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The Self-Storage Financial Climate: Strategies to Keep Cool if Rates Heat Up

By Shawn Hill Comments
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Interest rates can be a lot like the weather: difficult to accurately predict. I’ve lived in Chicago my entire life, and if someone had tried to bet me that I would be wearing shorts and golfing in mid-February, I would’ve taken a large wager and chalked up the opponent’s delusional optimism to a case of the Winter Blues.

Thankfully, I didn’t make such a bet. If I had, I would’ve lost big. Surprisingly, for almost a week in February, the temperature in the Windy City hovered around 65 degrees, topping out above 70 one day. I certainly didn’t see it coming, and it’s now abundantly clear that I have no business forecasting the weather.

Given my profession as a mortgage banker, I’m probably better suited to predicting interest rates for the self-storage industry. But I learned long ago there’s no upside in trying to forecast such a thing. Even the most seasoned economists can’t accurately estimate the speed and magnitude at which rates will change. There are simply too many complicating factors that can and will affect the outcome.

After many years of smooth sailing on the seas of self-storage finance, with historically low rates and little volatility, real estate investors are now left wondering what the future holds and how pending changes might impact their portfolios. Between the presidential-election outcome and indicators from the Federal Reserve, they know low rates likely can’t last. What might that mean for self-storage borrowers in the year ahead?

Headwinds Predicted

In 2015, the Federal Reserve began to signal that incremental increases were on the horizon. Yet between 2015 and 2016, there were only two modest 0.25 percent rate increases, both at the end of each year. This year, the federal funds rate is likely to continue rising, but it’s important to remember that the benchmark index is only one component of a borrower’s cost of funds; the other component is the risk premium spread.

Much like with broader weather patterns, to gain proper perspective, it’s often useful to revisit the past as a point of reference. Notably in 2007, the average all-in mortgage rate for self-storage assets originated via commercial mortgage-backed securities (CMBS) loans was roughly 6 percent. At the time, the corresponding federal funds rate ranged from 4.25 to 4.75 percent, and the 10-Year Treasury ranged from a low of 3.88 percent to a high of 5.12 percent over the course of that year. Comparatively, a sample of CMBS loans originated in 2016 had an average coupon of 4.8 percent, with the fed funds rate at or around 0.25 percent, and a corresponding range of 1.37 percent to 2.59 percent for the 10-Year Treasury.

 

2007

2016

Average CMBS Coupon

6.0%

4.8%

Average 10-Year Treasury

4.63%

1.84%

Implied Spread Premium

1.37%

2.96%

Sources: DBRS Group of Cos., U.S. Department of Treasury

This clearly illustrates the inverse relationship between the forces that affect risk premium spread and the underlying indices that have generally existed through time. The good news for borrowers is CMBS spreads clearly have room to come in as the Fed considers rate increases, and the benchmark indices for CMBS (treasuries and swaps) respond accordingly.

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