By Casey McGrath
So you have a relationship with Bob the Banker in town, and Bob’s agreed to finance your self-storage facility for five years at 5 percent. You know Bob, so you trust him; but the reality is he likely is not giving you the best rate and terms available in the market.
The hard truth is rate and terms matter. Your monthly loan payment is likely your largest expense, and it greatly affects the cash going into your pocket when all the bills are paid. So if you’re not shopping your loan, you’re giving a lot of extra cash to Bob and his boys down at the bank. Let’s explore why and how you can change this outcome.
Competition: Rates and the Amortization Period
If a banker knows he’s the only one touching your loan, he’s not nearly as motivated to lower his rate to what may be considered local market interest rates. One way to counter this is to put together a professional document with three years of property-level historical profit-and-loss statements or tax returns, an occupancy report, and a personal financial statement for all sponsors on the loan. This package can then be “shopped” to several local lenders.
Talk to three to five loan officers and you’re likely to get a wide variety of interest rates, amortization periods and loan fees. At the end of the day, it matters. Consider this example: You have a $1 million loan coming due. The banker with whom you have a relationship offers a five-year quote at 5 percent with a 20-year amortization. A competing lender offers a five-year loan at 4 percent with a 25-year amortization. Over the course of five years, that lender will save you nearly $80,000.
This is scalable, so shopping a $2 million loan would save you about $160,000 in this scenario. That’s real money by any standard. No wonder Bob the Banker has been so friendly.
Term: The Importance of 10-Year Money
Most local banks offer three- and five-year term loans, and occasionally they’ll go to seven and 10 years. There are several non-bank, non-retail lending outlets that consistently lend 10-year money, including commercial mortgage-backed security (CMBS) lenders and life-insurance companies.
Getting a 10-year loan is beneficial in several ways. First, it pushes your interest-rate risk out 10 years rather than just five. Given today’s rates, it’s hard to imagine rates going lower in five years. Because of inflationary pressures, the likely end of quantitative easing by the federal government, an improving economy and the demand for capital, it’s very conceivable that rates five years from now will be higher than today. A five-year loan exposes you to the market rates in five years, while a 10-year loan pushes that risk out to 10 years.
Second, there’s appraisal risk. Many self-storage owners experienced this firsthand as capitalization (cap) rates jumped in 2008 and 2009. Those looking to refinance were sometimes not able to get financing up to the outstanding loan balance due to depreciation in value, and therefore, had to inject additional equity into the deal at refinance. A 10-year loan offers more time for properties to regain their value should there be a market correction, diminishing the likelihood of a necessary capital injection.