This month, our roundtable of broker experts gathered to discuss the state of self-storage real estate in the Northeast. Lets hear what they have to say about their respective cities and regions. Our panel includes: Guy Blake, Upstate Commercial Group, Kingston, N.Y.; Linda Cinelli, LC Realty, North Branch, N.J.; Joe Mendola, NAI Norwood Group, Bedford, N.H.; and Chuck Shields, Beacon Commercial Real Estate, Conshohocken, Pa. My comments are in italics.
How are local self-storage lenders reacting to the so-called credit crunch?
Blake: Were seeing much tighter underwriting standards from the local lenders in Upstate New York and higher cap rates on the properties that are for sale.
Cinelli: Lenders are re-looking at many deals. Unless the facility is in a prime location with high occupancy, lenders look at the trailing 12 months of income and not the pro forma financials.
Mendola: The local New England lenders are being accommodating toward lending needs. They dont have the same loan-portfolio challenges of the larger national lenders. The whole sub-prime event has made everyone cautious, but good borrowers with strong signatures and well-thought-out projects have no problem.
Shields: Locally, our lenders seem to be following the patterns of most of the country in that interest rates still seem to be reasonable but lenders have tightened underwriting standards. Lenders have become more selective, require more detailed financials and look for more conservative pro formas. In many cases, they look for more equity in the deal.
The credit crunch is quite real and still has a long way to play out. While residential loans have been clobbered, commercial loans appear to be holding up well. However, a recession could negatively impact rents and occupancies. Given the loose underwriting of many recent commercial loans, theres certainly a possibility for the infection to spread. Luckily, self-storage has the lowest default rate of any real estate class, and most of the facilities we see are moderately leveraged.
CMBS lenders are becoming pickier about locations and total loan amounts. How is this affecting potential buyers?
Cinelli: Buyers are not as willing to accept a story about potential increases in rates and occupancy at the facilities theyre considering. Loan rates are higher; the buyers are looking at a minimum of 8 percent on their return before debt.
Mendola: Yes, CMBS lenders have the Wall Street affect to deal with. Even though the one-year T-bill is a full 100 basis points lower than it was six months ago, the credit spreads have widened to the point that the rate for leveraged deals is 75 to 100 basis points higher than it was last summer. Under leveraged deals of 60 percent to 70 percent seem to fare better than the 75 percent to 80 percent deals. These lenders do not seem to be in a real hurry to get their money back out on the street.
Shields: As the CMBS lenders change their attitudes, philosophies and standards about lending, the buyers attitudes also change. A lot of buyers are now looking to more class- A locations and facilities because they give them the best opportunity to get funding. On the other hand, there are a number of buyers who are eliminated. These buyers would look to acquire class-B and -C facilities, but now cant meet the lenders standards or they dont have the cash for deals that require additional equity.
You can be sure that any deal that is made by a CMBS lender today is getting big-time scrutiny. As Mendola says, the days of unlimited leverage are gone! Thus loan-to-value ratios are probably the most important thing lenders look at when underwriting today.
Given the unsettled investment markets, how are buyers and sellers reacting?
Blake: Buyers have reacted immediately and are looking for lower risk and higher cap rates than they were a year ago. Sellers, not surprisingly, seem hesitant to admit that the days of doing 8 cap on pro forma deals are over. At the moment, there seems to be a wider gap between buyers and sellers because buyers have adjusted to the changing market, but many sellers have not.
Cinelli: Many buyers are looking for self-storage projects to purchase, but the frenzy is over. The properties need to meet higher expectations than ever before. Sellers whove been in the business for a while are becoming disillusioned and are looking to get out of self-storage, finding that the business now is not exactly what they bargained for.
Mendola: In this unsettled market, sellers and buyers seem to be acting in a usual way when the market begins to turn. Sellers want the valuations of six to nine months ago and buyers want to buy at a value that is reflective of these uncertain financing markets.
Shields: Both buyers and sellers look at the economy and the financing market a little differently. The buyer sees the economy?especially the housing market, on which self-storage is so dependent?and wonder, if he bought or developed a facility, could he stabilize it? How long would it take, and could he keep it stabilized? The conditions for financing are a whole other set of concerns. Sellers find themselves with devalued properties, fewer buyers in the marketplace, and buyers with difficulty finding financing.
Buyers potential profit has been reduced by higher loan rates and low leverage, so they need more return from the property they are buying. Buyers are also figuring in more risk in the cap rates than in the past.
What impact have the credit problems had on cap rates in your area?
Blake: Cap rates are up easily 100 basis points except, perhaps, on large class-A facilities.
Cinelli: In past years, buyers were more inclined to buy at rates comparable to the lending rates because they were anticipating higher income based on the pro formas of the properties. Now buyers want a 1 percent to 3 percent return over lenders rates, depending on facility performance and cash-flow expectations.
Mendola: Cap rates are a function of mortgage constants and the relative competitive nature in each market. Overall, the cap rates are following the credit spreads of about 75 to 100 basis points higher than six months ago.
Shields: Major lenders are seeing cap rates between 7.75 and 9.5, with increases of about 50 to 75 basis points. This can be attributed to the higher cost of capital, the overall availability (or lack) of funds, and the tightening of underwriting standards. Were left to wonder to what extent these conditions will continue and how much it will affect cap rates going forward.
These comments from the Northeast about increasing cap rates are consistent with what we hear across the country. Just to show how much this means in terms of value (sale price), a one-point increase in the cap rate from say 7 percent to 8 percent reduces the value by 14.3 percent.
Many sellers have determined that now is a good time to sell for both market and personal reasons. Are they seeking reasonable pricing, and are there difficulties in finding qualified buyers at market prices?
Blake: Its never difficult to find buyers at market prices. The trouble were seeing in the upstate New York market is a lack of sellers willing to sell their properties at reasonable prices.
Cinelli: Sellers are still not realistic about market prices for their facilities. Only recently have we seen sellers start to listen to the market and what banks are saying about value. In our area, most buyers are serious and qualifying for loans is not an issue; qualifying properties is the problem.
Mendola: Sellers still want the highest value for their investment because they recognize that self-storage is getting more expensive and more difficult to build. Its like looking at a stock like Google when it was $745 per share. Now that Google is under $700, the investor still wants the higher price for the stock. This is the same condition for sellers of self-storage. Its difficult to get buyers to commit to properties where the price is higher than current market rates support. However, if the facility has high barriers to entry and is located in a growing area, it will still command the best price possible.
Shields: I tend to question how many real sellers are in the marketplace today. Some sellers are not ready for reality, to accept that values have dropped due to market conditions. Theyre waiting for buyers who will pay yesterdays prices and theyre willing to wait. I think theyll have a long one. There are still buyers who want to buy self-storage, but there are fewer who can pass the lending scrutiny. The buyers who are strong and qualified have good banking relationships and are willing to wait for properly priced locations, at which time they will react.
Sellers always want yesterdays price when markets are contracting; somehow the review mirror is easier to see than the windshield of the future. The reality is self-storage facility prices, even after a one-point adjustment in cap rates, are still at very near historically high values. Most commercial real estate cycles last in the range of three or four years, so its still a good time to consider selling.
The combination of any decline in revenues, because of overbuilding or a recession, plus an increase in cap rates can really impair values (a $1 drop in revenue reduces the value by $12.50.) The combination of declining revenue and increasing cap rates can be devastating to current values. If you think this cant happen, you werent in the business in the 1980s.
Michael L. McCune is the president of Argus Self Storage Sales Network, a real estate brokerage and development company based in Denver. Argus also operates www.selfstorage.com, a marketing medium for industry owners. For more information, call 800.55.STORE.