Navigating the closing process in today’s self-storage market hasn’t exactly been smooth because of recent capital markets fluctuations. But the closing process can certainly be more streamlined if a buyer takes the proper precautions and performs the necessary due diligence related to the transaction.
While the letter of intent and contract in a self-storage sale are still primary steps in the closing process, underwriting has become much more stringent than it was three years ago, or even one year ago. Lenders who agreed to finance self-storage facilities in the second and third quarters of 2007 are having a difficult time fulfilling their commitments.
The ability of lenders—particular conduit lenders—to finance storage properties has greatly decreased. Following the sub-prime mortgage crisis, the conduit-loan market all but dried up, and alternative sources are taking over. In addition, a number of investors are borrowing from local banks, regional banks or life-insurance companies. In most cases, banks or life-insurance companies can expedite a loan closing faster than the troubled Wall Street conduits.
Local and regional banks are taking advantage of this opportunity to gain market share, and some are offering loans without prepayment penalties. A variety of solutions are being implemented with these lenders to facilitate transactions, including seller carryback, bridge debt, short-term variable debt and assumable financing.
Overall in the commercial real estate market, some risk premium has returned, with cap rates expected to rise by an average of 20 to 50 basis points by the end of 2007. Higher-quality assets in strong markets, and those with assumable or seller financing, will be affected the least. Market-wide, while increased borrowing costs and limited price appreciation will put upward pressure on cap rates, a dramatic correction is not expected.
Looking at current investment trends, self-storage buyers and lenders have become more discerning, causing a greater distinction in cap rate and pricing trends based on quality and location. Lenders have become more selective, showing a strong preference toward historically tight markets and top-quality properties that can show current strong occupancy and rent growth. Local market factors play a much more critical role once again, as opposed to the broad-based cap rate compression from 2001 to 2006.