Anticipate the Future
As mentioned earlier, if the debt yield is less than 12 percent, there’s a good chance the deal may be over leveraged by current standards, meaning the debt will need to be paid down to get a new loan that meets current underwriting parameters. Although debt yield is a useful measure, it’s also critical to understand that when you refinance, the asset will be subject to a new appraisal, and the property value may have declined. Couple this with the lower loan-to-value ratios available to investors today, and there’s a strong possibility you may have a significant cash requirement to close.
If you’re an investor in this position, here are some proactive steps you can take to help make the best of a sticky situation.
Scrutinize your operating expenses. The old guideline in finance is that every $10,000 reduction in operating expenses will bring $100,000 in value to the bottom line using a 10 percent cap rate (for easy math). While it’s not advisable to cut expenses in areas critical to your business operation, always examine discretionary items. Recognize that these add up and impact bottom-line cash flow, and by corollary, your property’s valuation.
Reserve cash. If you believe there’s an equity gap, immediately begin reserving some excess cash flow from operation. Problem-solving can cost money, and if you’re forced to go to the market and respond to an equity gap upon refinance or sale, this strategy should provide at least some cash to help fill it.
Be proactive with your current lender. It’s crucial to contact your lender as soon as possible to discuss modifying or extending the current loan. In this market, it pays to be proactive and leave plenty of time to fully explore your options. Meeting your lender allows you to gauge his reaction and better understand available options. If successful, being proactive may allow for a workable solution that’s much better than being forced to sell or refinance with another lender.
Do your homework. Prior to contacting your lender, do your homework and arm yourself with relevant information. Talk with a qualified self-storage broker to better understand the property’s value and determine if selling is viable. In addition, a mortgage professional can give you a valuable underwriting opinion and identify potential refinancing alternatives. This proactive approach can demonstrate to the lender that a loan modification is the best scenario for all parties involved. After all, the incumbent lender is a partner in the current transaction.
Work With Your Lender
If your property has adequate cash flow to service its existing debt but still faces the possibility of a loan default and subsequent foreclosure, remember the loan’s non-performance is more likely due to current market conditions than the property itself or its owner/manager. Foreclosure is an expensive process for lenders, and they certainly don’t want to be property owners. If the underlying weakness is due to market conditions and not mismanagement, the lender may determine that the most economical solution is to modify loan terms with the existing owner rather than foreclose and be forced to manage or sell bank-owned real estate in a depressed market.