Alternatively, if you are selling your property, you may encounter a bid/ask spread where the offers might not measure up to your expectations in light of financing parameters driving the deal. In this market, it is ultimately the underwritten cash flow that drives the loan amount. When the dust finally settles on the cap-rate debate, loan dollars are more likely constrained by debt-service coverage as opposed to LTV.
Many storage investors could ultimately find themselves in a situation where there are not adequate loan proceeds available to refinance the current outstanding loan balance. Overlay this with the new leverage standards and tougher underwriting criteria, and it becomes fairly obvious there is an equity gap in the capital structure in many of these maturing deals that will need to be filled.
If you have a loan coming due or you simply want to complete a “quick and dirty” analysis to determine if your loan is overleveraged, you can easily conduct a “stressed loan constant sizing analysis” to gain a better perspective of where you stand and what a lender is likely to conclude. The nice part of this do-it-yourself loan-sizing technique is it eliminates any debate about cap rates from the equation.
Start the calculation by taking your outstanding loan balance and multiplying it by 10 percent. The result is the amount of your debt-service payment when using a 10 percent loan constant. Next, take your underwritten net cash flow (revenue minus expenses, not including debt service or depreciation) and divide by the debt-service number you calculated.
It's critical to use a bank underwriting methodology to derive the cash-flow number, which means you need to include a management fee, even if you do not have one. Your revenue should include a realistic market vacancy with operating expenses between 30 and 40 percent. If the debt-service coverage ratio (DSCR) on a 10 constant is less than 1.25, there is good chance you may be overleveraged.
The following example shows two loan scenarios and helps explain the mathematical calculation.
Obviously, there are many factors that make a real scenario much more complicated. We could debate endlessly about cap rates, values, available leverage points, etc., and I will be the first to admit every situation is unique and requires special examination. The purpose of the exercise is to help you consider your individual deals and provide a useful tool to quickly determine potential hurdles in any near-term refinancing.