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2017 Financial Planning: Loan Types and Options for Self-Storage Owners

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By Adam Karnes

Historically low interest rates coupled with strong operating fundamentals equate to readily available mortgage capital for self-storage owners who seek financing. Those aiming to lock in longer-term debt and insulate themselves from prospective rate increases will find a number of attractive options in the market. Following is a summary of some common debt products available for borrowers.

Local and Regional Banks

According to data compiled by the Mortgage Bankers Association (MBA), the dollar volume of commercial bank originations through the second quarter of 2016 was up approximately 33 percent year over year. As a result, banks and thrifts maintain their position as the largest holders of commercial and multi-family debt at nearly 40 percent of the $2.9 trillion outstanding. While this indicates strong commercial bank lending, there’s evidence that local and regional banks are experiencing a “lending chill” because of the regulatory scrutiny of real estate loans.

Local and regional banks are relationship-driven lenders that can offer very competitive interest rates. Borrowers should be prepared to place their operating or depository accounts with that bank and should also anticipate the bank conducting an extensive credit review.

Banks will lend up to 80 percent loan to value (LTV), offering terms ranging from one to 10 years, which amortize over 20 to 25 years. They commonly require personal-recourse guarantees, which can be scaled back or even eliminated at lower leverage. They typically aim to maintain transaction costs at a reasonable level, and owners can often negotiate prepayment provisions. Finally, the interest rate will vary based on the factors above, and the rate package is often executed through a swap agreement.

The CMBS Market

The commercial mortgage-backed securities (CMBS) market appeared to be finding its post-recession footing in 2015, which at approximately $101 billion of total U.S. issuances was the strongest year since the recession. The sentiment going into 2016 was it would be similar to and possibly surpass 2015. However, through October, issuance was down nearly 37 percent year over year.

Jamie Woodwell, vice president of commercial real estate research for MBA, has said the CMBS market is seeing far more loans paying off and paying down than new loans being originated. This is despite $232 billion in CMBS loans scheduled to mature in 2016 and 2017—affectionately labeled “the wall of refinances” by Trepp.

Furthermore, a new round of risk-retention measures took effect in December as part of the Dodd-Frank Act, which has already caused some choppiness in CMBS activity and may continue to do so. While commercial banks and life-insurance companies have stepped up to the plate and taken on some of the maturing volume, it stands to reason the balance sheets of these institutions will inevitably fill up. As such, a case could be made that the market needs a CMBS recovery.

While they’ll vary based on individual deals, here are some common CMBS debt terms:

  • Non-recourse loans
  • Leverage up to 75 percent (can increase with mezzanine)
  • Five- to 10-year terms
  • Fixed interest rate
  • Amortization schedules up to 30 years
  • Interest-only periods available
  • 8 percent debt yield minimum
  • Large primary-market deals preferred; may compete for smaller loans in secondary markets
  • Closing costs of approximately $50,000 all in; some lenders offer a fixed-cost option for $25,000 (excluding survey, title and borrower legal fees)
  • Prepayment typically yield maintenance or defeasance

The interest rate in CMBS transactions is calculated by adding a risk-spread premium to the “swap side” offering index. For example, a 10-year rate is found by adding the lender’s risk-spread premium to the 10-year swap. Therefore, with spreads in the 2.75 percent range (275 basis points) and the 10-year swap at 1.5 percent, the applicable rate on 10-year CMBS money would be 4.25 percent.

CMBS lenders are aggressive in nature and have historically produced extremely compelling quotes for self-storage owners, regardless of what the CMBS market might suggest. CMBS debt allows borrowers to lock in low rates for up to 10 years, and the loans are also assumable—both valuable hedges against rate increases. Assuming the industry can wade the regulatory waters and capital-market volatility, CMBS loans can present a very attractive piece of financing going forward.

Life-Insurance Loans

Life-insurance companies are another source of commercial debt for self-storage owners. According to the MBA’s “Quarterly Databook,” the second quarter of 2016 marked the second largest origination quarter ever for life companies. As such, these lenders account for 14 percent of all outstanding commercial/multi-family mortgage debt.

Insurance lenders allow borrowers to lock in longer-term rates on a non-recourse basis, similar to CMBS. However, unlike CMBS, life companies are extremely conservative and prefer to lend on high-quality stabilized assets in primary markets.

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