Neil Gussis, senior vice president, First Security Commercial Mortgage
When we last caught up with Neal Gussis in the June 1995 issue of Inside Self-Storage, securitized lending was just beginning to make inroads in the self-storage industry by providing new, non-recourse, financing alternatives. Many self-storage owners and operators were completely unfamiliar with this form of property financing and were accustomed to only working with a local bank for their self-storage lending needs. Since then, securitized financing, as well as Mr. Gussis' firm, First Security Commercial Mortgage, have grown exponentially. Today, securitized lending--through a vehicle known as commercial mortgage backed securities (CMBS)--is a dominant force in commercial mortgage financing nationwide, including self-storage.
First Security Commercial Mortgage was among the first CMBS lenders to enter the self-storage marketplace. Mr. Gussis helped lead his firm's move into self-storage financing in 1993 and continues to direct a specialized team of originators, analysts, underwriters and closing professionals dedicated to the industry. First Security has grown since 1995 from one office to six, and now employs five times as many employees as it did four years ago.
Mr. Gussis serves as a senior vice president with the firm and is responsible for its self-storage financing programs. He was one of First Security's founding members and has an extensive background in real-estate financing.
We met with Mr. Gussis to gain his insights and reflections on changes in the self-storage industry and financing options available to owners.
What financing changes have you seen in self-storage since you became involved in it, specifically over the past five years and, more specifically, the past 6 months?
The changes in the past five years in self-storage financing have been nothing short of dramatic. Self-storage owners are no longer captive to their local bank for financing; they have a myriad of options for the type of loan and the lending source. We have seen self-storage financing become much more available, primarily due to the exposure that the REITS and national self-storage lending programs have provided the industry. A greater number of financing institutions understand the self-storage business than did five years ago.
Securitized, or conduit, lending has become a very popular financing vehicle because of its attractive long-term rates and non-recourse features. Statistics show that the total volume of commercial mortgages originated, pooled and issued as CMBS has grown from $19 billion in 1995 to more than $77 billion in 1998. That's dramatic growth and speaks volumes for the importance of this financing option.
In the past five years, interest rates have gone through a full cycle and now are on the next cycle. Through October 1998, interest rates continued to fall based on a combination of several beneficial factors including strong operating results of facilities, dropping indices (such as the U.S. Treasury yield, Prime and LIBOR), increased acceptance by lenders and investors of self-storage, and heavy lending competition.
Many borrowers took advantage of lowering their interest rates with financing options that had plummeted below 7 percent in some instances (available during the last half of 1998). This environment caused lenders to lend on "skinny" margins based on the assumption that their cost of funds remained the same.
In 1998's fourth quarter, the investment community became concerned by negative global economic developments, which resulted in a dramatically increased cost of capital to lenders. Many conduit lenders decided to exit the business, including some major CMBS sources.
Today, the market has returned, and the self-storage industry still has financing organizations lending to facility owners. The lenders who specialize in self-storage should remain in a strong position to supply capital to the industry. This is because they have built a reputation with investors of their industry knowledge and underwriting quality. Those companies, including First Security, will be in a position to be a direct lender backed by various capital sources, depending on the owner's financing objectives. More importantly, while spreads have increased from their all-time lows, interest rates were still hovering around plus or minus 8 percent in early 1999.
Banks are generally more familiar with the industry. However, in local markets, financing availability varies, since some banks still have little understanding of self-storage and will continue to have little interest in providing loans. Some banks will lend based on the relationship and the borrower's recourse. Over the past five years, bank financing has been instrumental for construction projects, expansions, short-term financing and for smaller loans under $1 million. A majority of bank financing is recourse.
The industry has been fortunate to have a select group of securitized lenders that actively seek self-storage deals. Many securitized lenders like to diversify their portfolio with some self-storage loans, yet, very few have truly committed to this industry. And even rarer are the firms in which the lending team stays consistent year after year.
Financing relationships have also shifted during the past five years from mainly banks to, now, both banks and conduit lenders. Customers today are much more familiar with securitized lending and its procedures; conduit lending is no longer an "unknown" form of financing. Many self-storage owners have experienced a securitized loan transaction and are now repeat customers, either for new property acquisitions or through refinancing. In fact, 50 percent of First Security's self-storage business comes from repeat customers or referrals.
What is your take on Wall Street's recent roller-coaster-like scenario?
Long before last fall's volatility that was brought on by international loan defaults and corresponding currency devaluations, we had predicted CMBS lender consolidation. We knew that, through acquisitions and mergers, only a handful of strong financing organizations with the necessary critical mass of capital and infrastructure to originate and close deals would survive into the 21st century.
Last October's events only accelerated this trend. Lenders hurt by the downturn have exited CMBS financing. New players who did not take these losses have entered the market. There is clearly plenty of liquidity in the CMBS market for the risk/return profile.
