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A View From the Street: Keeping Your Balance on the New Playing Field

Shawn Hill and Minh Tran Comments

We all know the business adage about how a level playing field allows for fair competition. Given 2007’s financial turmoil, the turf for self-storage real estate financing and property transactions is still level, but at a dramatically different point of balance than what many owners became accustomed to in recent years.

With this new game, we’re all confronted with the same difficult market conditions, so it’s not a question of whether anyone has an unfair advantage, but rather how each of us copes with the current environment. Thriving on this redefined field will require property owners to readjust their points of equilibrium and gain their balance as market shifts continue to redefine how we conduct real estate-related transactions.

New Rules of Engagement

Last year’s credit-market turmoil has led to new, much more conservative rules of engagement for storage owners. Become familiar with these redefined rules, because they’ll ultimately affect how you operate your business and plan future investment strategies.

Wall Street has redefined the “best practices” of underwriting commercial real estate by reverting to more conservative historical norms. Gone are the recent halcyon days of lending on projected cash flows, interest-only underwriting, high-leverage first-mortgage debt, and lax debt-service-coverage (DSC) standards. Going forward, the more conservative measurements of in-place rents and historical cash flow will reign supreme. Investors will also need higher levels of old-fashioned equity and bottom-line cash flow, as lenders will strictly adhere to 75 percent to 80 percent loan-to-value (LTV) standards and 1.2x DSC constraints.

The risk profile on debt capital has also changed, resulting in wider credit spreads by at least 100 basis points on average. Further, there’ll be a clear differentiation between short-term bridge loans and long-term permanent debt, as lenders will segregate these products using leverage, pricing and deal structure.

For self-storage owners, the overall math is pretty straightforward: More equity and more expensive debt equal a higher overall weighted cost of capital.

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