See "refinance" for a description of this type of credit.

Construction Partners. How about asking each of your suppliers and sub-contractors to invest their goods and services as a contribution toward the project for partial ownership? This could be a very complicated and difficult method of financing, but it is creative and has proven to be a successful, non-traditional financing method.

Equity Partner or Contractor Partner. This is a fairly common method of financing. If you are a contractor and can contribute to the construction, but lack the land or development expertise, then you have solved one-third of the challenge. Perhaps you have an equity partner willing to invest cash to build the facility with the prospect of a more traditional form of permanent financing.

Development Partners. Several of the large real-estate investment trust's offer joint-venture development programs with a combination of equity and debt financing. These tend to be very deal-specific transactions and can often have constraints that would not give the developer "free reign" or total control over the project. This can be a very inexpensive way to access capital and can be a "marriage made in heaven" for the right partners.

Existing Facility Finance Options

Refinance- or Purchase-money Loans. At such times that loans have matured, or to recapture equity in an on-going existing facility, the most common credit facility is the typical refinance--loan structure based on cash flow. This loan is of low-risk and generally carries the most favorable of rates and terms. Typically, these are long-term, low-cost, "cash out" transactions and are readily available from national lenders (conduits), such as First Security Commercial Mortgage, Belgravia Mortgage Capital and some investment banking (securities) firms such as Bear Sterns or CS First Boston. Local banks may also offer a refinance or purchase money transaction, although the local bank may require a personal guarantee (recourse) and/or additional collateral. Bank loans may not have the significant payment penalties--a very attractive feature for some investors.

If you are a contractor and can contribute to the construction,
but lack the land or development expertise, then you have solved
one-third of the challenge.

Hard-money Loans. If the debtor has had credit problems, it may be necessary to obtain financing from a hard-money lender. The term "hard money" is suitable because it is usually hard to pay back. Typically, based on the value of the property more than any other factor, these loans will carry interest rates 5 percent to 10 percent above market rates. Oftentimes, the hard-money loan is a precursor to a sale that takes place as the result of a deed instead of foreclosure. A loan broker arranges the hard-money loan, which is usually a last resort when all conventional financing methods are exhausted.

Less Conventional Sources

Syndication. The tool of choice in the 1970s and 1980s was pre'TRA '86. This involves the grouping together of individual investors and having them fund the transaction. This is a difficult method for novices or developers looking for an income stream. Typically, the syndicate makes money on the front and back ends of the deal, and usually returns in the form of disbursements (dividends) the cash flows. There used to be tax advantages for offering passive investors this type of transaction, but those days are gone. Syndications often involve high legal fees at the time of solicitation (as compared to more conventional lending), but are still generally less expensive than bank or conduit loans. The level of fees to the investor may be high to very high.

Seek legal counsel when considering any non-conventional
source of financing, and if the source is not well-known,
investigate the origin of the funds, as well.

Securitization. This method is generally only available at very large dollar amounts, unless several deals are being secured at one time, in the range of $50 million-$100 million. They are very expensive up front, and usually carry all of the provisions of a typical conduit loan. In fact, it is identical to the conduit loan, with the exception of the source of origination. The debtor receives some fee savings because of economies of scale. Rates are sensitive to the bond market, usually tied to Treasury bond rates.

Public Offerings. This method is strictly limited to only the largest of deals, and only makes sense as the deal size gets close to $250 million. They are available through brokerage (stock market) firms and are very expensive up front--not so much as a percentage of the total transaction, but they can cost a lot of money, with no guarantee the deal will close. The funding is highly volatile depending upon the stock market, and requires extremely strong debtors with high growth aspirations.

Uncle Bob and Aunt Tillie. Yes, relatives can serve as a source of capital. I firmly believe that family and friend connections to capital are one of the least explored and greatest resources for capital. All things being equal, this is usually the least expensive and most easily approved methods of financing. There may be an emotional price to pay, not quantified in currency.

The following chart gives a matrix of financing alternatives and some key points. By juxtaposing the terms and types, one can identify the type of financing that may best suit their needs. Borrowers are encouraged to always get a second opinion and "shop" their financing options. Once the lender has made an offer, it is not proper to disclose those terms to a competitive lender and try to bid one against the other.

Borrowers should always attempt to negotiate with the lender. Perhaps up-front costs can be reduced or interest rates shaved slightly. It does not hurt to ask. Seek legal counsel when considering any non-conventional source of financing, and if the source is not well-known, investigate the origin of the funds, as well.

R.K. Kliebenstein is the director of acquisitions for The Amsdell Companies of Cleveland. Prior to his current assignment, he worked for Westar Management in Las Vegas, where he was responsible for new-store marketing. His tenure in real estate dates back to 1979, with a focus on self-storage since 1990. Mr. Kliebenstein may be reached at (800) 234-4494, ext. 227.

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