Anticipating the Refinance

The fall marks the season when many people focus on time ahead. The kids are back in school, summer vacations are over, and the days are getting shorter. This is the time when I start the house projects I put off over the summer.

Have you ever noticed the first 80 percent of a house project generally goes pretty smooth--it's the finishing touches that take the most time? Often, several trips to the hardware store are required to complete the project. One lesson I learned the hard way is when I take the time to anticipate potential problems and plan accordingly, I spend significantly less time hanging out at The Home Depot.

As all the articles you'll read in this finance issue indicate, it is a tremendous time to take advantage of the incredibly low interest-rate environment. Similar to my life's lesson with respect to house projects, it is worth taking time to focus and anticipate potential issues that may arise when applying to refinance your self-storage property.

Short-Term Rental Agreements

Since most lenders are used to dealing with commercial properties and longer-term leases, the concept of monthly rental agreements may be less familiar and therefore require some explaining. Consider that many of the larger self storage operators' reports that the average commercial user stays between 20 to 28 months and that the average residential user stays between eight and 11 months. There are many positive factors to having monthly rental agreements. First, month-to-month leases are minimized by the large tenant base, avoiding potential large and concentrated rollover often associated with commercial properties. Additionally, monthly leases allow the owner to adjust rents up or down to the market on a relatively elastic basis, giving the operator greater flexibility to consistently perform with the market. Finally, short-term leases do not rely on the credit of larger tenants.

Size Does Matter

When deciding which lender to choose, pick one that will be able to provide you the service you deserve. It is not advisable to go to a lender that will focus on deals significantly larger or smaller than your transaction. Most national lenders, specifically those who offer conduit loans, will usually avoid making loans less than $1 million. In fact, the minimum loan size for conduit lenders is often $2 million to $2.5 million.

There are, however, several conduit lenders who will focus on "smaller loans" through their small- or micro-loan programs. The loan size for most of these programs is between $1million and $3 million. Small-loan programs offer many benefits, including fixed processing costs of generally around $10,000, which includes lender legal, but not title, survey and financing fees. These programs also involve smaller transaction documents that may be more streamlined to process.


One factor lenders always consider when assessing the viability of a real estate project is demand. When it comes to financing, there are generally no steadfast rules regarding the size or make-up of the surrounding community. A lender will instead analyze the supply-and-demand ratio of the population in a one-, three- and five-mile radius, with the most emphasis generally based on the three-mile radius. This does depend somewhat on the size of the community, however.

For example, in smaller communities, additional supply may have a much larger effect on existing facilities then it would in a much larger one. Consider the following thoughts as guidelines: What are the barriers to entry to building additional product in your market? Does seasonality affect the demand of your occupants, such as college students, military personnel, or summer and winter occupants?

Expansions and Lease-Up Projects

Self-storage owners are conditioned to being in lease-up. The beauty of projects in this industry is their ability to phase in additional buildings as properties mature and stabilize. As soon as a property reaches a critical occupancy level--and assuming the land capacity exists--the next phase of buildings is usually under construction. Additional phases are typically financed as add-ons to the original construction loan or under separate loans for each phase. Regardless, when considering making a permanent financing arrangement, lenders will look at the historic performance of the property.

Whether or not you build a project in its entirety, the question invariably arises as to when is the right time to seek permanent financing. If you seek to optimize your loan, it is advisable to wait until the property reaches 85 percent to 95 percent of physical occupancy, and 80 percent to 85 percent of economic occupancy, based on current asking rents. Lenders calculate income on a trailing 12-month basis. Therefore, with a compelling, steadily increasing historic revenue pattern, aggressive lenders will use the most recent months to determine the loan size.

Older Properties

Older properties are often the most vulnerable to new competition for a variety of reasons. For instance, older properties were often built in industrial locations with marginal access and exposure. If you are the operator of an older property, consider the following: What have you done to keep your market share? Has the property really been maintained and updated recently?

Lenders will compare the quality of a facility to its competition when making a lending decision. If there are physical attributes that may be an issue prior to financing, take the time to fix them, or present a plan to the lender that addresses physical deficiencies with proceeds generated from the loan request.

Market Occupancy

Comparing your property to the rest of the market is an easy task that can be accomplished by answering two questions. Ready? The first question is: Have you been able to maintain or improve your occupancy? The second question is: Has your competition been able to maintain or improve its occupancy?

These questions are very important, because the lender will analyze current market occupancy to determine the occupancy that will be used for underwriting. If the general market has shown softening and vacancies are increasing, lenders will likely be more conservative in their underwriting. In certain circumstances, a shrewd operator can demonstrate that although physical occupancy has declined or remained steady, income has risen. Good management can often offset physical occupancy by increasing unit sizes that are more in demand or controlling expenses.

