Most investors purchase self-storage for three reasons: cash flow, appreciation and tax benefits. Your goals will impact the kind of financing best for you.
Cash flow is simply the gross revenue (rent) generated from the property minus operating expenses (insurance, taxes, utilities, etc.) and financing expenses (principal and interest). Most investors are looking to maximize revenue and minimize expenses for the highest level of cash flow possible.
Appreciation is achieved when the property's value increases over the period an investor maintains control over it. Sources of appreciation include local demand for land and buildings, physical additions to the property and facility upgrades.
Tax benefits such as depreciation and 1031 Exchanges are reasons some investors purchase property. Depreciation allows a tax deduction without cash payment, which in turn increases after-tax cash flow to the investor. A 1031 Exchange lets an investor trade up to a higher-value property while deferring the taxes.
Finance Your Project
Now that you understand some of the advantages of owning self-storage, you need to figure out the best way to finance the project. You have two main financing options: short-term/bridge and long-term/permanent:
Short term/bridge (3-5 years): This type of financing is ideal when purchasing a facility that has experienced poor management, needs additional units or is a quick flip. The short-term loan can give the investor time to improve the property and increase the net operating income prior to seeking long-term financing. For loans where facilities are operating below stabilized occupancy (generally 80 percent), the best source of financing is a local bank. The typical down payment is 20 percent to 25 percent of the purchase price. The loan is normally recourse, meaning the borrower will be personally liable for the loan.
Long-term/permanent (5, 10 and 15 years): Go this route when refinancing a short-term loan or acquiring/refinancing a stabilized property (80 percent-plus occupancy). For long-term loans more than $1 million, the best source of financing is a conduit lender versus a bank loan. By definition, conduit loans pool similar real estate assets together and sell them to outside investors. This enables conduit lenders to offer lower rates, longer amortization periods and loans that are typically non recourse.
Conduit rates are based off the appropriate U.S. Treasury yield (the most common is the 10-year, now at 4.5 percent) as opposed to bank rates, which typically relate to the prime rate, currently at 8.25 percent (both rates are as of November 2006).
Most banks are able to offer a maximum of 20-year amortization while conduit lenders can offer amortization periods of 20, 25 and 30 years. A non recourse means that the property is the collateral and the borrower is not personally liable for the loan.
With lower rates and longer amortization periods, more cash flow is available to be returned to the borrower. The following table demonstrates the difference in payment between a typical bank and conduit loan. The cash flow lost by using a bank loan is over $60,000 yearly.
Several items are necessary for a conduit loan. Beyond the basic information regarding the property and borrower, the following items are generally required:
- The past three years of income statements on the property
- Monthly income statements for the past 12 months
- Current rent roll
- Occupancy history for the last three years and monthly history for the past 12 months
- Tenant delinquency report
- Insurance bill
- Tax bill
- Copy of the management agreement
- Site plan
- “As built” survey
- Borrower’s tax returns for prior three years
- Personal financial statement
- Articles of organization or incorporation
The lender will also order an appraisal, environmental and engineering report. This may seem like a large amount of due diligence, but it’s well worth the annual savings a conduit loan can provide.
When acquiring or refinancing a self-storage facility or any commercial real estate, evaluate all of the financing options available. This is the easiest way to prevent cash flow loss and create value as an investor.
Matt Lexow-Gray is a senior loan originator with S&W Capital and Realty, a boutique mortgage brokerage firm that strives to find solutions to borrowers financing needs. For more information, call 888.525.9081; e-mail email@example.com; visit www.sandwcapital.com.