By Jeff Rauth
Many self-storage owners struggle with cash flow. Real estate and equipment costs are often their largest monthly expense. One of the easiest ways to increase the cash flow of your facility is to restructure your current business debt and leases. By doing so, you may be able to reduce your monthly payments by 30 percent to 50 percent or more. Below is a sample scenario.
Existing commercial real estate mortgage loan:
- Original loan amount: $1.2 million
- Current loan balance: $750,000
- 20-year amortization
- 6 percent interest rate
- Monthly payment: $8,718
Existing equipment loan:
- Original loan amount: $150,000
- Current loan balance: $85,000
- Five-year amortization
- 8.5 percent interest rate
- Monthly payment: $3,383
Existing equipment lease:
- Current buyout value: $50,000
- Monthly payment: $2,300
Existing note from partner buyout:
- Current balance: $90,000
- Monthly payment: $1,600
All this adds up to a total monthly payment of $16,001. By restructuring the above debt ($975,000) on a 25-year amortization schedule at a 6 percent interest rate, the new monthly payment would be $6,057. That’s a monthly savings of $9,944 and a yearly savings of $119,328, resulting in a 62 percent cash-flow improvement.
This may sound too good to be true, but in reality, these types of transactions are done all the time. The cash-flow savings is accomplished by re-amortizing existing debt and spreading out the payments over a longer period of time. Even when the interest rate is higher on a new loan, the monthly payments will still likely be lower due to the longer amortization. For example, using the scenario above, when the $975,000 debt is restructured at an interest rate of 10 percent, the monthly payment is only $8,951, representing a monthly cash-flow savings of $7,050.
Are You a Good Candidate?
For many self-storage owners, debt restructuring can be the difference between a business that thrives and one that merely survives—or worse, goes out of business. If you’re struggling with cash-flow challenges, here are some things to look at to determine if you’re a good candidate for restructuring:
- Your current cash flow is “tight,” i.e. you have a difficult time paying your monthly bills.
- You have debt that has been in place for more than four years.
- Over the years, you’ve acquired and/or leased equipment on a staggered basis and now have two or more monthly payments.
- The amortization schedules on your existing loans are less than 25 years.
- The interest rates on your existing loans are higher than 6 percent.
- You’ve already paid down a significant amount of debt on your loans.
If your facility is newer or the majority of your existing debt has been in place for less than four years, the cash-flow savings may not be as significant unless the interest rate on existing loans is higher. Another scenario is if the existing amortization schedule on existing loans is shorter than that of the debt-restructure financing.
Also, most banks and loan programs have different amortization-schedule requirements for real estate debt versus equipment debt. For example, with the Small Business Administration (SBA) 7(a) program, real estate debt is normally financed over 25 years, while equipment is financed over the useful life of the equipment or up to 10 years. However, if 51 percent or more of the debt being refinanced is allocated toward real estate, then technically, all of the debt being refinanced can go on a 25-year amortization schedule with the SBA 7(a) program. This is an important point and one of the main drivers behind cash-flow savings.
For example, if a self-storage property has real estate debt of $750,000 and equipment/partnership buyout debt of $225,000, the real estate debt would be 77 percent of the total loan amount. This means all of the loan proceeds would be eligible for a 25-year amortization schedule on an SBA 7(a) loan.
Not every bank or lender will be interested in re-amortizing a loan over a longer period of time than what a borrower currently has in place, and conservative underwriters may have personal views that oppose such terms. In these instances, the best solution is to quickly move on to another lender with a more commonsense approach to underwriting.
Loan-to-value (LTV) ratios are one of the major underwriting components. SBA loans on self-storage properties can go up to 90 percent LTV while conventional loans typically reach 75 percent LTV. With this type of transaction, the lender will want to be in first-lien position on all assets including goodwill, equipment, inventory, real estate, etc. If the proposed loan amount exceeds the lender’s LTV requirements, the loan isn’t likely to close.
The biggest downside of debt restructuring is starting over again with a longer amortization schedule. Borrowers will also incur costs associated with appraisals, bank fees, environmental reports and title insurance. As such, those who have strong cash flow and are aggressively paying off debt may not benefit as much from debt-restructure financing.
Flourish or Fail
Self-storage owners often struggle with cash flow because the amortization schedules on existing loans are too short or the interest rates are too high. Restructuring current debt and leases for a business experiencing cash-flow problems can be the difference between flourishing and failing.
Cash-flow savings of 30 percent to 50 percent is not uncommon, especially when long-standing multiple debts and/or leases are included in the debt restructure. In addition, many borrowers wrap renovation costs and new equipment into the transaction, resulting in both increased cash flow and an updated property.
Jeff Rauth is vice president of business development for Celtic Bank, a nationwide Small Business Administration (SBA) lender. The company was the eighth largest SBA lender in the nation for 2014. For more information; e-mail [email protected], visit www.celticbank.com.