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Self-Storage Financing Forecast: Headwinds Will Stiffen for Borrowers

By Neal Gussis Comments
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While the 2008 financial meltdown created stormy conditions for commercial real estate owners and lenders nationwide, the climate in the self-storage industry has been relatively mild, with a nice wind at our backs. With high occupancy rates and increasing rents alongside numerous attractive financing options, facility operators have seen their investments appreciate in recent years. Many have exploited low capitalization (cap) rates and sold their properties for great returns, while others have expanded and developed new sites. Many have also refinanced their loans to lower rates and recapture some equity.

Except for new-development financing, there have been few post-recession headwinds when seeking appealing loan alternatives, but don’t expect this calm weather pattern to last indefinitely. There are clear indications that atmospheric conditions are changing within the industry and the capital markets. This will affect your financing and refinancing options. Here’s how.

New Construction

A void occurred in self-storage supply when virtually no new properties were constructed during the height of the recession (2008 to 2011). During the last five years, however, high purchase prices for existing properties and solid anticipated returns for development projects have contributed to the industry’s expansion, with new facilities appearing steadily since 2013.

A governing factor for new construction has been a conservative lending community, which continues to use its discretion when financing developments. Because underwriting standards closely scrutinize any project sponsorship’s financial strength and experience, most of the new supply coming online is being built by existing operators.

The storage industry has enjoyed an expansionary cycle, which many believe will start leveling off in 2018 or 2019. The self-storage real estate investment trusts (REITs) have all reported that year-over-year revenue increases are now receding in many key metropolitan areas. A few markets are even down year over year. Notably, the REITs have also reported offering more concessions and discounts to lure new customers. On a brighter note, they’re all still reporting near-peak occupancy levels.

Construction financing is again becoming more difficult to obtain. There are two primary reasons for this: First, lenders need to maintain balance in their financing portfolios, and in many cases, the construction “bucket” is now full. Second, with this being the fifth year of the current expansion cycle, they’re more closely examining new and prospective competition when offering terms for development loans or refinancing.

Interest-Rate Movement

Historically, the Federal Reserve has used the Federal Funds Rate to stimulate, maintain or slow economic growth. Fed comments and actions have heightened expectations that there will be three rate hikes in 2017, with two 0.25 percent hikes already occurring in March and June. In mid-August, the Fed’s target fund rate was 1.25 percent, with indications it would increase to 1.50 percent when the next rate hike is implemented by year-end.

The Prime rate and LIBOR indices move in sync with the Federal Funds Rate. In August, Prime was 4.25 percent, and the 30-day LIBOR was at 1.23 percent. Both are expected to rise 0.25 percent by year-end as well.

While there are many factors to consider given the capital markets’ dynamic nature, the knee-jerk reaction to the Fed’s decision to raise rates will be higher costs of funds and steeper borrowing rates.

Variable vs. Fixed Rates

To hedge against these rate increases, many storage owners have locked into fixed-rate financing during the past decade, since mortgage rates have hovered at historically low levels. Simultaneously, others have capitalized on favorable variable-rate terms that have been even lower than many fixed-rate options.

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