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A Dynamic Market

Neil Gussis Comments

Securitized Lenders:
What is the deal?

By Neil Gussis

Lenders that securitize their loans are here to stay. The savvy self-storage owner understands financing alternatives, takes advantage of good economic conditions and focuses on lenders with expertise in the self-storage industry.

A Dynamic Market

Several years have passed since commercial mortgage-backed securities (CMBS) first emerged as a dynamic and credible source of funding. As the '90s draw to a close, most borrowers reviewing their lending options are well beyond the "CMBS get-acquainted period." They know these loans offer real-estate owners low interest rate, non-recourse (with standard exceptions) and high-leverage, long-term, fixed-rate loans.

Although self-storage loans make up only a fraction of all commercial loans securitized, consider that commercial mortgage-backed securities transactions totaled $29.9 billion in 1996, jumped to $44 billion in 1997, and had already reached $42.7 billion in the first six months of 1998. When you realize that in the average year all lending combined approaches $144 billion, it's obvious that the CMBS market now serves as a major source of capital for real-estate owners.

The CMBS market became readily available to self-storage owners in 1994. Since then, owners have enjoyed an unprecedented period of financing opportunities at unparalleled interest rates. Major thanks must be given to the real estate investment trusts (REITs) and the handful of financing companies that have communicated the viability and strengths of the self-storage industry to Wall Street investors. Commercial mortgage-backed securities bond pricing has dropped dramatically over the past four years, due in part to the rating agencies' and investors' continued understanding and acceptance of loans collateralized by self-storage properties.

As many of us have experienced, Wall Street investors (typically pension funds, banks, insurance companies and other financial institutions) can and will change their investment criteria from time to time, based on real and perceived risks. The result of the investment risk assessment directly affects the cost of funds available to securitized lenders.

Like many other types of investments, commercial mortgage-backed securities are constantly being re-evaluated. They no longer experience declining bond pricing, which translates to lower interest-rate spreads to the self-storage owner. In fact, most securitized lenders are now offering spreads 0.75 percent to 1 percent over those offered six months ago. It's likely that interest-rate spreads will continue to increase and decrease based on overall market conditions. Self-storage loans are of course not the only properties experiencing these adjustments to spreads; commercial mortgage-backed securities for all commercial property types also face relatively similar adjustments.

The good news is that, as of mid-September, the index was at an all-time low (securitized lenders use the U.S. Treasury yield plus a spread to determine the total interest rate to be passed on to the borrower on a fixed-rate basis). For example, in September, First Security Commercial Mortgage was regularly locking fixed-rate mortgages for self-storage between 7.125 percent and 7.75 percent, even after adjustments to their spreads. Relative to any other period of time in the CMBS/self-storage relationship, these are very attractive overall rates.

Jumping on the Bandwagon

Considering CMBS' widespread acceptance as a funding source, it comes as no surprise that there are numerous lenders eager to wave the CMBS banner.

Today, there are plenty of conduit lenders who aggressively court the self-storage industry with a wide variety of CMBS loan packages. Solicited and unsolicited offers for securitized (or conduit) lending programs hit the desks of owners and operators from direct lenders, brokers and correspondents on a regular basis.

However, the fact is that not everyone who flies the CMBS flag is a good fit for the self-storage borrower. In truth, some lenders may talk a good game, but have little in the way of an industry track record to back up their claims.

Now more than ever, it's important to feel comfortable with your financing choice. We're entering a period when world economic conditions are volatile. Based on the instability of the costs of funds available to securitized lenders, it's best to be wary of lenders who ask for excess fees up-front, and to make sure they have the ability to deliver on a quote.

Look for Industry Experience

You'll have no problem finding lenders that "dabble" in self-storage: those who jump in and out of the industry but depend on other areas for their bread and butter. Many of these lenders "do a little self-storage" to add diversity to their portfolios. Sometimes they offer very attractive deals, yet have closed few or no loans to self-storage operators. That's why it's important to look for a niche lender, someone who regularly works with, and consequently understands, the self-storage industry.

