The State of Industry Financing

Though lenders may run scarce, the 'paper' is still out there

By R.K. Kliebenstein

Thelast few years have witnessed many changes in the arena of finance, andself-storage financing has been no exception. In September 1998, the financeworld was rocked by the collapse of the CMBS (commercial mortgage backedsecurities) market. Interest rates were at an all-time low. I remember closing aloan for a client at nearly 6 percent, fixed, for 10 years--and with rates thatlow, the securitization of loans became a very unprofitable proposition. Just afew months earlier, loan note rates were in the low 7 percent range, and theconduit lenders had to take a negative position. They wrote loans at 7 percentand were having to sell them at less than 6 percent in the secondary market.This caused them to write loans with floor rates (which are still in placetoday). Some lenders did not even fund commitments they had made when theinterest rates were "upside down."

The year 2000 brought more changes to the self-storage lending arena. The twoprimary providers of self-storage loans, Finova Realty Capital and FirstSecurity Commercial Mortgage, pulled out of the market. That left GE Capital andHeller Financial as the last standing big names in self-storage finance, but GEhas been closing offices across the country (including the one in my hometown),and after 12 calls to Heller Financial about a loan, I gave up. I suspect manyborrowers had a much lower tolerance. Though my telephone calls to GE werereturned, no one could direct me to the person in charge of self-storage loans.Hopefully, now that former Finova executive Eric Snyder is on board with them,they will have a renewed interest in this industry.

Self-storage loan expert Neal Gussis (formerly of First Security) is now atBeacon Realty Capital and is actively making loans. A regular industry speakerand author, he is committed to self-storage lending, and generally attends allthe industry tradeshows and conferences.

Refinance Loans

Lending advance rates have not decreased much. Loans are still being writtenat 75 percent to 80 percent loan-to-value based on appraised value. It does seemthe appraised values are falling behind the sales data for storage properties,causing loan amounts to be more conservative. This caution is likely to continueuntil most of the new construction in the marketplace reaches stabilizedoccupancy. Typically, cap rates on appraisals are near 10 percent.

Terms are very competitive. Amortizations range from 20 to 25 years, andloans are generally due in three, five, seven or 10 years. This makes paymentsvery affordable.

Some loans will require recourse or personal guarantees. Conduit loansgenerally only require a personal guarantee from the borrower, protecting thelender against fraud or environmental concerns. The term for these exceptions tonon-recourse is "carve-outs." Bank loans usually require the fullpersonal guarantee of the borrower. This simply means that in the event of aforeclosure, the guarantor may be liable to the bank for any deficiency balance.The borrower's personal residence may be at risk.

Prepayment penalties and "lock-outs" are a negative feature ofconduit loans. These loans are very expensive to prepay and, in somecases, you are not even allowed to prepay the loan. This is the biggestdisadvantage of the conduit loan, and is usually regarded as the trade-off fornot having to provide personal guarantees. Most bank loans have only nominalprepayment clauses.

Loan expenses don't vary greatly from lender to lender. The borrower canusually expect the following closing costs:

One thing to note about the above expenses are the borrower's legal fees.Because most conduit loans have standardized documentation, if you are using anattorney who is familiar with securitized loans, the borrower's legal costs canbe reduced greatly, as the lawyer has most likely already seen the verbiage.Legal review of a bank loan may require the lawyer to analyze each sectionindividually, so the fees could be twice as much for a bank loan as they are fora conduit.

Interest rates are the last--but not least--loan feature open for discussion.Interest-rate spreads have increased since the September 1998 CMBS crash. Self-storage margins vary from 225 to 320 basis points, depending on the loan risk.To achieve the lowest rate, the loan-to-value should not exceed 50 percent, andthe debt-service coverage should be greater than 1.7:1. For an explanation ofthese terms, please refer to accompanying glossary.

Construction Loans

Construction loans are best made and administered by local banks with whomthe borrower has a relationship. The loans are typically short in term (24 to 36months) and are due upon completion of construction. The interest rates areusually tied to the prime rate, or the rate the lender charges to its bestcustomers (such as IBM or Ford). The spread is usually 1 percent or 2 percentabove prime. Typically, these loans are full recourse (personally guaranteed)and are 65 percent of the cost of construction. One to two points are charged.Some banks offer a "mini-perm" loan, which is a combination of aconstruction and permanent loan. The term is usually five years, which affordsthe borrower adequate time to reach stabilization.

In Conclusion...

The good news is that capital is available. If financial markets remainstable, and interest rates do not go dramatically up or down, then capitalshould continue to be available. A good loan broker can help younegotiate through the labyrinth of terms and options. Try to find a broker whocan offer bank loans as well as conduit loans. Experience counts for a lot inthis game, and you are often at an advantage to do business with an individualor firm that specializes in self-storage lending.

R.K. Kliebenstein, owner and founder of Coast-To-Coast Storage in BocaRaton, Fla., is a mortgage banker and broker. Coast-To-Coast makes self-storageloans exclusively. For more information, call 561.367.9241.

Glossary of Terms

Basis Point: One-hundredth of a percent, i.e., 100 basis points equals1 percent.

Conduit Loan: A loan usually made by a securities firm that sellsbonds to investors to raise money for the purpose of lending.

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

Index: The instrument used in determining the base for the cost ofmoney. The Treasury rate is most commonly used for fixed-rate loans while theLIBOR index may be used for variable-rate transactions. Usually expressed inbasis points.

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

Lock-Out: A provision in a loan indicating a period of time duringwhich the borrower is not allowed to prepay.

Margin (or Spread): The rate above the index that is charged. Loosely,this is the investor's "profit." If an investor placed funds in U.S.Treasury bills, the margin is the amount above the Treasury bill rate. Usuallyexpressed in basis points.

Note Rate: The annual interest rate you pay. The rate is the indexplus the margin.

Prepayment Penalty: A fee charged by the lender to a borrower who payshis loan off early.

Recourse: Alternately known as a personal guarantee. If a loan is indefault, the personal assets of the borrower are open for attachment by thelender to cure an amount of the loan payoff in excess of the proceeds fromforeclosure sale.

Securitization: The process of selling bonds to raise money for thepurpose of lending.

Yield Maintenance: A prepayment penalty that assures the lender thatif a loan is paid off early, no interest will be lost, as though the loan werepaid at the end of the term. For example: A loan with a note rate of 10 percentis due in the year 2010. The borrower prepays in 2005, and the Treasury billrate on five-year money is 5 percent. The yield maintenance would, therefore, be25 percent (or 5 percent per year).