Initially, you want to decide which lending parameters you are willing to accept as part of the loan package. The parameters will vary depending on the lender and loan program. For instance, banks generally offer recourse financing programs with limited or no prepay penalties, but typically don't offer fixed rates longer than five years (although maturities can go longer than five years). On the flip side, Wall Street conduits (securitized lending) mainly offer nonrecourse, fixed-rate financing for terms of 10 to 20 years, but have very tough prepay-penalty language and also require impounds for taxes, insurance and replacement reserves.
Key lending parameters include but are not limited to:
- Percent occupancy (percent of rented units to total units)
- Recourse (personal liability) or nonrecourse (no personal liability)
- Prepayment flexibility (ability to pay more than the payment without penalty)
- Hold period (length of time you plan to keep the property)
- Amortization (length of time over which the payment is calculated)
- Impounds (escrows for taxes, insurance, reserves)
Your facility's current level of occupancy can often dictate what kind of lender you choose. The nonrecourse lender generally underwrites off the trailing 12 months of cash flow. If your facility is just coming out of construction, has just reached stabilized occupancy or is not yet at stabilization, you may not qualify for the desired loan dollars with a conduit.
In these situations, banks will usually be more flexible in providing maximum loan dollars, basing their loan amount more on the appraisal than the past 12 months of operating statements. In any case, it may be difficult to place long-term financing on any property just coming out of construction with little or no occupancy. Hopefully, the construction lender built in a mini- or long-term permanent loan as part of its original construction commitment.
State laws vary, but recourse usually requires a personal guarantee from one or more individuals. This places the assets of the guarantor at risk in the event of a default and is normal in construction and permanent loans for traditional institutional lenders. Nonrecourse means the lender can typically only go after the property to satisfy the mortgage or deed of trust in the event of default.
A nonrecourse loan usually carries what are called "bad boy" carve-out guarantees. This means the lender can go after the "carve-out guarantor" for satisfaction of the debt if it is determined the guarantor committed fraud, waste, mismanagement, misrepresentation or environmental contamination leading to the default in payment or other loan covenant.
Most borrowers obtain recourse loans for construction purposes and for loans that require flexibility on some other parameter such as prepayment, LTV (loan-to-value) or amortization where nonrecourse will not provide the needed loan attributes. Those borrowers requiring nonrecourse are mainly concerned about personal liability and are typically a managing member, officer or general partner of a borrowing entity where their interest is limited or minimal.
Prepayment flexibility gives the borrower the ability to pay the loan in part or full without penalty. Flexibility is important if there is a future need or desire to pull cash out from equity in the property, add on additional storage units, sell the property, or simply to refinance for a better rate.
For example, if you're thinking about adding units in the future through the use of a construction loan, it is important to note most banks will not loan behind an existing first mortgage unless that mortgage is also from the same lender. If the first mortgage cannot be prepaid due to a lock-out or the subject property is not on a separate tax parcel, the construction lender will usually not provide construction financing subject to the aforementioned. If a loan is prepayable with a penalty, you may be forced to pay the penalty to terminate the first mortgage and obtain the needed construction financing. Conduit lenders do not allow secondary financing and have very tough prepayment-penalty language, including a lockout period prohibiting any prepayment in the first few years.
It is important to determine how long you plan to hold on to the property when considering financing options. If you think you may be selling the property in three to five years, you may not be as concerned about the rate as you may be with the costs of financing. A low 10-year fixed rate with stiff prepayment penalties and high loan costs--indicative of most conduit loan programs-may actually work against you if the property is not held to term.
Conduit loans can cost a minimum of $15,000 (appraisal, environmental, engineering, survey, legal, application fees) plus the 1 percent loan-origination fee. Additionally, the prepayment penalty can cost six figures in the wrong interest-rate environment if the loan is paid off vs. being assumed by a new owner. However, if holding for the full 10-year term, a conduit loan may well be worth the cost given the low interest rates today (less than 7 percent, fixed).