You're best served by a lender whose services are tailored to your specific needs, and whose underwriting and legal staffs are intimately familiar with how to underwrite your sources of income and analyze your operating expenses. You want someone who understands that late fees and administrative charges are part of operating income, and recognizes the importance of a good on- and off-site management team. In times of expanding supply, you need a lender who can accurately assess your market and make informed decisions. And most importantly, if you're looking to the future, you want a lender who will be there for your next deal.

One way to recognize an experienced self-storage lender is to observe the level of scrutiny he exercises in his business. Those committed to the self-storage industry will look for the same healthy signs you would, including capable management, efficient daily operation and growth potential. Beyond that, it pays huge dividends to ask your potential lender a lot of questions up-front about funding sources, references, track record and the lender's history in self-storage.

As in your business, reputation and accountability are strong motivators for a financing company that specializes in a niche such as self-storage. The self-storage community is still relatively small and well networked. Companies such as First Security Commercial Mortgage and FINOVA have achieved a certain degree of success in the industry based on good word-of-mouth.

Above and beyond everything else, position yourself as close to the decision-maker as possible. It's not hard to find brokers--or even satellite offices of brokers--who are ready to act as a middleman to your loan transaction. Unfortunately, brokers and other go-betweens may be unwilling or unable to give your loan the attention it deserves. Dealing directly with a lender means you'll be able to more quickly resolve any unforeseen issues that may arise during a transaction.

Name Your Priorities

As you look for a CMBS lender, take the time to ask yourself some fundamental questions. What's more important to you: The ultimate interest rate? Costs of the transaction? Delivery and processing system? The terms for which you are going to be obligated over the next seven or more years? Establishing a relationship with a disciplined, dedicated lender who's ready to work with you now and in the future?

These are questions worth pondering before you sign on the dotted line. Either way, you'll have to live with your decision for a while.

The Loan Application Process

Once you've found a CMBS lender you're comfortable with and are ready to initiate the loan- application process, here are a few words of advice:

  • Work closely with your lender up-front, so that you'll understand from the beginning what's expected of you in terms of time, effort and documentation.
  • A lot of people will be involved in the approval process, so be prepared to experience a high degree of scrutiny.
  • Be prepared to answer the same questions more than a few times.
  • It's a fact of life: Those who lend money thrive on paperwork. Prepare to push a lot of paper.
  • Through all of this, make it a point to know everyone you're working with, and what each person needs from you to expedite your loan application.

It's important to remember that the loan process communicates important facts to the lender. It demonstrates how and why your project will be successful enough to repay a loan and generate a profit. To that end, the loan application is designed to mitigate your lender's risk, while increasing efficiencies in the granting and servicing of your loan. Plus, the added scrutiny often results in getting you more money at less cost.

A Changing CMBS Market

It's important to note that the CMBS market is approaching a shakeout period. Several lenders already have pulled out of the market, and others are likely to follow. Industry watchers insist that when all is said and done, the CMBS playing field will be much smaller. Those who remain will be the stronger players, the ones most likely to remain the dominant lenders for the long haul. Consequently, when looking for a loan, it's best to focus on the reliability of the lender to deliver.

It's also worth noting that due to changing markets and the volatility in securitized lenders' cost of funds, you will be exposed to many new loan-quoting styles, a number of which provide lenders with the flexibility to change the terms. Use good business judgement when evaluating your financing alternatives.

The Choice Is Yours

Finally, while commercial mortgage-backed securities can be an ideal source of lending, they're not necessarily the right fit for everyone. In particular, if you're shopping for non-aggressive loan terms (low loan-to-value, recourse, or a short-term loan), you may find that a bank or similar lending institution better suits your needs.

For the vast majority of borrowers, though, there is no better time to seek out a securitized lender that knows the self-storage industry, carries a solid reputation for accountability and is prepared to work closely with you through every stage of the loan-application process.

Neal Gussis is a senior vice president with First Security Commercial Mortgage in Chicago, where he oversees the firm's self-storage commercial lending programs nationwide. For more information, call (312) 425-9300.

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