The current view from the street (summer 2008) is pretty grim. One only needs to browse daily business headlines to recognize the severity of the nation’s economic situation.
The “credit crunch” has gone from Wall Street to Main Street, and is leaving the road littered with potholes and other obstacles for borrowers and investors to navigate. While this view isn’t the greatest, self-storage owners and investors can survey the landscape by examining a few key sectors of the current real estate finance market, gaining valuable knowledge to help make educated and powerful investment decisions.
Fannie Mae and Freddie Mac
Fannie Mae and Freddie Mac are shareholder-owned mortgage finance companies charged by Congress with supporting the U.S. housing sector by keeping money flowing in the mortgage markets. Due to congressional charter and an implied government guarantee, the two are often referred to as government-sponsored enterprises.
Fannie and Freddie are the cornerstones of the residential mortgage market. Including investments and guarantees, Fannie Mae’s total business topped $3 trillion for the first time in May, while Freddie Mac had $2.2 trillion. These two firms are involved in nearly half of the U.S. residential mortgage market.
Stock prices for both companies hit 52-week lows in July as market speculation predicted the government was poised to step in to help resolve major funding problems. To illustrate the magnitude of the decline, consider that shares of Fannie Mae traded as high of $70.57 in July 2007 and dipped to the $7 range by July 2008. Meanwhile, Freddie Mac shares, which hit $67.20 in the summer of 2007, plunged to the $5 range a year later. Fannie and Freddie have reported more than $11 billion in losses since the housing market bubble burst in mid 2007.
Banks and Financial Institutions
Global banking and financial stocks have fallen sharply in the last year due to the credit crisis. Bear Stearns no longer exists; Wall Street mainstay Lehman Brothers (at the time of this writing) was looking at long-term survival options given its plummeting share price; IndyMac Bank failed and was taken over by the Federal Deposit Insurance Corp.; and other national and regional banks faced similar fates as IndyMac. RBC Capital Markets analyst Gerard Cassidy was quoted by Reuters saying that as many as 300 banks could fail in the next three years.
For the past several years, the commercial mortgage-backed securities (CMBS) market drove record transaction activity (property sales and refinancing) for all types of commercial real estate, including self-storage, through widespread availability of aggressive debt terms. That market, however, has come to a screeching halt during the credit crisis.
Consider that the annual CMBS fixed-rate conduit loan volume from 2005 to 2007 was $136 billion, $161 billion and $189 billion, respectively, according to Commercial Real Estate Direct. Self-storage lending accounted for $6 billion. Progress achieved during this three-year period allowed the self-storage real estate market to reach previously unforeseen pricing levels as cap rates compressed in the face of aggressive debt.
In contrast, through the first six months of 2008, total CMBS volume nationwide dropped to $10.7 billion, most of which was carry-over volume from loans originated in 2007. There has been little, if any, new CMBS loan production thus far in 2008.
Knowledge Is Power
Indeed, today’s view isn’t the rosiest. The straight facts are the economy is a mess and the average storage owner or investor can do little about recessionary fears, rising energy costs or the state of financial markets. But what they can do during this time is continue to gain knowledge and understanding.
Quoting Sir Francis Bacon: “Knowledge is power.” With knowledge and understanding of the situation’s magnitude, you can apply constructive energy into developing powerful strategies to ride out this economic turbulence. Below are six suggestions to survive the storm.
Understand the current market and have reasonable expectations about deal terms. If you are a self-storage property buyer, apply reasonable debt parameters to the transaction and bid the purchase accordingly. Conversely, if you are a seller, understand the implications that current debt parameters have had on cap rates. If possible, try to avoid spending valuable time, money and resources on a deal that will need to be re-tooled, or worse, might collapse from foreseen events.
If you are well capitalized, the time may soon arrive for bargain shopping. Storage buyers who were aggressive three years ago and took short-term debt positions may be overleveraged, creating potential opportunities to partner with or buy these individuals out of their equity positions. Also, look for opportunities to buy bank-owned real estate for little more than the existing note balance, as banks scramble to recapitalize foreclosed deals.
If you are assuming an existing CMBS note, you might be able to exceed the available loan-to-value ratio in the current market and get in to deals with less than the typical equity requirement. For example, consider a deal made at full leverage two years ago with a couple years of interest-only payments. Even if this transaction’s value has slipped on the asset, the outstanding loan can typically be assumed. You will need to work with the loan servicer to assume the debt, but if you can negotiate a favorable purchase price from the borrower, it might result in an advantageous position where the equity contribution going in is minimized.
If you are a seller with a recent vintage CMBS loan in place, you may be able to capitalize on the tremendous rates and terms in place on your asset. If there was an initial interest-only period on the loan, or even if you just have a 30-year amortization, it is likely that little to no amortization has occurred on the debt in the past couple of years. When marketing your property for sale, make sure you understand and highlight the positive impacts it can have on the deal; aggressive rates and terms in place are an asset that will potentially allow the buyer to step into a financing package that is more aggressive than the current market’s offerings.
If you have a loan coming due in the foreseeable future, get started on refinancing and allow plenty of time. Due to a myriad of factors, lenders have been segmented in this market. It can certainly work to your advantage to shop for the best terms. Equally important is to know when to stop shopping for financing. This is not a market where you need every last basis point on a rate. Certainty of transaction execution is what is paramount.
If you do need to transact in the current market, consider short-term financing. The yield curve has taken a more traditional shape, which means the longer out you go, the higher the rate will be. Also, by accessing a short-term deal, you can revisit the loan in just a few years. Hopefully, then, the markets will have stabilized and can present more compelling long-term loan options.
Shawn Hill is a senior vice president with Beacon Realty Capital. To reach him, call 312.207.8237; e-mail firstname.lastname@example.org.