Since the meltdown of the subprime market and its domino effect on the commercial lending markets (conduits in particular), the availability of loan dollars and variety of lending options has been significantly reduced. While financing is still available, the desire to maximize loan dollars for both construction and permanent loans is being met with much resistance from the lending community. The availability of better rate loan programs is harder to find, especially in non-metro areas, for unstabilized properties and higher loan-to-value (LTV) requests.
The Wall Street conduit market has all but gone away. Those remaining are requiring spreads approaching or above 400 basis points (4 percent) over the Treasury. With the conduit departure, there is no reason for banks and insurance companies to reduce spreads to the extremely low level previously offered by Wall Street in order to compete. As such, they have gone back to traditional loan margins to provide the yields required to be profitable or to better a yield found in safer investments such as corporate bonds.
Since departing, the multibillion-dollar conduit financing vehicle has left a huge void in the ability to finance self-storage properties, not only at high LTVs and long amortizations with interest-only components, but also as important on a “non-recourse” basis. The non-recourse financing has fallen on the shoulders of the insurance companies (IC) and pension funds (PF), both of which are known for cherry-picking properties and underwriting conservatively.
One of the biggest drawbacks to this remaining non-recourse financing source is the higher minimum loan amounts many IC and PFs require. In addition, not every IC and PF will work with self-storage—especially if it is not a class-A facility or constructed of metal. Many lenders have already filled up their “lending buckets” for the year with more preferred property types such as apartments, anchored retail centers and multi-tenant industrial.
In some cases, insurance companies also prefer to buy existing unsecuritized conduit product off the conduit’s books at a discount rather than fund new originations, further diluting the available funding pool. By buying stabilized conduit product with impounds typically held by the servicer for tenant improvements, leasing commissions, replacement reserves, taxes and insurance, and by cherry-picking the better properties from the portfolio, the insurance companies more or less guarantee themselves a good product on book with stiff prepayment penalties should the borrower pay the loan off early.
However, if you and the property qualify, long-term IC and PF rates in the mid- to high 6 percent range can still be obtained with some of these lenders. There are also a few portfolio and balance sheet lenders offering non-recourse financing, but typically at much lower LTVs and on stabilized properties with good histories and strong sponsors.
Fixed rates are typically not cheap for the balance-sheet lenders with 10-year fixed rates approaching the 7 to 7.5 percent range. You will still find rates in the low 6 percent range or better if you can live with a floating (adjustable) rate or short-term fixed-rate product.
If you are willing to accept a loan with recourse, some banks and credit unions still offer 10-year fixed rates under 7 percent. However, many credit unions are also filling up their lending allotments for the year and selling off loans to other institutions in order to originate more.
As many searching for financing have already discovered, the underwriting requirements have tightened and loan parameters have become more difficult. What was once the norm has become the exception with 75 to 80 percent LTVs now down typically 60 to 70 percent, with 75 percent being the exception for the strongest borrowers and projects.
Previously, debt-coverage ratios underwritten as low as 1.15 are now a 1.25 or higher. While still available, 30-year amortizations are less prevalent and usually reserved for quality locations and projects, stronger borrowers and better cash-flow properties.
Other obstacles in today’s market include the lack of available funding capacity due to lenders’ loan allocations being tapped out. Some are withdrawing from the lending market in total or pulling back from specific property types such as self-storage and other commercial property to focus more on the less volatile and risky multi-family and mobile-home park loans.
Lending giants like Citibank, once a formidable player in commercial and self-storage financing, left the market in March. Washington Mutual, another lending giant, finds self-storage to be an unacceptable property type. With the conduit departure, banks, savings and loans, credit unions and insurance companies were left to pick up the void left by lenders no longer in the self-storage financing arena. These remaining lenders’ pipelines filled up quickly with loans from all property types.
Many were actively financing commercial properties, then began restricting volume mid year by leaving the market, raising rates, lowering maximum loan amounts, raising debt-coverage ratios (DCR) or lowering LTVs.
