By David Smyle
We’ve seen the beginning of a slow economic recovery this year, with occupancies increasing in most commercial-property types. This is not to say we’re out of the woods, however; the threat of a double-dip recession still looms, and weak economic numbers continue to rear their ugly heads. There’s great pressure on the economy, with unemployment above 9 percent and home foreclosures continuing. All this leads to talk that we’re not seeing the bottom yet.
The health of self-storage varies across the country, with factors such as overbuilding, job loss and even natural disasters affecting occupancies. Rent compression has hurt many properties’ cash flow and value, with discounts needed to secure tenants. But while some self-storage facilities have fallen to foreclosure and others are struggling, there are deals getting done. There’s still some hope as interest rates remain low, allowing for excellent finance opportunities.
New Loan Avenues
With all the bank consolidations, mergers, closures and straight failures, the availability of capital has certainly been restricted, but we’re light years from 2008 when lending virtually ground to a halt.
Revamped SBA lending. Probably the biggest assist for commercial real estate has been the revamping of Small Business Association (SBA) and U.S. Department of Agriculture (USDA) loan programs, which now allow for high loan-to-value (LTV) purchases and refinances on owner-user storage properties. With property values down as much as 50 percent in some areas, many loans with LTVs that were once within conventional tolerance levels now cannot be refinanced without a loan paydown or a bank extension of the current debt—even if exceeding their current LTV guidelines of 60 percent to 65 percent. For those owner-operated properties, the SBA has thrown out a lifeline, allowing up to 90 percent LTV refinances under the 7A or 504 programs (assuming they’re not refinancing another SBA or USDA loan).
Conduit lending. The conduit market, which had exited the financing arena completely, has returned with a new look. The new conduit loan typically has a $5 million minimum loan size, an LTV not higher than 70 percent to 75 percent, amortization at 25 years vs. 30 years, and rates well above the sub-5 percent lows we saw in the mid 2000s.
However, we’re beginning to see the return of small conduit programs, with a few now starting at $1 million; and rates are still good from a historical basis, under 6 percent fixed for 10 years. Underwriting is stricter than before, and a good cash flow and debt coverage ratio are essential.
Insurance companies. Insurance companies continue to provide excellent financing opportunities to well-occupied, -located and -operating properties. The unique competitive advantage insurance companies offer over most other lenders is the ability to structure long-term, low fixed rates, and self-amortizing and long-term low-fixed loans with long amortization programs. A 25-year fixed-rate program, whether straight or broken into several fixed-rate periods, is not uncommon for insurance companies to arrange.
The downside to this type of financing is the need for properties to exhibit higher standards than they would for a typical bank loan. Insurance companies normally like properties in larger metropolitan areas, ones that are made of better-quality construction materials as well as good access and visibility. They also usually underwrite to a cap rate, which may be higher than the appraisal to add another level of comfort.
Today, fixed rates for 10-year terms can be in the low 5 percent range with 25- and sometimes 30- year amortization. Although many insurance companies like larger deals of $5 million or more, there are a number that will go down to $1 million, and even a few that will do loans as small as $500,000. However, those loans typically carry a recourse requirement, whereas most other insurance-company loans are of a non-recourse nature.
Banks and credit unions. That leaves us with banks and credit unions to cover the portion of the market that conduit lenders and insurance companies don’t or won’t finance. Banking has certainly become much more conservative in the last few years with FDIC scrutiny, making life difficult for smaller institutions or those that are less than well-capitalized.
Many banks are cautious about making a loan with any weakness in underwriting, even though offsetting strengths would have mitigated weaker aspects under previous circumstances. Even borrowers with excellent balance sheets can be turned down because the property may have less than desirable LTV, occupancy, deferred maintenance, etc.
The banking world, quite frankly, is still running scared. But if you’re a long-time customer with a good track record, you stand a better chance of achieving a refinance, which may be out of underwriting guidelines. Expect most LTVs to be in the 60 percent to 70 percent range, with 75 percent LTV an exception through anything other than an SBA-type program. However, higher-leveraged SBA transactions may carry additional collateral requirements with them, which can often mean a second trust deed on a residence.