Net-Operating Income (NOI) vs. Banker's NOI

Truck-Rental Income. The most common adjustment to income made by lenders relates to truck rentals. In fact, most lenders will highly discount or plain not allow truck-rental income. The logic behind this is truck rental is more like business-generated income than real estate-generated income. Furthermore, from the lender's perspective, truck-rental income cannot be anticipated.

Real Estate Taxes. Often, the historical real estate tax number is not representative of the current or future tax liability. The lender will look to the taxing authorities to determine whether any adjustments to your historic real estate taxes should be made in its underwriting. If possible, include the most recent tax bill for the property as part of any loan package so the lender can refer to it, thereby helping to avoid any surprises.

Management Fee. For properties that are larger than approximately $750,000 in value, a lender will include an off-site, third-party management fee. This fee is in addition to any on-site management fee that may already be included in the property's historical operating expenses. Typically, this expense will be 5 percent to 6 percent of total collected revenue.

Insurance Costs. Today, the lender's underwritten expense will likely exceed the historic cost of the premium. Lenders look to what current insurance premiums are, regardless of the cost of the policy historically--mainly due to the fact the cost of insurance has increased significantly over the past year. In addition, it is important to remember the new insurance premium will be based on the new loan amount; therefore, if the loan on the property has increased, plan for the cost of insurance to increase.

Finally, if you are switching lenders, the insurance requirements may change, depending on the new lender's coverage requirements. In addition to paying more for insurance, the anticipated increase will be used by the lender to determine the stabilized operating income to be used when underwriting your loan request.

Conduit Loans

Loans that are to be securitized will have additional hurdles to overcome. In addition to maximum loan-to-value and minimum debt-service coverage requirements, a securitized lender will also stress the cash flow to achieve a stabilized basis. The nuances and subtleties relating to this topic could be the subject of a separate paper, but simply put, a loan application that states a 1.30 debt- service coverage based on the actual interest rate may, in fact, be misleading.

Read carefully when reviewing a loan application to determine if there are any debt-service requirements based on a fixed constant. The loan constant is the total amount of principal and interest to be paid annually, divided by the loan amount. A fixed constant, on the other hand, may be an artificial threshold put in place by the lender to protect against sizing the loan in an artificially low interest-rate environment.

Cash-Out: The Devil in Disguise

Cashing out is one of the great rewards of owning investment property. From a lender's perspective, however, large cash-out can mean increased scrutiny and the potential to cut loan dollars, thereby reducing some of the risk in the transaction. Consider the following: How long have you held your investment in your property? Are you going to recover part or all of your initial investment with a refinance? Are you receiving additional cash over and above your initial investment from your refinance?

Lenders are getting more conservative. If you are seeking to recover 100 percent of the initial cash investment or more, essentially removing your equity from the deal, the lender will need to get comfortable with the historic cash flow, as well as your property's ability to maintain its value. Some lenders will limit loans to a certain percentage of costs. Most permanent lenders will provide financing up to 75 percent of current value, but sometimes, on newly constructed properties, lenders become more conservative, especially in instances that provide the owner significant cash proceeds beyond his initial investment

Appraised Value

To say that interest rates are extremely low would be an understatement. For a stabilized self-storage property, the appraised value will largely determine how much borrowing capacity the property will support. Most lenders will typically lend up to 75 percent of the appraised value. This is not the only constraint lenders will consider, however, as they will also constrain the loan to a debt-service coverage of 1.25 to 1.35.

Without going into calculations, it is safe to assume that, under most circumstances, the loan-to-value will be the ultimate determining factor. Use the following as a guideline for estimating value: If your property is an A- or B-quality facility, divide the NOI by 9.75 percent, which is a reasonable cap rate for self-storage product in today's environment. This calculation will yield an estimate of value, 75 percent of which should be a reasonable loan request for the property.

Borrower Credentials

It is important to remember the property and its operations do not stand on their own. Like any good marriage, one half complements the other in terms of providing strength. It is important to present a package to the lender that is well-organized and documented with concise information highlighting your management capabilities. In comparison to the loan request, sound net worth and a reasonable amount of liquid assets will be evaluated in a positive manner. Whether the loan is recourse or nonrecourse, lenders like the assurance that the borrowers behind the project have the resources and wherewithal to withstand downturns or unexpected negative events.

Money is cheap right now. If you are considering pursuing a refinance in the coming months, it is imperative to develop a plan that will achieve your objective. Lenders may be more conservative than they have been in recent years, but they are always looking to provide funding for well-proven operators. By anticipating the potential issues, the loan process will inevitably go much smoother.

Neal Gussis is a senior vice president at Beacon Realty Capital Inc., a financial-services firm that arranges debt for self-storage and other commercial real estate owners. He has been actively involved in financing self-storage properties for nine years. He also serves on the Self Storage Association regional board of directors for the Central region. He can be reached at 312.207.8240 or [email protected]

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