The construction loan piece of the pie has also been negatively affected by the credit crisis. Self-storage, which had a hard time being accepted by many lenders in the first place as a viable property type, now finds itself with even fewer lenders willing to finance construction at the desired higher (80 to 85 percent) loan-to-cost levels.
In addition to the overbuilding that has occurred in many parts of the country, many lenders are shying away from self-storage due to its perceived special-use tag. Lenders may also require a lower loan to cost or higher cap rate than market for underwriting purposes. Strong borrower financial statements need to include excellent liquidity in addition to net worth, and the borrower may also need a secondary source of income from a primary occupation or other to qualify.
Lenders may also prefer the borrower has experience in owning and managing self-storage properties even if an outside property management firm will operate the property. Don’t be shocked to see rates in the prime plus-2 percent range (7 percent) or more to obtain construction financing today.
One large national self-storage construction lender, while still offering rates at prime plus-0 percent, requires borrowers to have enough cash in the bank to pay the interest cost out-of-pocket through lease-up as they don’t build in interest reserves into the loan. They also require a strong borrower financial statement, and underwrite the property to a minimum 8 percent cap rate and 1.30 DCR, which may reduce the LTV and, thus, the loan-to-cost loan amount calculation due to LTV restrictions.
Other lending nightmare issues include the amount of time it takes to close a loan. IC and PFs are notoriously slow, with 75- to 90-day closing timeframes common. Many portfolio lenders have cut staff or are running lean, extending out closing timeframes due to workload. This is not the case with every lender, but it is happening enough to be a concern on purchase transactions with short closing timeframes or escrows without extension possibilities.
Properties which contain a majority of RV/boat parking versus brick and mortar enclosed storage, or mixed-use facilities such as a carwash or retail may find a harder time obtaining a best rate and high LTV financing due to either the large amount of business income being generated from carwashes or the lack of enclosed storage spaces. RV/boat-heavy facilities will need to distinguish themselves from a land loan.
Lending activity in 2008 has been reported by many to be down 50 percent from last year’s already lower figures due, in part, to a lack of sales activity and a general slowdown in the economy. Refinances are also not as plentiful because many refinanced when the 10-year rates were at 6 percent or below with no need to pull cash out or be subjected to a large prepayment penalty.
Those looking to refinance for reasons other than a maturing loan are in a wait-and-see attitude, hoping to obtain longer-term fixed rates less than the current 6.5-7 percent market. If they already had a fixed rate, it may have rolled into an adjustable, and the floating rate may be advantageous for now, given the low-loan indexes (prime, Treasury, LIBOR), so there is no rush to convert to a fixed rate.
All this being said, the industry is still seeing financing completed in all areas of the country, including some large portfolio refinance transactions and expansion purchases by growing companies. Rates remain relatively stable and competitive on a historical level and deals can still make sense.
There is more short-term (five years or less) money available than longer term, and the rates can vary widely depending on location, lack of lender competition and deal parameters. One can expect to find rates between 6 and 7 percent for the most part. Depending on loan term and amortizations, the loans should be in the 20- to 30-year range in most areas. Non-recourse loans are harder to come by. The biggest issue compared to previous years is the lack of lender choices and loan options available on a national basis.
Allow yourself plenty of time to research financing options and be prepared to possibly extend the closing time on purchases to allow for the financing search and lender funding timelines.
Next year will likely mirror 2008 with respect to rates and financing issues as the single-family residences debacle has still not fully played out, the upcoming bailout of Fannie Mae and Freddie Mac is yet to come, and the presidential election may certainly affect interest rates, the economy and world events. If you’re expecting rates to drop significantly, I wouldn’t hold your breath. It is probably as good as it is going to get for a while.
David Smyle is president of Benchmark Financial. The La Mesa, Calif., company is a commercial mortgage banker providing financing options for self-storage and other commercial property types nationwide. To reach him, call 877.862.7916; visit www.benchmarkfin.com.