By Anita Huedepohl
We’ve all heard the expression “rob Peter to pay Paul,” but what if Peter’s not home? That may be the way people feel in today’s economic times. With an historic number of foreclosures, both commercial and residential, it’s sometimes hard to remember how things used to be and how we can plan to get back there.
All businesses operate based on profit and loss, commonly called P&L. There’s a natural ebb and flow to how funds arrive on your doorstep, are processed and ultimately end up in your pocket. It’s much like a great recipe for your mom’s chocolate cake—it will not taste the same unless all the ingredients are added at just the right time and in just the right amounts. Although it’s much more complicated than that, the principle is the same.
Self-storage operators are often confused about the difference between gross and net revenue when it comes to annual profit. They’ll say, “We made $875,000 last year!” My response is usually, “Great. Is that net or gross?” Ninety-nine percent of the time, you can hear the crickets as the client tries to explain why he told me the gross rather than the net. It’s always a case of “We netted $250,000 on our $2.9 million proposed refinance.” For some reason, people don’t want to go with the bottom line, and yet that’s what we need to see to get the funds they require. Lenders don’t look at gross, they only look at net operating income (NOI). That’s not to say we can’t work with those figures if we use the right amortization schedule and lock period.
That leads us to the right product for the right property. It may surprise you that sometimes the lowest interest rate is not in the facility owner's best interest. Those low, low rates are often for very short periods of time and can really tie up your cash flow if you don’t read the fine print, which often states the rate is going up in 90 days to a range that’s going to tie up all of your “net.”
When borrowers ask me, “What’s your lowest interest rate?,” I automatically know they may not be aware of all the factors that affect the product they think they want. It’s my job to shed light on what may be best for their property, given the NOI, debt-service coverage ratio, property value and use of proceeds, if any.
For example, I recently worked with a storage owner who had a 6 percent interest rate. Sounds fair, doesn’t it? He was looking for a rate in the 3 percent range, which is not attainable in commercial lending. I explained that residential and commercial lending are at completely opposite ends of the spectrum and priced very differently. He said he was having cash-flow issues because although the interest rate was 6 percent, it was based on a 10-year lock. A lock is the amount of time a lender will keep your rate at the terms it provided. It’s often confused with amortization, which is the number of months a lender uses to calculate the monthly payments. Let’s compare some loan scenarios for him.
Not only can we cut the payment nearly in half and free up his cash flow for improvements, building a new group of buildings or paying down the existing debts of the business, he no longer has to “rob Peter to pay Paul” every month. The best part is there’s no prepayment penalty. This means the operator can pay down the loan each year or pay it off early if he desires.