From Start to FinishPutting a loan package in order

From Start to Finish
Putting a loan package in order

By Joe Fordonski

Finding the type of financing that best fits their needs is key to self-storage owners today. Given the volatility in the commercial mortgage backed securities (CMBS) market over the past 12 months, lenders are offering different types of financing to meet their borrower's needs. This type of environment allows the borrower great flexibility.

Fixed-rate financing is still the most common financing vehicle. This structure is most common with those owners looking to hold on to the property for a long time. Fixed-rate financing can be achieved through a lender who has a CMBS division. CMBS loans are pooled and securitized on Wall Street and provide some of the lowest-rate financing in the market. The overall interest rate is determined by adding a spread (also called a margin) to the 10-year Treasury rate. The loan is typically amortized over 25 years with a balloon payment due at the end of 10 years. Again, this option fits best for borrowers planning to hold their facility for a long period as a fixed-rate loan can contain considerable prepayment penalties.

If you have recently acquired a poorly managed facility or are expanding your facility and experiencing rapidly increasing net operating income, an earnout structure may better fit your needs. An earnout loan allows you to qualify for more loan dollars, based on certain benchmarks, within 12 months of the initial funding. This second funding can provide you additional dollars once net operating income has increased, although typically at a higher interest rate.

There are options available through a non-CMBS division of a lending institution. You may want to consider a bridge loan if you plan on increasing the net operating income of the facility then sell it in the near future. This kind of loan will usually consist of a variable interest rate and a short term (typically three years). Instead of being priced over the Treasury rate, bridge loans are priced over LIBOR. Unlike a CMBS loan, bridge loans have minimal prepayment penalties. In most cases, facilities financed with a bridge loan are either sold or refinanced with a CMBS loan at the end of their term.

Once you have decided on what type of financing best suits your needs, a financing package must be prepared a submitted to the lender. A package should include the following items:

  • Brief summary of your financing request and the history of the property;
  • Description of the property;
  • Photographs of the property;
  • Occupancy reports for the previous 12 months;
  • Operating statements for the past 12 months and previous three calendar or fiscal years; and
  • Financial statements and resume of the borrower.

It is very important to provide good historical records and explanations for the property. Complete records will benefit you as they assist the lender to adjust income and expense levels up or down, which, in turn, affects the level of loan dollars available. For example, the facility may have required repairs in 1998 that are not typically classified as "ongoing" or "routine" maintenance. Loan dollars can be maximized if these types of expenses can be documented. The lender will exclude these types of items from its underwriting, thus enabling maximum loan dollars to be achieved. Failure to identify non-recurring items will affect the amount of underwritten net operating income.

Once the lender has reviewed and underwritten your loan package, a formal application will be prepared for your review. This application should be reviewed by you so that all the components of the transaction are thoroughly understood. You should also review the "Glossary of Commonly Used Terms" on page 32. Understanding these terms will help you to better negotiate the loan application and better understand the structure of your loan.

The two most important qualifications in the loan application in determining your final loan amount are the loan-to-value (LTV) and debt service coverage ratio (DSCR) requirements. LTV is expressed as a percentage and compares the loan amount to the value of the property as determined by a third-party appraiser. In most cases, lenders will not exceed 75 percent. Some lenders, however, will lend up to 80 percent. DSCR is a ratio that compares annual net operating income to annual service payments. Most lenders require a minimum DSCR of 1.25:1.00.

After the loan package has been submitted and the loan application executed, it is time to move to the actual loan closing. Typically, this process includes:

  • Submitting due-diligence items;
  • Ordering an appraisal report;
  • Ordering a phase-one environmental report;
  • Ordering an engineering or property-condition report;
  • Ordering a seismic report (depending on property location);
  • Loan document preparation.

The lender will provide the borrower with a substantial list of items required in order to begin a thorough analysis of the loan request. The lender will require such items as operating statements, occupancy reports, partnership agreements, management agreements and many other items deemed necessary for review. At the same time, the lender will engage third parties to prepare the appraisal, environmental and engineering and seismic report (if required).

