Everything's Coming Up Roses
Lenders Offering All-Time Low Interest Rates
By Eric Snyder
There is absolutely no question that now is the time to refinance your self-storage facility. The current interest-rate environment is one of the best in the last 25 years. At the beginning of September 1998, the 10-year Treasury (which is the index used by most lenders for fixed-rate loans) had a yield of 5 percent. Lenders will then add a spread to the 10-year Treasury, which is called a margin, to determine the overall interest rate to the borrower. The average spread at the time of this article was 2.4 percent, which equates to a 7.4-percent-fixed rate for 10 years. This lending environment provides the borrower with an opportunity to capitalize on historically low fixed-rate financing.
In addition to the historically low interest rates, there are flexible financing structures available in the market to meet almost any financing need. You may want to pursue low fixed-rate financing if you are a borrower looking to hold onto the property for a long time. This can be achieved through a lender who has a commercial mortgage backed services (CMBS) division. CMBS loans are securitized on Wall Street and provide some of the lowest fixed-rate financing available in the market. However, this option locks you into a loan for a long period of time since the prepayment penalties can be considerable.
Therefore, it might be in your best interest to consider an earnout if you have a facility with a rapidly increasing net operating income (perhaps due to the fact that you purchased a poorly managed facility or recently expanded), consequently qualifying you for more loan dollars within the next 12 months. An earnout can provide you with a second funding once you have increased your net operating income, but at a higher interest rate than a standard loan.
Finally, you may need to obtain financing options that are not available through the CMBS division of lending institutions. For example, you may want to consider a bridge loan if you want to increase the net operating income of a facility and then sell it in the near future. This kind of loan will not be provided through the CMBS division of a financial institution since it is usually a variable-rate loan for a short period of time (normally three years). Instead, it will be priced over the LIBOR (not the Treasury) index by the portfolio lending division of a finance company. The advantage of this kind of loan is that there will be a minimal prepayment penalty, unlike CMBS loans.
The Financial Package
After you have decided what type of financing structure best suits your needs, you will need to prepare a financing package to submit to a lender. It is important to develop a relationship with a lender who can accommodate all of your financing needs through either its CMBS or portfolio lending divisions. Your package for the lender should include the following six items:
- Brief summary of the history of the property and your financing request;
- Pictures of the property;
- Occupancy reports for the past 12 months;
- Operating statements for the past 12 months and previous three years;
- Financial statement and resume for the borrower; and
- Completed questionnaire provided by the borrower.
The most important ingredient to a lender package is good historical records and explanations for past performance of the property. Good records may work in your favor when the lender is adjusting income levels down or expense levels up, which affects your ability to qualify for the loan. For example, the facility might have required extraordinary repairs in 1997 not typically recognized as "ordinary repair and maintenance." You can maximize your loan dollars if you can document these extraordinary repairs since the lender will exclude them from the underwriting. If you did not have documentation to this effect, the lender may underwrite a higher expense number for repairs and maintenance and reduce your loan dollars.
Once the lender has reviewed your loan package, they will prepare a formal application for your review. You should review this application thoroughly and make sure you understand all the different components of the loan application. At the end of this article is a glossary of terms that will be beneficial for you in your review of a lender's loan application. If you have a sufficient understanding of these terms it will help you be prepared to negotiate the loan application that provides you with a structure that best suits your individual financing needs.
The two most important qualifications in the loan application that will determine your final loan amount are the loan-to-value (LTV) and debt service coverage ratio (DSCR) requirements. The LTV is a percentage that compares the loan amount to the value ascertained by a third-party appraiser. In most cases this percentage cannot exceed 75 percent, with some lenders going to up to 80 percent. The DSCR is a ratio that compares net operating income to debt service. Most lenders will require a minimum DSCR of 1.25:1.00.
After you have negotiated and executed the loan application, the lender will begin the process of closing the loan, which typically involves the following six steps:
- Submitting due diligence items;
- Ordering an appraisal report;
- Ordering an environmental phase-one report;
- Ordering a property-condition report;
- Ordering a seismic report; and
- Document negotiation.
Submitting due diligence items requires supplying the lender with a substantial list of items in order to begin a thorough analysis of your loan request. The lender will request items such as operating statements, occupancy reports, management agreements, partnership agreements and many other items deemed necessary for review. Simultaneous to the request of due diligence items, the lender will engage third-party vendors to prepare an appraisal report, a property-condition report, an environmental phase-one report and a seismic report.
