A self-storage owner who is overleveraged in today’s finance market may be concerned about the fate of his property. The good news is there are options available that will allow him to retain both ownership and control of his asset. Read on for self-storage debt-restructuring solutions.
Most commercial real estate investors are well aware of the financial turmoil that has occurred over the past several years. However, it may still come as a surprise to learn that despite the signs and sentiment of an apparent “recovery,” there are currently more than $60 billion securitized loans in some stage of actual default. Moreover, if one assumes there’s a similar amount of defaulted portfolio loans being held by banks, insurance companies and other financial institutions, the sum quickly escalates to nearly $120 billion of defaulted loans in the commercial real estate market.
Although that number may be astounding, many industry experts estimate the amount is even greater. In fact, from the time the recession began to the present, the amount of CMBS (commercial mortgage-backed securities) loans in default went from less than 1 percent of total loans outstanding in 2007 to more than 9 percent in August 2011, according to Trepp LLC, an independent provider of loan and commercial real estate information.
Perhaps of greater concern, the number of CMBS loans scheduled to mature between now and 2017 is estimated at more than $400 billion. When adding the life-company, bank and government-sponsored enterprise products maturing, that number doubles.
Leverage: The Root of Current Evils
The driving force behind the current problem relates to leverage, and perhaps the most serious issue facing commercial real estate investors today is the potential equity gap between the value of their property and the amount of their outstanding debt. According to Moody’s/REAL Commercial Property Price Index, in this recession, commercial real estate values have dropped by as much as 40 percent across the board from their peak in 2007.
Since it was not uncommon for commercial real estate assets to be purchased with an 80/20 debt-to-equity ratio, one does not need to be a mathematical genius to figure out that in light of post-recession valuations, assets may be worth much less than the outstanding debt amount. In fact, based on current estimates, it’s conceivable that up to two-thirds of all loans currently scheduled for maturity will not qualify for refinancing at an amount required to pay off the existing debt.
Illustrating the Problem: Practical Examples
A portfolio of storage assets generating $1 million in net operating income (NOI) five years ago, valued at a 7.5 percent cap rate, would have been valued at roughly $13.3 million. This portfolio would have likely qualified for debt of around $10.6 million in loan proceeds at 80 percent loan to value (LTV). If we assume the loan was interest-only with a five-year call, a very realistic note in the glory days of commercial real estate finance, and that the maximum available leverage in today’s market lies at 70 percent LTV, a proceeds shortfall at refinance of roughly $1.3 million emerges.
If we take this analysis a step further and assume there’s been some stress on the asset during the recession, resulting from either a deterioration of cash flow or an increase in cap rate, the magnitude of the shortfall can escalate rapidly. In this stressed example, let’s assume a pretty realistic increase in cap rates of only 50 basis points. This minor increase, combined with the new available 70 percent leverage, inflates the proceeds shortfall to almost $2 million that will be needed to refinance the portfolio.
Although generic, these types of scenarios are very realistic because they illustrate the situation that many property owners, self-storage or otherwise, currently face. This can present a significant problem, as many owners don’t have the equity at their disposal that will be required to recapitalize the transaction. Candidly, an owner faced with this predicament is undoubtedly in a tough spot. However, depending on the specific situation, there are likely options available.
The magnitude of equity erosion often dictates the options available to the borrower. If the equity erosion is contained and there’s cash flow available to service the debt, the simple subordinate debt options can present a pretty straightforward solution for filling a short-term equity gap. In cases where equity erosion is more severe, however, a complete restructure of the debt may be a more viable solution.