You Down With OPM?

RK Kliebenstein Comments
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Other peoples’ money (OPM) is the key to making commercial real estate yield the greatest return on investment. More important than capitalization rates, revenue management and expense control, cash is king. And never in the modern history of finance has there been a better time to use OPM to fund projects. There are several compelling forces driving the phenomenon:
  • An abundance of liquidity from investors who are rushing to self-storage.
  • Historically low interest rates.
  • A large supply of money for debt from the institutions.

Stocks vs. Sticks

This slippery slope began a few years ago and was fueled by 9/11. The pundits tell us the economy has recovered, but every time I hear the radio commercial for that attorney who claims to recover money from stock losses by bringing suit against the brokerage houses, I realize just how much people lost in the market meltdown. If you have a 401k or investments in mutual funds, you know what I’m talking about.

On a recent trip to Silicon Valley, I saw where the mammoths of the high-flying technology industry once stood. What the collapse in tech stocks and the general market has done is create an impetus for investors to look elsewhere to find a safe haven for their money. The investment landscape has changed from “How do I grow my portfolio?” to “How do I hold on to my capital?” It seems that in a race, the high-tech hares have been outpaced by the terrific REIT tortoises that have been steady earners even during the collapse.

The net result has been a renewed interest in placing capital in bricks and mortar, including self-storage. The best evidence is the emergence of two new self-storage REITs: Extra Space Storage and U-Store-It. In addition to stock-market investing in real estate-based firms, there has been a migration of capital from the stocks to the sticks. Investors are rushing to find property in which to put their money. This has been good for self-storage developers who can deploy cash from liquidated stocks as investors attempt to balance to their portfolios.

How Low Can It Go?

One of the key assumptions of a good feasibility study is the prediction of future interest rates. Wow, did I miss the mark on a few studies in which I projected 2005 construction loans in the 9 percent range! With the current low-rate structure, self-storage looks like a great investment. Even once marginal deals look like stellar performers—today, with no bet on tomorrow.

The rush to refinance is staggering. Teaser rates in the 1.5 percent range create previously unheard of returns, offsetting longer lease-ups (the effect of greater competition), increased land and construction costs, and sloppy operations. What will happen when interest rates return to previous levels? Hold on to your hats, because it could be a rough ride for marginally capitalized developers or, worse yet, investors.

But that’s enough speculation about rates. Let’s get back to leverage. If you are fortunate enough to have a short-life conduit loan or well-seasoned loan coming to maturity, the time to get into the debt market seems to be now. Developers should replace their construction loans with permanent financing, locking in low rates and recapturing their equity.

If you’re in the market to sell your facility, phenomenally low cap rates have created paper value that may allow you to take advantage of equity created not by your skills as an operator, but by being in the right place at the right time. On the other hand, seasoned properties in strong markets may have weathered the storms of competition and appreciated through high occupancies and good revenue management. For the aggressive leverage investor, this means liquidity for other projects. For the conservative, it equates to a strong balance sheet and higher taxable cash flows. Perhaps rather than sell, you might consider using OPM to net the highest return from your investment.

Developers can push the envelope to create leverage opportunities that will maximize low rates. In the 1970s, we called it “creative financing,” but today it just seems like an astute investing tactic: Recover all the initial capital from a project and create an immeasurable return on investment. This may create some stress on cash flow until rental rates increase, but with today’s underwriting, there should still be a cushion of 20 percent (1.20 debt-service coverage) to as high as 33 percent.

Who Buys Lunch?

Many years ago, when I was a commercial banker, the client almost always paid for lunch. The general attitude was that the customer took hat in hand and pleaded for money to borrow. The early baby boomers will remember the respect people had for the esteemed banker. In fact, it was usually quite prestigious to be the branch manager of a bank, with a three-piece suit and fancy office.

Today it’s a whole different ball game. Just recently, I met with my banker at the grocery store. (Seriously, that’s where the closest bank branch was.) The pimple-faced loan officer was dressed in a pair of khaki shorts and a collared tee shirt. When I asked about a commercial loan for self-storage, he offered no scrutinizing looks, no condescending attitude, and no request for a financial statement. Instead, I was handed a keyboard and asked if I wanted to apply online for $4 million. There was no wise counsel, no discussion of interest rates, no fox-and-hound chase for a great deal, only a database that held the fate of the project in its digits.

Commercial banks, investment bankers, finance companies and even savings-and-loan institutions have more money than we ever thought possible. In years gone by, low interest rates often equated to a shortage of capital. Banks were reluctant to tie up funds in long-term obligations, knowing full well the tides would change and they would be caught with ugly, low-interest loans when rates rose to “normal” levels. This seems to have changed with the securitization of loans.

Several years ago, many scoffed at the idea that there may never again be a shortage of capital, based on the ability of the bond market to create money for debt. The skeptics are now satisfied. Even when interest rates seemed to have bottomed out, the hunger to create bonds based on debt kept money in the marketplace. But many don’t understand the long-term effect of this.

Think about money in 10-year Treasury bills. T-bills were once considered some of the most conservative, low-yielding investments. In January 2000, the rate was 6.7 percent. As of Aug. 15 of this year, it stood at a whopping 4.3 percent, and just six months prior, it was at 3.3 percent. Today, these bonds look pretty darn good. This trend compels us to believe interest rates will continue to increase, and the cost of borrowing will move commensurately.

There may be no time better than the present to make finance and investment decisions. The bankers’ vaults are fat. The financial community works with tireless effort to get money into the hands of capable borrowers. What does this mean for you?

  • A compelling argument for refinance instead of a sale.
  • A seemingly endless supply of capital.
  • Bargain pricing on interest rates.
  • Money committed for equity at rates of return that may seem “genius” in a few short years.
  • Aggressive lenders vying for business.
  • Potentially huge arbitrage that employs money at historically low costs and deploys cash in investments that may have significantly higher returns.

RK Kliebenstein is the president of Coast-To-Coast Storage, a licensed Florida mortgage brokerage and self-storage consultancy firm. Mr. Kliebenstein is co-author of the recently released book

How to Invest in Self-Storage and an expert in self-storage finance, with underwriting of more than $250 million in self-storage loans. For more information, call 877.622.5508, ext. 81; e-mail rk@askrk.com.
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