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Insight to Self-Storage Real Estate in 2008

Michael L. McCune Comments

The first month of 2008 was beset with significant financial and political "rock-n-roll." If you are like me, much of it doesn’t seem to fit into a neat package and signifies what the rest of the year will bring. However, if you will indulge me, I will give you two thoughts on the self-storage real estate market that will hopefully provide some perspective for you to ponder.

The Credit Crunch

The sub-prime residential loan debacle has caused problems in the commercial real estate world as well. It was clear the commercial underwriting standards (how lenders value properties and how much they lend) were quite loose by most historic patterns in late 2006 and early 2007. It was a great time to get a real estate loan, as rates were low and loan proceeds were high.

In late 2007, the rating agencies began to tighten underwriting. The largest source of funds for commercial mortgages came from Wall Street firms, which created commercial mortgage backed securities (CMBS) loans that were repackaged and sold to investors. In late summer 2007, loan underwriters decided commercial loans were too generous in terms of loan proceeds and values were overestimated.

Sound familiar? At present, the problem is not nearly as serious as the residential situation, but no one is certain what will happen if the credit crisis becomes worse. This situation has also affected values of commercial real estate as cap rates have generally increased by about 1 percent (from 7 percent to 8 percent, depending on locales).

With the change in underwriting trends and the general concern about mortgage-backed securities, the CMBS market for funds has now become dramatically less available to real estate borrowers. Life insurance companies and many banks have stayed in the lending game for commercial properties, but they are being very conservative about valuations, projections and loan amounts.

The good news is loan interest rates haven’t changed much since the "good old days" of early 2007. This is because a lot of money has been invested for safety reasons in U.S. Treasury securities and the Fed is lowering the discount rate driving down rates on the benchmark 10-year Treasury bond. The dark side of the situation is that the risk spreads (the amount that lenders add on to the T-bill rate to get the loan interest rate) have gone up dramatically. Over the last year, spreads have gone from about 1.2 percent to about 3 percent at the time this article was written.

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