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2018 Debt Forecast: The Lending Climate Remains Clear for Self-Storage Borrowers

By Shawn Hill Comments

Editor’s note: This article was written in October. Due to the dynamic nature of the financial markets, the information presented could be subject to change.

Last year was strong for self-storage borrowers, and while it feels like we’re nearing the later innings of a predictable 10-year cycle, we’re heading into 2018 on solid footing. Decade-old loans are refinancing at historically low interest rates, and there are plenty of debt products to meet myriad rate, term and structural needs for acquisitions, refinancing and even new construction.

As always, it’s possible that unforeseen global events will fundamentally shift the economic landscape in unpredictable ways. Absent such factors—which go beyond the scope of this article—borrowers aiming to lock in longer-term debt and insulate themselves from potential rate increases should find many attractive options this year. Following is a summary of the common debt products available.

Small Business Administration (SBA) Loans

SBA loans have been available for self-storage since 2010, but have proven especially beneficial to owners in non-primary markets where traditional financing may be more difficult to find. They’re also useful for those looking to eclipse conventional leverage standards of 75 percent loan-to-value (LTV) or wanting to construct properties during this development cycle. There are two programs available for self-storage borrowers:

SBA 7(a). These loan proceeds can be used for acquisition, refinance and construction. Though loans through this program are typically variable-rate, commonly structured with a prime-based rate that resets quarterly, some lenders offer fixed-rate pricing. In either case, 7(a) loans are fully amortizing on a 25-year schedule, and they open to prepayment after the third year.

SBA 504. These loans are slightly more complicated in structure and are compartmentalized between a first lien, second lien and the owner’s equity. More specifically, a local bank provides the bottom 50 percent of the capital stack in the form of a first lien at conventional rates and terms. The second lien, up to 40 percent of additional project funding, comes from an SBA 504 loan, which is made available through a Certified Development Corporation (CDC). This component offers borrowers a low 20-year fixed rate (debenture rate) that carries a prepayment penalty for the first 10 years. When combined, the blended rate for borrowers is very attractive.

Historically, 504 loans were limited to acquisitions, but as of 2016, the SBA began offering a refinance option. These loans are available up to $13 million (potentially more) and can be structured with both a fixed- and variable-rate component. The 504 program also allows for construction, which makes larger class-A projects a reality through the SBA.

All-in rates for both 7(a) and 504 programs vary from lender to lender depending on a multitude of factors such as leverage, borrower profile and project strength. Borrowers should be aware that the processing, underwriting, approving and closing for an SBA loan can be time-consuming due to the document-heavy nature of any federal program. They should also expect to pay guarantee fees up to 3 percent of the loan amount, in addition to other closing costs customary with real estate transactions.

Overall, access to SBA financing has proven to be positive for the self-storage industry, injecting an additional source of capital and liquidity into the market.

Commercial Banks

Commercial banks are the largest originators of real estate loans, so it shouldn’t surprise us that they’ve been the primary source of capital for many self-storage owners. Banks are relationship-driven lenders that can meet a variety of borrower needs, ranging from shorter-term capital for construction, acquisitions or refinancing to longer-term, permanent debt.

The current regulatory climate means borrowers should expect an extensive credit review analyzing global cash flow (full financial picture), net worth and liquidity. A borrower’s ability to obtain a bank loan and the terms offered may be driven by the strength and tenure of his existing relationship with that bank. Regardless, he should be prepared to place operating accounts and other depository relationships with that bank.

Bank interest rates are attractive but vary greatly depending on factors such as loan term, borrower strength, leverage, etc. In October 2017, rates ranged from 3.5 percent to 5 percent on a fixed- or floating-rate basis on loans with terms from one to five years. To stay competitive and win deals, banks are increasingly offering seven- and 10-year fixed-rate term loans at competitive interest rates, often using a swap agreement. Bank amortization schedules are typically on the conservative side at 20 or 25 years, with leverage available today up to 75 percent LTV.

Banks typically require personal-recourse guarantees on almost all loans; however, the amount of recourse may be reduced or eliminated for lower-leverage loans under 65 percent LTV. Transaction costs for bank deals are generally very reasonable, and prepayments can be negotiated on a deal-by-deal basis.

Credit Unions

Credit unions have become an increasingly relevant financing source following the financial crisis. They’re like banks but with several notable differences.

First, whereas banks tend to be extremely relationship-driven, credit unions are more transactional in nature. Second, while most banks prefer to lend within a designated footprint that largely follows its presence or with existing clients, credit unions will lend nationally and often to a borrower with whom it has no pre-existing relationship. Credit unions are also cash-flow lenders and aren’t equipped to handle the complexities of construction or other transitional deals that may require draws, interest-carry, etc.

Commercial Mortgage-Backed Securities (CMBS)

CMBS loans are designed to be longer-term and offer a non-recourse debt option for five-, seven- or 10-year fixed rates. They typically feature amortization schedules up to 30 years, often with an interest-only period during the initial term. They also allow borrowers to leverage up to 75 percent LTV in a first-mortgage position.

CMBS lenders prefer larger deals in primary markets but are also competitive for smaller transactions in secondary or even tertiary markets. Rates on CMBS products today are between 4 percent and 5 percent.

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