Choosing a lender is a vital part of any successful self-storage financing transaction, but in today’s environment, it may seem like lenders are choosing you rather than the other way around. How can you be prepared?
Even in an uncertain lending market like the one we are experiencing now, property owners still have a need for financing—whether it is new financing, a revolving line of credit, structured financing to recapitalize property investment, or a refinancing of an existing loan to more favorable terms. With vast changes in the financing environment during the past 16 months, particularly with the near-extinction of commercial mortgage-backed securities (CMBS) financing alternatives, the challenge for storage owners is to find the best lender to help them accomplish their financing goals.
Undoubtedly, we are in a lender’s market and the ability to achieve your financing goals is controlled by lending sources. While a borrower may have an idea of what he needs regarding financing, he must be flexible with his expectations relative to terms and loan proceeds in order for the transaction to actually work.
Do Your Homework
Before choosing a lender, determine in which real estate asset classes the potential lending institution specializes, how many self-storage financing transactions it has completed, and if it currently has money allocated for storage property. Because self-storage is not considered one of the four major food groups (office, multi-family, retail and industrial), some lenders are not familiar with underwriting a storage loan, may think storage lending is riskier than other property types and avoids self-storage transactions altogether.
Plenty of lenders, however, have been financing self-storage properties for years. In addition, you will likely find other lending sources interested in entering the self-storage market because of the positive press the industry has received during the current economic downturn. The low default rate on storage loans is an enticing statistic for lenders seeking commercial real estate transactions in today’s volatile environment.
Finding a lending source is just the first step. Next, you need to find one with available capital. Due to the credit crunch, finding a financing source with money to lend has become a serious issue for property owners. It is a classic supply-and-demand conundrum. While the need for financing is still strong, there has been a reduction in the supply of loans (due in large part to the sidelining of most conduit funding sources), along with a corresponding increase in the cost of obtaining bank financing. When this equation will return to a better sense of equilibrium is anyone’s guess.
Local, regional and national banks, life insurance companies and traditional lenders are currently receiving more self-storage loan requests than they have available money to lend. To ensure they select borrowers with the best ability to meet a loan’s requirements, these lending institutions have become more conservative in the past year with their storage program parameters and underwriting criteria.
Today, it seems lenders are interviewing property owners more than the other way around, which was the perceived modus operandi in recent years when debt capital was more plentiful. Because of this relatively new dynamic, your relationships with lenders are critical to achieving your borrowing goals.
A lender familiar with a borrower, financials and self-storage properties, and has the ability to meet loan requirements is more likely to believe in the validity of your financing request. Lenders are not only “investing” in the property, but in the borrower as well. It is incumbent upon you to build these relationships to support your financing requests.
Loan size is another factor in choosing the right lender. A storage property owner who needs financing between $1 million and $10 million would likely have the best prospects with a local or regional bank; while an owner requiring $10 million or more might start with a national bank or life insurance company.
Borrowers must recognize that regardless of the loan request size, lenders view each transaction differently. For example, a local bank will have different loan requirements than a life insurance company. Much of this is due to the lender’s threshold of exposure and risk.
Another byproduct of the credit crunch is lenders are more closely adhering to their minimum and maximum loan amounts. There is some room for flexibility on the minimum, however, and it usually comes under the condition of the property owner providing future business to the lender. In general, lenders look at self-storage properties in early stages of lease-up phases as more risky investments.
Big, Small, Local, Regional, National
For transactions that are local in nature, a local bank is likely the right financing source, especially for smaller loans and/or construction loans. The bank will finance based on personal relationships and is more apt to want to personally inspect a property. As a borrower, you may receive more favorable terms and flexibility.
Many local banks now require a borrower to place a minimum of 10 percent of the loan amount into deposit accounts at the bank. As more scrutiny is placed on the banking industry, depositors are paying more attention to the strength and viability of their banks. If any red flags appear and there is a moderate to aggressive run on the deposits of banks, insolvency becomes an issue. This is not in the underlying fundamentals of a bank’s assets, but rather the cash-to-loan ratio becomes unbalanced and exceeds the fluctuations that can be managed by using the overnight Fed window.
Nervousness on the part of depositors also can be a self-fulfilling prophecy as the run on deposits is the very thing that sends a bank into insolvency, not the bank’s performance. The deposit-account requirement is a tool that banks use to build in an additional delta in the deposits to loan ratio.
For larger, single-property loans and loans supporting multiple properties on a regional or national basis, regional and national banks and life insurance companies are the best options. Among other risk factors, these lenders concentrate on loan-to-value (LTV) and debt-coverage ratios. The higher the LTV ratio, the stricter the rest of the loan terms. However, LTV ratios have been trending downward recently. You will see more banks doing transactions that are either full recourse or feature some alternative source of credit enhancement such as a letter of credit.
In today’s economic environment, it is important to stay abreast of who is and is not lending. And once you find a source with available capital, you then must drill down to their specific lending requirements and criteria. With this information and proper expectations, you can better focus your search for realistic financing sources that can successfully support your transaction. Be sure to do your research and consult with a capital markets consultant if necessary to obtain the best information and options for your needs.
Jessica Mandel is an associate director in the Houston office of HFF (Holliday Fenoglio Fowler LP). She can be reached at 713.376.2216; [email protected].