The State of Industry Financing

R.K. Kliebenstein Comments
Posted in Articles, Finance
The State of Industry FinancingThough lenders may run scarce, the 'paper' is still out there

By R.K. Kliebenstein

The last few years have witnessed many changes in the arena of finance, and self-storage financing has been no exception. In September 1998, the finance world was rocked by the collapse of the CMBS (commercial mortgage backed securities) market. Interest rates were at an all-time low. I remember closing a loan for a client at nearly 6 percent, fixed, for 10 years--and with rates that low, the securitization of loans became a very unprofitable proposition. Just a few months earlier, loan note rates were in the low 7 percent range, and the conduit lenders had to take a negative position. They wrote loans at 7 percent and were having to sell them at less than 6 percent in the secondary market. This caused them to write loans with floor rates (which are still in place today). Some lenders did not even fund commitments they had made when the interest rates were "upside down."

The year 2000 brought more changes to the self-storage lending arena. The two primary providers of self-storage loans, Finova Realty Capital and First Security Commercial Mortgage, pulled out of the market. That left GE Capital and Heller Financial as the last standing big names in self-storage finance, but GE has been closing offices across the country (including the one in my hometown), and after 12 calls to Heller Financial about a loan, I gave up. I suspect many borrowers had a much lower tolerance. Though my telephone calls to GE were returned, no one could direct me to the person in charge of self-storage loans. Hopefully, now that former Finova executive Eric Snyder is on board with them, they will have a renewed interest in this industry.

Self-storage loan expert Neal Gussis (formerly of First Security) is now at Beacon Realty Capital and is actively making loans. A regular industry speaker and author, he is committed to self-storage lending, and generally attends all the industry tradeshows and conferences.

Refinance Loans

Lending advance rates have not decreased much. Loans are still being written at 75 percent to 80 percent loan-to-value based on appraised value. It does seem the appraised values are falling behind the sales data for storage properties, causing loan amounts to be more conservative. This caution is likely to continue until most of the new construction in the marketplace reaches stabilized occupancy. Typically, cap rates on appraisals are near 10 percent.

Terms are very competitive. Amortizations range from 20 to 25 years, and loans are generally due in three, five, seven or 10 years. This makes payments very affordable.

Some loans will require recourse or personal guarantees. Conduit loans generally only require a personal guarantee from the borrower, protecting the lender against fraud or environmental concerns. The term for these exceptions to non-recourse is "carve-outs." Bank loans usually require the full personal guarantee of the borrower. This simply means that in the event of a foreclosure, the guarantor may be liable to the bank for any deficiency balance. The borrower's personal residence may be at risk.

Prepayment penalties and "lock-outs" are a negative feature of conduit loans. These loans are very expensive to prepay and, in some cases, you are not even allowed to prepay the loan. This is the biggest disadvantage of the conduit loan, and is usually regarded as the trade-off for not having to provide personal guarantees. Most bank loans have only nominal prepayment clauses.

Loan expenses don't vary greatly from lender to lender. The borrower can usually expect the following closing costs:

Bank Loan Conduit Loan
Appraisal $2,500 $3,500 $3,500 $4,500
Engineering Report --- $2,000 $2,000 $2,500
Survey $1,000 $2,000 $2,000 $2,700
Accounting Audit --- --- $1,500 $2,000
Site Inspection --- $500 $1,000 $2,000
Lender Legal $5,000 --- $7,000 $9,500
Enviromental $1,500 $2,500 $2,000 $2,500
Totals $10,000 $10,500 $19,000 $25,700

One thing to note about the above expenses are the borrower's legal fees. Because most conduit loans have standardized documentation, if you are using an attorney who is familiar with securitized loans, the borrower's legal costs can be reduced greatly, as the lawyer has most likely already seen the verbiage. Legal review of a bank loan may require the lawyer to analyze each section individually, so the fees could be twice as much for a bank loan as they are for a conduit.

Interest rates are the last--but not least--loan feature open for discussion. Interest-rate spreads have increased since the September 1998 CMBS crash. Self- storage margins vary from 225 to 320 basis points, depending on the loan risk. To achieve the lowest rate, the loan-to-value should not exceed 50 percent, and the debt-service coverage should be greater than 1.7:1. For an explanation of these terms, please refer to accompanying glossary.

Construction Loans

Construction loans are best made and administered by local banks with whom the borrower has a relationship. The loans are typically short in term (24 to 36 months) and are due upon completion of construction. The interest rates are usually tied to the prime rate, or the rate the lender charges to its best customers (such as IBM or Ford). The spread is usually 1 percent or 2 percent above prime. Typically, these loans are full recourse (personally guaranteed) and are 65 percent of the cost of construction. One to two points are charged. Some banks offer a "mini-perm" loan, which is a combination of a construction and permanent loan. The term is usually five years, which affords the borrower adequate time to reach stabilization.

In Conclusion...

The good news is that capital is available. If financial markets remain stable, and interest rates do not go dramatically up or down, then capital should continue to be available. A good loan broker can help you negotiate through the labyrinth of terms and options. Try to find a broker who can offer bank loans as well as conduit loans. Experience counts for a lot in this game, and you are often at an advantage to do business with an individual or firm that specializes in self-storage lending.

R.K. Kliebenstein, owner and founder of Coast-To-Coast Storage in Boca Raton, Fla., is a mortgage banker and broker. Coast-To-Coast makes self-storage loans exclusively. For more information, call 561.367.9241.

Glossary of Terms

Basis Point: One-hundredth of a percent, i.e., 100 basis points equals 1 percent.

Conduit Loan: A loan usually made by a securities firm that sells bonds to investors to raise money for the purpose of lending.

Debt Service Coverage Ratio (DSCR): A ratio used to express the relationship between annual net-operating income and annual debt service. Most lenders require a minimum DSCR of 1.25:1.00. For example, if the annual debt service is $100,000, the annual net income has to be equal to or greater than $125,000.

Index: The instrument used in determining the base for the cost of money. The Treasury rate is most commonly used for fixed-rate loans while the LIBOR index may be used for variable-rate transactions. Usually expressed in basis points.

Loan-to-Value (LTV): The percentage amount borrowed in the acquisition or refinancing of a property. The value of the property is determined by a third-party appraiser.

Lock-Out: A provision in a loan indicating a period of time during which the borrower is not allowed to prepay.

Margin (or Spread): The rate above the index that is charged. Loosely, this is the investor's "profit." If an investor placed funds in U.S. Treasury bills, the margin is the amount above the Treasury bill rate. Usually expressed in basis points.

Note Rate: The annual interest rate you pay. The rate is the index plus the margin.

Prepayment Penalty: A fee charged by the lender to a borrower who pays his loan off early.

Recourse: Alternately known as a personal guarantee. If a loan is in default, the personal assets of the borrower are open for attachment by the lender to cure an amount of the loan payoff in excess of the proceeds from foreclosure sale.

Securitization: The process of selling bonds to raise money for the purpose of lending.

Yield Maintenance: A prepayment penalty that assures the lender that if a loan is paid off early, no interest will be lost, as though the loan were paid at the end of the term. For example: A loan with a note rate of 10 percent is due in the year 2010. The borrower prepays in 2005, and the Treasury bill rate on five-year money is 5 percent. The yield maintenance would, therefore, be 25 percent (or 5 percent per year).

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