The appraisal will be used in determining whether or not the loan-to-value requirement has been achieved as presented in the application. The engineering report will identify any immediate repairs required and will also verify the amount of reserves the lender will be required to escrow. The phase-one environmental report details any environmental concerns at the property. In the event the phase one uncovers items that require further investigation, the borrower will required to have these completed prior to the funding of the loan. Depending on where the property is located, the lender may require a seismic report. The seismic report will determine a probable maximum loss (PML) percentage. In most cases, if this number exceeds 20 percent, the lender will require an earthquake insurance policy be issued prior to closing.

Once all the reports have been received and the property visited, the lender will review the due-diligence items submitted and submit a credit committee package summarizing the deal. This package will be reviewed by individuals within their lending institution who have authority to approve a loan. Typically, once the loan is approved, an approval letter is sent to the borrower, and legal counsel will be engaged to prepare loan documents. Following review and negotiation of the loan documents by the borrower's counsel, the loan should be in a position to close within a few weeks.

It is important to remember that the loan process can be rather time consuming. Substantial information must be gathered prior to closing. It will benefit you to maintain thorough and accurate records at all times. This will enable you to obtain optimum financing for your facility. The "typical" loan process takes approximately 90 days. Allow 30 days to prepare the loan package and identify a lender whose program best suits your needs, and another 60 days for the loan to close. The key to the whole process is identifying up front what your exact financing needs are.

Joe Fordonski is responsible for the analysis and negotiation of self-storage loan requests at FINOVA Realty Capital (formerly Belgravia Capital) in Irvine, Calif. For more information, call (949) 442-8000;  

Glossary of Commonly Used Terms
Understanding your loan application

Amortization--The number of years necessary to pay the loan balance down to zero. This includes principal and interest payments. A typical fixed-rate loan is amortized over 25 years.

Assumption/Transfer Provision--Most lenders will allow a one-time assumption of the loan subject to the lender's approval and payment of a 1 percent fee.

Debt Service Coverage Ratio (DSCR)--A ratio used to express the relationship between annual net operating income and annual debt service. Most lenders require a minimum DSCR of 1.25:1.00. For example, if the annual debt service is $100,000, the annual net income has to be equal to or greater than $125,000.

Impound/Escrow Account--An account used for the deposit of valuable considerations, such as money. The most common use is for the collection of property taxes and insurance premiums.

Index--The instrument used in determining the base for the cost of money. The Treasury rate is most commonly used for fixed-rate loans while the LIBOR index may be used for variable-rate transactions.

Loan-to-Value (LTV)--The percentage amount borrowed in the acquisition or refinancing of a property. The value of the property is determined by a third-party appraiser.

Margin--The spread between the index and interest rate.

Mortgage Constant--An equal annual payment, expressed as a percentage, that will amortize the principal and pay interest over the life of the loan. It is important to look at the application and determine if there is a minimum constant required by the lender.

Prepayment Premium or Penalty--A penalty for an advanced payment on a mortgage. The most common penalty is known as defeasance, which is the substitution of Treasuries for the remaining payments on the loan.

Reserves Account--An account to collect reserves for capital improvements. Most lenders will require that an account be established to collect reserves in accordance with the report prepared by a third-party engineer. In most cases, there will be a minimum collection of 15 cents per square foot, regardless of the results of the engineering report.

Securitization--A securitization involves a lender bundling similar mortgages that are analyzed by rating agencies and then used as collateral for bonds purchased by institutional investors. This type of financing is ideal for borrowers looking for low fixed-rate financing.

Single-Purpose Entity--A requirement by all CMBS lenders, a single-purpose entity restricts the borrowing entity from owning any other facility other that the property being financed.

Term--This is the period of time between the borrowing date and due date. In most cases, the term of the loan will coincide with the Treasury bill. For example a 10-year loan will be priced over a 10-year Treasury bill.

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