Fresh paint, safe and secure storage areas, attractive landscaping ... smart business owners know that both small and large capital expenditures can go a long way toward improving their self- storage facilities’ cash flow and resale value.
So the question is not if you should renovate, but how to finance the project. This article reviews the four major sources of financing available.
A construction loan is the best way to finance significant improvements. If you plan to add more buildings, for example, a construction loan will provide funds underwritten to the future value of your property.
- Future value. The loan amount will be based on the “as completed” value.
- Interest reserve. The loan will be issued with an interest reserve in the loan so that payments do not need to be made during the course of construction and lease-up.
- Due diligence. The lender will underwrite the budget and perform due diligence on your builder, including the appraiser’s opinion on the future value of your facility.
- Fees. The fees and interest reserve will increase the loan amount.
- Paperwork. The construction loan process is a time-consuming and document intensive one with many moving parts.
- Time. Consider this loan process may take 60 days or longer to close.
Construction-Loan Case Study: A new owner acquired a self storage property with 10,000 net rentable square feet for $1.3 million. The site had land to build another 50,000 square feet. The construction costs were $2.1 million against a future value of $7.2 million. The bank loan covered 85 percent of the total cost of the project and carried a three-year interest reserve during the build and lease-up phase.
Refinance and Pull Cash Out
Refinancing your property (or another property in your portfolio) can be the smartest way to pay for the cost of improvements if your rehab is significant but not transformational in nature.
- Maximum leverage. If the bank is willing to lend you a large amount of money based upon the value of your property—take it! You are unlocking your equity.
- Safety. The bank-ordered appraisal will provide you with valuable up-to-date information about your market and competitors. Bank due diligence will reveal if you are spending more on rehab than the property will generate.
- Costs. Most borrowers are charged a percentage of the total amount of the loan, including broker fees, bank fees and closing costs, and third-party fees for title, escrow and appraisal.
- Paperwork. You should have three years of your property income/expense reports in good shape and all of your tax returns filed and in good standing before approaching a lender or broker to move forward with your loan request.
- Time. Refinancing is a process that could easily take up to 45 days or longer.
Refinancing Case Study: A property built in the ’80s valued at $4.6 million required $350,000 in upgrades. The mortgage was $1.9 million at 7.5 percent due in four years. The owners refinanced at a lender-friendly 50 percent LTV and got cash out to complete the rehab. The new loan on their facility is a non-recourse, $2.3 million with an interest rate of 6 percent and a five-year term.
Leaning on a Second Lien
A second lien (a smaller, junior debt piece placed behind the larger first lien) is best for minor improvements such as cosmetic upgrades and site enhancements.
- Low documentation. Unlike a complete refinance, many seconds can be placed with just a few forms.
- Relatively quick. If time is of the essence, many seconds can close within 30 days.
- Keep your first lien. Placing a second lets you keep your first lien in place. If you have a great rate on your first or face a high prepayment penalty for refinancing, consider a second.
- Line of credit. Commercial seconds are sometimes offered as a line of credit, the same as on your home where you pay interest only on the amount drawn.
- Interest rates. Seconds are a higher-risk loan; therefore, money is priced as such.
- Limited lenders. Placing seconds on commercial properties is a niche in the lending industry; your choices will be limited. Also, your first lien holder may not allow a second to be placed, so check before considering this option.
- Exit strategy. The LTV of the property must allow for sufficient leverage to take this cash out, and there should be a clear exit strategy to pay down the second.
Second Lien Case Study: The owner of a 5-year-old property wanted to address his competition by enlarging the office/retail space and improving signage. The cost to complete was $120,000. The owner placed a second lien, which maxed out at 65 percent LTV. He repaid the line of credit with revenue from increased occupancy and retail sales.
Cash Out of Pocket
If the costs of rehab are extremely small and you have a low interest rate on your current loan (and the cash to spare), then cash is a viable option.
- Easiest. No forms. No banks. No fees.
- Fastest. See above!
- You are in charge.
- Spending reserves. The worst situation of all is when borrowers run out of money before the project is completed and then have no cash reserves when they go to refinance at a bank.
- Going over budget. You will be overseeing all aspects of the project, so plan for contingency. Unlike a bank loan, there are no protections in place.
Cash Case Study: The owner of a 10-year-old property wanted to install a new gate and secured entry system, which cost $35,000. She took $20,000 out of the property’s reserve account and $15,000 out of her personal savings to fund the improvements. The job was completed in one week and she replaced the funds on a monthly schedule of repayments.
No matter how you do it, the budget for your upgrades should be completed in detail by a qualified self-storage builder who can suggest the most current trends in the look/feel of self-storage properties, and the best use of your funds for a return on investment.
Georgia Ragsdale is CEO of Los Angeles-based Watermark Financial Inc., a boutique commercial brokerage firm placing construction loans and financing self-storage properties nationwide. To reach her, e-mail [email protected]; visit www.watermarkfinancialgroup.com.