Amortization is the number of months over which your loan payment is calculated. The longer the amortization, the lower the loan payment. Amortization can vary with most banks at 15 to 25 years, although 30 years is available with some lenders. Conduit lenders, the predominant long-term, fixed-rate lenders, amortize loans over 20 to 25 years in most cases, with newer facilities or low LTV requests sometimes achieving 30 years.
Impounds are a monthly amount paid along with your principal and interest payment to cover real estate taxes, insurance and replacement reserves. The lender collects these funds from you and makes the payment for you, ensuring the property is well maintained and secure from nonmonetary defaults. While some borrowers don't mind impounds, it does restrict monthly cash flow, and minimal interest is paid on the impounded funds if paid at all.
Replacement reserves are funds held aside for future replacement of capital-improvement items such as roofs, exterior painting, driveway resealing, appliance replacement, carpet replacement, and furniture, fixtures and equipment. Most banks don't require impounds, while most nonrecourse lenders will.
Long-term lenders include banks, savings and loans (S&Ls), thrift and loans, conduits, insurance companies, pension funds and, in some cases, credit unions. On occasion, you may even find private parties willing to lend at long-term, reasonable rates, given what they may be earning in bank savings accounts and the stock market. While programs vary around the country, you can usually find a loan program somewhat close to your parameters.
Banks, S&Ls, Thrifts
Most of these lenders will lend from 65 percent to 75 percent maximum LTV and, on rare occasion, 80 percent LTV. Programs usually consist of a three- or five-year fixed rate rolling to an additional fixed-rate period(s) or adjustable rate for the remainder of the loan term, which is usually 10 years but can be as long as 25 to 30 years. You may find a bank or similar institutional lender who is willing to fix a rate longer than five years, but often those lenders require a shorter amortization than 25 years. Adjustable-rate loans are very attractive in today's environment and are often 10-year or longer maturities.
Bank lenders typically offer programs with little or no prepay penalties, allowing for flexibility to refinance or add additional units with a construction loan. These lenders provide mainly recourse loans requiring personal guarantees from the borrower or borrowing entity principals.
As of press time, rates for three- to five-year bank fixed rates were in the mid 6 percent to low 7 percent range, with adjustables in the 5.5 percent to 6.5 percent range. Fixed rates longer than five years approach the low to mid 7 percent to 8 percent range. If obtaining a bank loan, be prepared to have a deposit relationship with the lender to get the terms you want.
Costs associated with bank loans are usually an appraisal fee and possibly an environmental-report fee, loan-origination fee of 0.5 percent to 1.5 percent, and miscellaneous processing, documentation and underwriting fees of $500 to $1,000. Impounds are generally not required.
A Wall Street securitized conduit loan is a mortgage originated and pooled with other storage loans from around the country, packaged (securitized) and sold on Wall Street as a commercial mortgage backed security (CMBS). There are numerous conduit lenders originating this type of loan. The end purchasers of these securitized instruments buy them expecting a specific return for the maturity of the CMBS. Because of this, the prepayment penalties are calculated to return to the investors the full amount of the expected return over the full term of the loan. The prepayment-penalty calculation involves a loss of yield formula that, when in a low interest-rate environment, can be prohibitive.
Since the securitized loan pools must pass the scrutiny of the credit-rating agencies and Securities and Exchange Commission (SEC), the loan must be consistent and homogenous. This means they all must have a certain level of due diligence performed, including appraisals, environmental reports, engineering (property-condition) reports, and ALTA surveys (in most states), with some level of legal review of reports, title issues and borrower-entity documents. The total cost of the due diligence can run from $15,000 to $30,000 depending on the lender and program offered. In most cases, conduits also impound for taxes, insurance and replacement reserves. Additional costs over a bank loan are also found in the required title endorsements and insurance coverage required by the conduit lenders.
