Securitized Lenders:
What is the deal?

By Neil Gussis

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

A Dynamic Market

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

Although self-storage loans make up only a fraction of all commercial loanssecuritized, consider that commercial mortgage-backed securities transactions totaled$29.9 billion in 1996, jumped to $44 billion in 1997, and had already reached $42.7billion in the first six months of 1998. When you realize that in the average year alllending combined approaches $144 billion, it's obvious that the CMBS market now serves asa 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 unparalleledinterest 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 strengthsof the self-storage industry to Wall Street investors. Commercial mortgage-backedsecurities bond pricing has dropped dramatically over the past four years, due in part tothe rating agencies' and investors' continued understanding and acceptance of loanscollateralized 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 investmentcriteria from time to time, based on real and perceived risks. The result of theinvestment risk assessment directly affects the cost of funds available to securitizedlenders.

Like many other types of investments, commercial mortgage-backed securities areconstantly being re-evaluated. They no longer experience declining bond pricing, whichtranslates to lower interest-rate spreads to the self-storage owner. In fact, mostsecuritized lenders are now offering spreads 0.75 percent to 1 percent over those offeredsix months ago. It's likely that interest-rate spreads will continue to increase anddecrease based on overall market conditions. Self-storage loans are of course not the onlyproperties experiencing these adjustments to spreads; commercial mortgage-backedsecurities 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 totalinterest rate to be passed on to the borrower on a fixed-rate basis). For example, inSeptember, First Security Commercial Mortgage was regularly locking fixed-rate mortgagesfor self-storage between 7.125 percent and 7.75 percent, even after adjustments to theirspreads. Relative to any other period of time in the CMBS/self-storage relationship, theseare very attractive overall rates.

Jumping on the Bandwagon

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

Today, there are plenty of conduit lenders who aggressively court the self-storageindustry with a wide variety of CMBS loan packages. Solicited and unsolicited offers forsecuritized (or conduit) lending programs hit the desks of owners and operators fromdirect 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 theself-storage borrower. In truth, some lenders may talk a good game, but have little in theway 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 theinstability of the costs of funds available to securitized lenders, it's best to be waryof lenders who ask for excess fees up-front, and to make sure they have the ability todeliver on a quote.

Look for Industry Experience

You'll have no problem finding lenders that "dabble" in self-storage: thosewho 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 theirportfolios. Sometimes they offer very attractive deals, yet have closed few or no loans toself-storage operators. That's why it's important to look for a niche lender, someone whoregularly works with, and consequently understands, the self-storage industry.

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

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

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

Above and beyond everything else, position yourself as close to the decision-maker aspossible. It's not hard to find brokers--or even satellite offices of brokers--who areready to act as a middleman to your loan transaction. Unfortunately, brokers and othergo-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 unforeseenissues that may arise during a transaction.

Name Your Priorities

As you look for a CMBS lender, take the time to ask yourself some fundamentalquestions. What's more important to you: The ultimate interest rate? Costs of thetransaction? Delivery and processing system? The terms for which you are going to beobligated over the next seven or more years? Establishing a relationship with adisciplined, 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 theloan- application process, here are a few words of advice:

It's important to remember that the loan process communicates important facts to thelender. It demonstrates how and why your project will be successful enough to repay a loanand generate a profit. To that end, the loan application is designed to mitigate yourlender'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. Severallenders already have pulled out of the market, and others are likely to follow. Industrywatchers insist that when all is said and done, the CMBS playing field will be muchsmaller. Those who remain will be the stronger players, the ones most likely to remain thedominant lenders for the long haul. Consequently, when looking for a loan, it's best tofocus on the reliability of the lender to deliver.

It's also worth noting that due to changing markets and the volatility in securitizedlenders' cost of funds, you will be exposed to many new loan-quoting styles, a number ofwhich provide lenders with the flexibility to change the terms. Use good businessjudgement 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 fornon-aggressive loan terms (low loan-to-value, recourse, or a short-term loan), you mayfind 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 asecuritized lender that knows the self-storage industry, carries a solid reputation foraccountability and is prepared to work closely with you through every stage of theloan-application process.

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