During the past several months, financing organizations have either exited the market or realigned themselves with one or more new capital sources in order to continue to position themselves as direct lenders. The companies who have secured post-October funding will have significant liquidity, a broader range of products to originate, and they will aggressively pursue new borrowers.
For conduit self-storage borrowers, this is all very positive news. While they can expect underwriting standards to be tighter than last summer, they can also anticipate higher-quality lending options since the market has reduced the number of players. The survivors will offer borrowers stronger and better deals that are more likely to close within the quoted terms and timeframes. We do not feel lenders will attempt to get out of their commitments. Borrowers can feel assured the CMBS market will continue to serve as a viable and dominant lending source.
Of course, global market conditions and the U.S. real-estate market temper all of these expectations. Real-estate markets are not in turmoil; supply and demand are currently in relative equilibrium. As long as the U.S. economy remains healthy, real-estate markets will perform well through the next 24 months. The cycle could change after that, but we expect a soft landing since the capital markets and investment community has responsibly rationed capital. This is in stark contrast to the late 1980s and early 1990s when we endured the savings-and-loan crisis caused by poor capital rationing.
What are your projections for the future of self-storage financing for the upcoming months? The upcoming year?
Except for some limited market choppiness, it's quite evident that liquidity has returned to the CMBS marketplace and that CMBS is well-developed for the long run. Our confidence in the CMBS markets is bolstered by the U.S. stock market's continued trek to new heights and the relative calm in international markets.
The capital markets and real-estate industry are strong, with solid fundamentals backing them. While the future is always unpredictable, we believe interest rates in self-storage financing have leveled off and are likely to stay in the general range they are today.
The most recent capital market events have led lenders to focus even more carefully on the quality of individual self-storage facilities, with underwriting standards that include more conservative loan-to-value ratios, increasing debt-service coverages, increasing spreads and a greater scrutiny of a property's operating history.
Are there any other ways you've seen the industry change?
There's no doubt the self-storage industry has become more sophisticated; what used to be considered state-of-the-art and improved competitive position is now considered a standard requirement to remain competitive in many markets. This is particularly the case in such features as security cameras, door alarms, climate-controlled units and ancillary services. Also, with the advance of computer technology and the vast availability of self-storage management and accounting software, a good majority of facilities are computerized. In fact, many lenders will not even consider lending on a facility if it is not computerized.
More owners today have three to 10 facilities. Consequently, these operators are upgrading the landscape of self-storage. Many are acquiring facilities, giving them "face lifts," and improving the management and operations. We see more owners taking advantage of the industry's professional management firms. Owners who expand their portfolios through development are generally building in good locations and building better-quality facilities. The building suppliers have also played a part in the industry upgrade. Suppliers have improved the quality of products and expanded options.
There certainly has been considerable construction and expansion in the past five years. The saturation levels are reaching new heights in many local markets.
Keep in mind, all the above factors will be considered by a lender in evaluating a facility's ability to maintain cash flow to support a financing request.
What do you recommend facility owners do to make a loan process easier?
The primary way to make a transaction process smoother is to keep consistent and accurate records. We need to see such data as physical occupancy history, square footage and unit expansions or changes on a monthly basis, breakouts of rental and other income, schedule of historic and future capital improvements, and a record of items that may cause rental income fluctuations (such as road construction near a facility or changes in advertising programs).
Lenders require extensive documentation, and the established financing organizations that understand the self-storage industry will provide facility owners with a complete list of the necessary items. The better prepared a borrower is for these documentation requirements, the easier the loan process.
Is there anything else you believe owners can do to feel comfortable with their lender?
Use common sense. If a deal sounds too good to be true, it probably is. Shop around. Feel comfortable with whom you deal with and what they tell you. Ask who is involved in the ultimate loan-approval decision. Deal directly with your lender as much as possible. In this way, you establish a relationship with the financing organization and can make the transaction process much smoother.
What do you generally look for in the way of indicators to see if a facility can sustain its income level?
At First Security Commercial Mortgage, we focus on consistent, monthly, net-operating income (NOI) as a benchmark. We also look closely at a facility's competitive situation, how it is positioned in the local market, its location, as well as its on-site and off-site management.
What advice would you give people just getting started in the self storage business?
Do your homework. Facility owners have so many more educational options today than they did in the past. The seminars and workshops at industry conferences have expanded greatly and offer outstanding learning experiences. The Self Storage Association's programs also provide a wealth of knowledge, and it's incumbent upon people to take advantage of them.
What is your company's objective regarding self-storage for the new millennium?
Our objective is quite simple: We plan to stay in self-storage financing and continue our dominant role as an industry lender. We were one of the first firms to provide securitized lending programs to facility owners and were instrumental in bringing low-interest-rate financing to the self-storage industry. We will continue to serve in our established leadership position and utilize our veteran team of self-storage lending experts to serve our customers' personalized needs.