Many times, conduits will also require you hold title to the property in a "single-asset entity" (SAE) to protect against bankruptcy. This can be a partnership, LLC or corporation where the subject property is the only asset owned by the entity. These lenders also prefer locations in major metro markets with good visibility and access, but this is not a hard and fast rule.
LTVs generally max out at 75 percent. Minimum loan amounts are typically $1 million to $2 million, with a few conduits venturing down to $500,000. Loans under a million usually require a recourse guarantee.
The typical conduit-lending program is a 10-year fixed rate with a 20- to 30-year amortization. The newer the property, the better quality of construction (concrete block, wood frame) and the lower the LTV, the more likely a 30-year amortization will be available. Straight metal buildings will often carry only a 20-year amortization. Those rates are around 6.25 percent to 7 percent fixed for the entire term.
Conduit lenders are one of the few that will offer a 15- or 20-year fixed-rate, self-amortized loan, meaning there is no balloon. The rates on those terms are slightly higher than the 10-year rates. Not all conduit programs are alike. Some are more aggressive in pricing with certain product types, while others offer both a regular and reduced-cost loan program.
Because rates are at historic lows, conduit loans can provide a very low and stable payment for long term periods not subject to interest-rate swings. Long-term interest savings can easily outweigh the initial costs for the conduit borrower.
Insurance Companies/Pension Funds
These unique lenders are portfolio lenders not under the same regulatory requirements as banks or conduits. These nonrecourse lenders finance most of the large commercial income properties with long-term, low, fixed-rate mortgages. In many ways, they are similar to conduit lending requiring impounds for some or all the same expenses and requiring the same third-party reports. However, they are generally more flexible on prepayment issues, entity requirements, and length of fixed-rate term and amortization. For example, they may do a 15-year fixed rate with a 25-year amortization vs. fully amortized under the conduit scenario.
Does your property qualify for this type of lending? These lenders are very conservative and typically "cherry pick" their loans, selecting top locations, excellent history, lower LTVs and better construction quality. If your property qualifies, this may be an excellent financing alternative. Insurance-company/pension-fund loans are almost exclusively originated through mortgage-banking correspondents and not directly through the company. Current rates for a 10-year fixed term are between 6 percent and 7 percent, with LTVs at a maximum of 75 percent.
Credit unions may be a hidden gem in your area. In some parts of the country, credit unions have begun originating commercial and apartment loans, including self-storage financing. Because they are regulated differently than banks, they can sometimes offer better rates, longer amortizations and more flexible terms than many traditional institutional lenders. They are, however, recourse lenders, but generally do not impound.
Commercial Mortgage Bankers/Brokers
These professionals can assist in finding the right lender for your particular transaction based on their knowledge of the industry and relationships with lenders not only in your immediate market, but originating nationwide. There are many banks, thrifts and conduits lending outside their geographic branch territory to diversify their portfolio. These lenders usually do not have a presence in the market outside their immediate territory other than through the mortgage banker/broker who acts as their agent or correspondent in procuring loans for the institution.
Mortgage bankers also act as direct lending correspondents for insurance companies, pension funds and some conduits, meaning they originate loans for these organizations vs. the organization having a separate employed staff to originate. In many cases, there is no additional charge to procure the services of the mortgage banker/broker due to its wholesale relationship with the lender. In these transactions, the mortgage banker/broker collects the loan-origination fee vs. the lender.
In summary, lenders today are very hungry to loan money, and there are many opportunities in the permanent-financing arena available to borrowers. When searching for financing, make a list of what parameters you want, and don't be afraid to negotiate terms with the lender. As long as your request is reasonable, lenders will generally try to accommodate you rather than lose a good loan to a competitor.
David Smyle is president of Benchmark Financial, which provides construction and permanent financing for self-storage, office, industrial, retail, apartment and other commercial properties. For more information, call 619.465.6200 or visit www.benchmarkfin.com.