The appraisal will determine whether or not the loan-to-value requirement was achieved per the loan application, and the property condition report will verify the amount of reserves the lender will require to be escrowed. The environmental phase-one report details any environmental concerns at the property and, should a phase-two report be necessary, the borrower will be required to have this completed before the lender will fund a loan. Finally, in some parts of the country, a seismic report will be required to determine a probable maximum loss (PML) percentage. In most instances, if this percentage exceeds 20 percent, the lender will require earthquake insurance prior to funding of the loan.
Once all the reports have been received and the lender has visited the property, the lender will review all the materials and summarize the deal structure in a credit committee package. This package will be submitted to the individuals within the lending institution who have authority to approve a deal. Normally, once the deal is approved, a loan-approval letter will be sent to the borrower and a legal team will be engaged to prepare loan documents. Once the loan documents have been favorably negotiated, the loan should close within a couple of weeks.
It is important to remember that the funding of a loan requires gathering substantial information. It can be rather time consuming and you should be prepared to spend time documenting operating performance and working closely with your lender to obtain the optimum financing for your project. To avoid surprises, you should estimate at least 30 days to prepare a package and identify a lender, and another 60 days to close the loan. Keep in mind, though, that with today's low interest rates, the payoff for your time could equate to an interest rate below 7.5 percent for 10 years.
Eric Snyder is director of Finova Realty Capital (formerly Belgravia). As the head of the Self Storage Program, Mr. Snyder is responsible for analysis and negotiation of loan requests throughout the United States, and has analyzed more than $2 billion in requests for self-storage financing. For more information, Finova Realty Capital may be contacted by phone, (949) 724-8700, or on the Web, www.finova.com.
GLOSSARY OF TERMS COMMONLY SEEN IN LOAN APPLICATIONS:
Amortization: The number of years necessary to pay the loan down to zero, including payments of principal and interest. Most self-storage loans are placed on a 25-year amortization schedule.
Assumption/Transfer: Most lenders will allow a one-time assumption of the loan upon their approval and a 1 percent transfer fee.
Debt Service Coverage Ratio (DSCR): A factor used to express the amount of difference between net operating income and the debt service. Most lenders will require a minimum DSCR of 1.25:1.00. For example, if the debt service is $100,000, then the net operating income needs to exceed $125,000 to qualify for the loan.
Impound/Escrow Account: An account used for the deposit of valuable considerations such as money with an impartial third party. The most common use for these accounts is for the collection of property taxes and insurance premiums.
Index: The instrument used to serve as a base for the cost of money. The LIBOR index may be used for variable-rate loans, and the Treasury bill may be used for fixed-rate loans. Most CMBS lenders will use the 7-, 10- or 15-year Treasury bill.
Loan-to-Value (LTV): The percentage amount borrowed in the acquisition or refinancing of a property. A third-party appraiser determines the value of a property.
Margin: This is the spread between the index and interest rate, and can range from 2.3 percent to 2.5 percent in today's market.
Mortgage Constant: An equal annual payment, expressed in a percentage that will amortize the principal and pay interest over the life of the mortgage. It is important to look at the loan application to determine if there is a minimum constant required by the lender.
Prepayment Premium or Penalty: A penalty for an advanced payment on a mortgage. The most common penalty is known as Defeasance, which is the substitution of Treasuries for the remaining payments on the loan.
Reserves Account: An account to collect reserves for capital improvements. Most lenders will require that an account be established to collect reserves in accordance with the report prepared by a third-party engineer. In most cases, there will be a minimum collection of 15 cents per square foot regardless of the results of the engineering report.
Securitization: A securitization involves a lender bundling similar mortgages that are analyzed by rating agencies and then used as collateral for bonds purchased by institutional investors. This type of financing is ideal for borrowers looking for low fixed-rate financing.
Single Purpose Entity: A requirement by all CMBS lenders, a single-purpose entity restricts the borrowing entity from owning any other facility other than the property being financed.
Term: This is the period of time between the borrowing date and due date. In most cases, the term of the loan will coincide with the Treasury bill. For example a 10-year loan will be priced over a 10-year Treasury bill.