As most owners and developers of self-storage properties know, obtaining the right financing package can be confusing. You can simplify the process by understanding the different loan types and how to package your request.
The majority of storage projects are financed by either conduit or portfolio lenders. Hard-money lenders may be used in situations where the borrower has a poor credit history or needs to quickly close escrow, but thats a topic for another article. Both conduit and portfolio lenders provide financing for properties stabilized or close to it. Only portfolio lenders will back construction or projects with low occupancy or that are still in lease-up.
The conduit loan will typically carry the lowest interest rate, a 30-year amortization and a 10-year-fixed rate. Interest rates are tied to the 10-year Treasury note plus a margin. If requested by the borrower, the loan can be structured with interest-only payments for part of the loan term. It can also include an earn-out provision if a property isnt fully stabilized but close. Typically, the earn-out period is no more than 36 months.
The loans are assumable and non-recourse to the borrower, except for standard carve-outs such as fraud, misrepresentation and environmental issues. Loan-to-value (LTV) is usually no more than 80 percent. The major focus in underwriting a conduit loan is the debt service coverage ratio (DSCR). The usual DSCR for a conduit lender is 1.25:1.
Conduit loans will have more restrictive loan covenants than portfolio loans and rarely allow junior financing. Therefore, to take additional equity out of a property, youd need to refinance it. Conduit loans also have a prohibition against prepayment for the first two to three years of the loan, referred to as the lockout period.
Conduit lenders tend to require an ownership structure that is single-asset entity, usually in the form of a limited liability company (LLC).
Portfolio lenders tend to be more flexible. They provide construction and permanent loans, and loans for properties in early lease-up. Although theyll usually require either full or partial recourse to the borrower, theyll be flexible on the type of ownership structure; i.e. they wont require a single-asset entity.
The interest rate is usually higher than that from a conduit lender, since a portfolio lenders cost of funds will be higher. Some will fix the rate for 10 years. However, many will try to stay with a shorter fixed-rate term, and the amortization period will vary from 20 to 30 years depending on the lender and the property. Theyll also provide adjustable-rate financing tied to LIBOR, COFI, prime rate or some other index.
You can also expect portfolio lenders to be more flexible in their DSCR requirements, since a compensating factor will be the financial strength of the borrower on a recourse loan. They may also consider interest-only for a short period.
Prepayment penalties vary, from no penalty for early prepayment to a stepped-down penalty. Third-party reporting requirements are less onerous, and the loan can be processed more expeditiously.
Portfolio lenders will typically allow junior financing as long as it meets their DSCR requirements. The loans may or may not be assumable.
Portfolio lenders are the primary source for construction financing. The construction loan will usually have a loan-to-cost (LTC) up to 75 percent for a self-storage project. The LTC will be calculated on the total cost of the project, including land cost, hard and soft construction costs, interest reserve, lease-up reserve, closing and other direct costs.
The lender will instruct the appraiser to provide three values: as is (basically, the land value as entitled); as completed but unleased; and stabilized. The property must have a stabilized value of at least 5 percent to 10 percent below the LTC. In other words, if the LTC were 75 percent, the LTV should be less than 70 percent of the stabilized value.
The construction loan will usually provide for a 12-to-18- month construction period and an 18-to-24-month lease-up period. At the end of that time, if the property is not stabilized, the borrower can obtain an extension for a fee. Alternately, if the property is producing sufficient income, the loan can be converted to a mini-perm. A borrower that intends to hold the property long-term is likely to obtain take-out financing from a conduit lender; this announces cash flow or allows him to take cash out of the project.
Putting Together a Loan Package
The loan package consists of two primary components: credit information about the borrower and key principals; and property data.
- Required credit documentation will depend on the borrowers structure. Is the property owned by an individual, an LLC, a corporation or a partnership? Expect to provide the following:
- Formation documents for the borrowing entity. For an LLC, this would include the operating agreement and articles of organization.
- Current financial statements for the borrower and key principals. A key principal is someone with a substantial ownership interest, generally in excess of 25 percent.
- Real estate owned, which should be included with the financial statement.
- Federal tax returns for the last two to three years.
- Verification of deposits. Lenders like to see the last three months of bank statements and the last quarter for investment accounts. These would be for the accounts shown on the financial statements described above.
Required Property Data
In regard to property information, prepare the following:
- Purchase agreement (for a purchase)
- Preliminary title report
- Operating statements (two to three years)
- Rent roll
- Unit-mix report
- Most recent 12-monthly management reports
- Itemized expenses on operating statements that are considered extraordinary, capital or entity costs (i.e., LLC fees)
- Real estate tax bill for current year
- Copies of existing environmental and engineering reports, property survey, etc.
- Site plan
- Copy of standard rental agreement
Beyond choosing your lender and assembling the required information lies the important work of successfully completing the loan process. It will require experience, expertise, coordination and cooperation between all parties. A quality mortgage broker can help assure you of a successful loan closing.
Kenneth Hirsch is president of Brownstone Investment Company Inc., providing commercial brokerage services to real estate investors. Brownstone has financed more than $100 million worth of self-storage projects, including construction, acquisition and take-out loans. For more information, call 415.395.7600; e-mail [email protected].
Rosemary Jensen is president of Pacific Storage Properties and CalPacific Investment Properties, providing real estate investment and brokerage services to the self-storage industry. In the past 12 months, she has brokered more than $47 million in self-storage property sales. For more information, call 415.986.4203; e-mail [email protected] ; visit www.cpiproperties.com .