November 1, 1997

8 Min Read
Show Me the Money

Show Me the Money

By R.K. Kliebenstein

Several types of loans and financing options exist for self-storage development. This article will outline a few of the most common types as well as offer some alternatives.

New Development Construction Loan

This is most easily issued by a local or regional lender withwhom the developer is an existing client. These are often"relationship" loans. The strength of the deal dependsgreatly on the ability and performance (track record) of theborrower than on the property. Gerald "Jerry" Buck ofHuntington Bank in Cleveland, Ohio, says the best place to lookfor construction financing is to start with your relationshipbank. "If they are not interested in the loan, they canoften tell you the banks in the market that are active in(self-storage) lending. And do not stop when you have one lenderinterested. A limited amount of competition is good."However, when too many lenders get involved, they becomediscouraged, and they spend their time pursuing easiertransactions, he adds.

Permanent loans are now being offered to self-storage
owners at very aggressive interest rates, long loan
terms and long amortization periods.

Forward Commitment. Accord-ing to Eric Snyder ofBelgravia Capital, "The self-storage industry is becomingincreasingly competitive and lenders are requiring developers toengage in extensive research prior to providing forwardcommitments." This transaction commits the permanent lenderto provide a "take-out" (see below) loan upon theachievement of an agreed-on criteria. The achievement of aspecific occupancy (percentage) or level of Net Operating Income(dollar amount) predicts the take out. The risk level is veryhigh if conditions for a take-out are not agreed upon.

The take-out loan will be highly speculative if the lender iswilling to state the loan will close on a certain date. A forwardcommitment under those circumstances would likely be arelationship loan, as previously discussed. There is usually a 1percent to 3 percent fee for this type of commitment.

Read the loan documentation carefully, paying attention to theterms and conditions agreed upon at the issue of the forward. Adeveloper may be willing to make commitments to get the deal donethat he would later regret, especially if market conditionschange to the benefit of the lender.

Take-out Loan. This moderate- to high-risk vehicle forfinance is prepared at the time the property has nearedstabilization or a distinct trend has developed that the lendercan underwrite. The loan pays off the construction or"mini-per," and is customarily referred to as a"perm" or "permanent loan." This creditfacility is typically long term and contains prepayment penaltiesand/or yields maintenance. "These loans are based on theoperating strength of the property," says Neal Gussis ofFirst Security Commercial. "Many (borrowers) utilize thisvehicle to achieve several objectives. Many construction lendershave limited funds available for a single borrower. Refinancingwith another lender allows the construction lender to have thefunding capacity for the next project."

"People also seek to replace the construction ormini-perm with a permanent loan to obtain some or all of theirinitial equity in the project," he continues. "Acompany can allow its clients to borrow in excess of the initialcost if the property's cash flow meets our required debt-servicecoverage. Many permanent loans also reduce the property owner'spersonal obligation (recourse). Because of the presence ofnational lenders specializing in self-storage, including FirstSecurity Commercial Mortgage, permanent loans are now beingoffered to self-storage owners at very aggressive interest rates,long loan terms and long amortization periods."

Mini-perm. This is often a combination of aconstruction loan and a take-out loan. The term varies from threeto five years, but basically gives a developer enough time tocomplete construction and stabilize income. It can often"roll-over" into a permanent loan, and is commonlyissued by regional banks.

Refinance Existing Property to Extract Equity. This isan excellent tool by which to develop new properties, if theoption is available. By refinancing an existing property andtaking out the equity, you may be able to pay for the new projectwithout finance costs to the project. Make certain if you havediffering entities for the new and old project that an equitablearrangement is made to pay for the access to capital. See"refinance" for a description of this type of credit.

Construction Partners. How about asking each of yoursuppliers and sub-contractors to invest their goods and servicesas a contribution toward the project for partial ownership? Thiscould be a very complicated and difficult method of financing,but it is creative and has proven to be a successful,non-traditional financing method.

Equity Partner or Contractor Partner. This is a fairlycommon method of financing. If you are a contractor and cancontribute to the construction, but lack the land or developmentexpertise, then you have solved one-third of the challenge.Perhaps you have an equity partner willing to invest cash tobuild the facility with the prospect of a more traditional formof permanent financing.

