With interest rates at record-low levels and a sagging economy, would this not be a great time for self-storage finance? One would certainly think the banks would jump at the chance to finance self-storage properties, given the low interest rates. Lower rates make it easier to qualify for a loan, correct? Lower rates mean the money costs the banks less, so they have more "profit," right?

Well, the news is not really so optimistic. Sure, lower rates mean your debt-service coverage is higher, so the loan is "stronger," but the story not told is one generated by fear and uncertainty. Bankers do not want to get caught with a low-interest-rate loan on the books, and when it comes time for you to qualify for a loan to pay them off, they want to make sure you will be able to qualify under "normal" lending conditions.

You have heard the political pundits speak of lowering interest rates to spark up the economy, but all it really does is put a fire under the feet of lenders to make better, more conservative loans--that usually means fewer loans pass muster, and the advances are at lower loan-to-values. Most borrowers are pursuing fixed-rate loans instead of variables when rates are as low as they are today.

Low Interest Rates Means Low Interest Rates, Right?

Low interest rates in the press (the lowering of the discount rate) means banks pay less for the money they borrow from the Fed. But in the real world--the self-storage borrowing world--it means some reduction in rates, but not in direct proportion to the Fed lowering the discount rate. Quite simply, if the Fed lowered the discount rate to 3 percent tomorrow, it would likely have little to no effect on your typical self-storage loan.

Since the commercial mortgage-backed securities (CMBS) collapse in September 1998, lenders have protected themselves with interest-rate floors so they do not get caught with loans on their books they cannot sell. That means that, generally, no matter what happens with discount rates, self-storage loan borrowers will still pay around 7.5 percent for loans--at a minimum. Short of a long explanation of securitization, lenders do not want to make loans in a low-interest-rate environment where when rates go back up--and they will go back up--they or conduits cannot sell the loans without losing money on the discount.

Is It Confusing Yet?

Let's use the following example. The numbers will not be accurate, but the concept is correct.

ABC Mortgage is arranging for a $2 million loan for Sam's Storage. The 5-year Treasury Index is at 4 percent. The interest rate or note rate ABC has provided is 6 percent. The loan is closed Nov. 1, and funded by Carl's Conduit. On Nov. 15, rates begin to rise very quickly, and by Christmas, the 5-year Treasury is at 8 percent. Sam is very happy! He got his loan closed before interest rates went up, and can now take $100,000 of the loan proceeds and buy a U.S. Treasury bill and make 2 percent just for being smart. Meanwhile, the stock market has regained all of its momentum, the Dow is up to 15,000 and stocks are hot. Sam is taking the rest of his money and investing in Dave's Dot.com and is just waiting to become a bizillionaire.

Carl's Conduit is now ready to securitize the loan. On Jan. 5, Carl's Conduit announces to Wall Street it has a pool of loans to sell. The bond market is in the tubes, and bond buyers are wanting a 9 percent return on their money--after all, they could buy U.S. Treasury bills at 8 percent, so for the extra risk of a mortgage-backed bond, they want at least 1 percent. Poor Carl! No one wants to buy the loans he made at 6 percent. In order to recoup his capital, he sells the note for $1.5 million and not only loses $500,000 of principle, but also loses all the costs of the transaction.

If ABC Mortgage had arranged for a portfolio loan instead of a conduit loan, Bob's Bank might have a similar problem. Banks operate on short-term money, such as savings deposits and borrowing from the Fed to make loans. Let's use much of the same scenario as with Carl's Conduit: When the Treasury rate increased to 8 percent, Chairman Alan Greenspan also raised the discount rate to 8 percent. Bob's Bank borrowed the $2 million it lent to Sam from the Federal Reserve at the great rate of 4 percent, and it borrowed the money for six months. When Bob's Bank had to borrow money again to "refinance" the money it lent Sam, it had to borrow it at 8 percent. Sam is only paying 6 percent, so Bob's Bank is losing 2 percent on every dollar of the loan. Sam's loan officer is now working as a relief manager at Sam's Storage.

Is It as Clear as Mud Yet?

The above examples are extreme, but they may help you understand that lenders are very careful in low-interest-rate environments to make good loans, because even if they did not lose money selling these loans, they cannot afford to have any borrowers default, which would mean they lose any interest or principle due to a foreclosure or bankruptcy. Therefore, to make "better" loans, they only advance 70 percent loan-to-value (LTV) instead of 75 percent LTV--a more conservative loan. They require the debt-service coverage (DSC) ratio to be 1.4 instead of 1.3, which simply means they make a smaller loan relative to the value. In some cases, the conservative loan underwriting does not even pay off the existing loan, such as a construction loan.

At the time of this writing (and things may have changed by press time), my company is quoting interest rates on refinance transactions at 7.5 percent to 7.75 percent for good loans (60 percent LTV, 1.6 DSC), and money is available to qualified borrowers. Borrowers can expect to pay 1 percent to 2 percent for loan-origination fees and 1 percent for loan costs (assuming the loan amount is at least $2 million). Construction loans are at prime plus 1 percent to prime plus 2 percent, and the advance rate is between 60 percent to 65 percent of cost, and 70 percent of value.

Coast-to-Coast Storage Mortgage specializes only in self-storage related loans. RK Kliebenstein, president, will be happy to explain in greater depth any of the above scenarios, and assist you in pre-qualifying for a loan. He can be reached at 561.367.9241.