Development Partners. Several of the large real-estateinvestment trust's offer joint-venture development programs witha combination of equity and debt financing. These tend to be verydeal-specific transactions and can often have constraints thatwould not give the developer "free reign" or totalcontrol over the project. This can be a very inexpensive way toaccess capital and can be a "marriage made in heaven"for the right partners.

Existing Facility Finance Options

Refinance- or Purchase-money Loans. At such times thatloans have matured, or to recapture equity in an on-goingexisting facility, the most common credit facility is the typicalrefinance--loan structure based on cash flow. This loan is oflow-risk and generally carries the most favorable of rates andterms. Typically, these are long-term, low-cost, "cashout" transactions and are readily available from nationallenders (conduits), such as First Security Commercial Mortgage,Belgravia Mortgage Capital and some investment banking(securities) firms such as Bear Sterns or CS First Boston. Localbanks may also offer a refinance or purchase money transaction,although the local bank may require a personal guarantee(recourse) and/or additional collateral. Bank loans may not havethe significant payment penalties--a very attractive feature forsome investors.

If you are a contractor and can contribute to the construction,
but lack the land or development expertise, then you have solved
one-third of the challenge.

Hard-money Loans. If the debtor has had creditproblems, it may be necessary to obtain financing from ahard-money lender. The term "hard money" is suitablebecause it is usually hard to pay back. Typically, based on thevalue of the property more than any other factor, these loanswill carry interest rates 5 percent to 10 percent above marketrates. Oftentimes, the hard-money loan is a precursor to a salethat takes place as the result of a deed instead of foreclosure.A loan broker arranges the hard-money loan, which is usually alast resort when all conventional financing methods areexhausted.

Less Conventional Sources

Syndication. The tool of choice in the 1970s and 1980swas pre'TRA '86. This involves the grouping together ofindividual investors and having them fund the transaction. Thisis a difficult method for novices or developers looking for anincome stream. Typically, the syndicate makes money on the frontand back ends of the deal, and usually returns in the form ofdisbursements (dividends) the cash flows. There used to be taxadvantages for offering passive investors this type oftransaction, but those days are gone. Syndications often involvehigh legal fees at the time of solicitation (as compared to moreconventional lending), but are still generally less expensivethan bank or conduit loans. The level of fees to the investor maybe high to very high.

Seek legal counsel when considering any non-conventional
source of financing, and if the source is not well-known,
investigate the origin of the funds, as well.

Securitization. This method is generally only availableat very large dollar amounts, unless several deals are beingsecured at one time, in the range of $50 million-$100 million.They are very expensive up front, and usually carry all of theprovisions of a typical conduit loan. In fact, it is identical tothe conduit loan, with the exception of the source oforigination. The debtor receives some fee savings because ofeconomies of scale. Rates are sensitive to the bond market,usually tied to Treasury bond rates.

Public Offerings. This method is strictly limited toonly the largest of deals, and only makes sense as the deal sizegets close to $250 million. They are available through brokerage(stock market) firms and are very expensive up front--not so muchas a percentage of the total transaction, but they can cost a lotof money, with no guarantee the deal will close. The funding ishighly volatile depending upon the stock market, and requiresextremely strong debtors with high growth aspirations.

Uncle Bob and Aunt Tillie. Yes, relatives can serve asa source of capital. I firmly believe that family and friendconnections to capital are one of the least explored and greatestresources for capital. All things being equal, this is usuallythe least expensive and most easily approved methods offinancing. There may be an emotional price to pay, not quantifiedin currency.

The following chart gives a matrix of financing alternativesand some key points. By juxtaposing the terms and types, one canidentify the type of financing that may best suit their needs.Borrowers are encouraged to always get a second opinion and"shop" their financing options. Once the lender hasmade an offer, it is not proper to disclose those terms to acompetitive lender and try to bid one against the other.

Borrowers should always attempt to negotiate with the lender.Perhaps up-front costs can be reduced or interest rates shavedslightly. It does not hurt to ask. Seek legal counsel whenconsidering any non-conventional source of financing, and if thesource is not well-known, investigate the origin of the funds, aswell.

R.K. Kliebenstein is the director of acquisitions for TheAmsdell Companies of Cleveland. Prior to his current assignment,he worked for Westar Management in Las Vegas, where he wasresponsible for new-store marketing. His tenure in real estatedates back to 1979, with a focus on self-storage since 1990. Mr.Kliebenstein may be reached at (800) 234-4494, ext. 227.

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