It’s the peak of football season. Each weekend, we see coaches analyzing down situations, pondering options, whispering into headset microphones and calling in plays.
Deciding whether to refinance your self-storage property is not much different. You must size up the financing field, especially since credit markets have tightened lending requirements in the past 18 months. You have to consider your facility’s operating history and borrowing ability given today’s lending environment. And you need to think how available credit will affect your investment returns. Only then will you know if it makes sense to make the call to refinance.
While the credit crunch has all but eliminated the go-to play from recent years (conduit financing), you don’t have to throw a desperation Hail Mary pass to obtain a loan in today’s market. You will certainly have to grind out some yardage in order to score storage refinancing, but with up-front analysis and educated play calling, you can be a winner in this arena.
The Playing Field
Let’s start by briefly examining today’s refinancing playing field. Conduit lenders have been on the sidelines for 12 months, and it is difficult to predict when they will suit up again for an appearance. For years, conduit loans were a great tool for borrowers to refinance stabilized or near-stabilized properties with long-term, non-recourse debt at attractive rates and long amortization periods.
These loans also allowed investors to pull out cash and equity based on the debt coverage and loan to values. Many experts offer two reasons for conduit lending’s return from the disabled list:
- Commercial property fundamentals remain strong with stable operating results and low default rates.
- Credit markets need a Wall Street securitization vehicle like conduit loans to provide marketplace liquidity since banks and life insurance companies alone simply do not have this capacity.
Upon their return, do not expect conduit loans to display the same dramatic pass-play style of recent years. They will be more akin to a conservative ground game that offers terms similar to those from the conduit rookie years of the mid-1990s.
For the past 18 months, banks have been—and will continue to be—the self-storage sector’s primary credit source. Unless it’s a large loan, these institutions keep loans on their balance sheets and are limited by the amount of capital they have and can raise. Banks face increasing regulatory pressures, and many have some exposure in residential or condominium construction projects, which is resulting in greater risk and fewer loan pay-offs.
Accordingly, many banks are now more selective with new loan originations by lending only to existing clients and select new customers, and quoting more conservative terms. You may find a bank’s risk-management condition will determine your financing request. While many lenders seeking to eliminate portions of their portfolio will politely ask clients to seek financing elsewhere, others are in stronger positions and wish to build clientele.
These days, the primary players on the refinancing field are storage owners whose current loans are coming due. The majority of this group is owners with maturing construction loans, but others are coming off permanent loans. According to the Self Storage Association’s Industry Trends, 6,835 new facilities were built in 2005 and 2006; so it’s now time for many owners to revisit their leverage options.
Borrowers should have these expectations as they walk onto the refinancing playing field:
- They will need to be more diligent in covering the market for a potential lender.
- Debt-service coverage will be higher, loan-to-values or costs will be lower, amortization periods could be lower and recourse will likely be expected.
- Property and sponsorship will be scrutinized much more intensely.
- Interest rates should be manageable, yet inflation is looming and rising rates could change field conditions soon.
Today’s refinancing playbook offers many game plans depending on the owner’s situation. Regardless of your field position, it’s a good call to maintain your existing banking relationships as the institutions currently holding the lending cards. Here’s a breakdown of various loan types, and suggested plays to ensure the best possible outcome.
If your construction loan matures in 2009, your request for permanent financing is easier to obtain if your property leased up as planned. Historic operating results will be your biggest obstacle in reaching a desired loan amount. While you may be stabilized today, or have reached lease-up in the past few months, it’s also possible that on a trailing 12-month basis your numbers are weaker because you were in lease-up phase. Expect lenders to look at your operating history beyond just the most recent months and underwrite conservatively. If you cannot make the case for a higher loan amount, ask the lender to build in a provision to increase the loan after you’ve achieved additional historic performance.
Further, although interest rates may be reasonable today, you should not lock into long-term deals with high prepayment penalties. The market will change and you likely will not want excess equity locked into your financing. Many construction loans are arranged as mini-perms and, in this market, the mini-perm option may be your best bet.
If your construction loan is coming due and your property is not stabilized, try to negotiate an extension with your existing lending institution. Even if it charges an extension fee or changes your interest rate, you will generally be better off than trying to find a new lender. If you do shop for a new loan on an unstabilized property, be prepared for scrutiny, highly conservative underwriting and additional equity investment. You’ll also have to justify when and why the project will lease up in the future. Your game plan will likely involve a take-out bridge lender willing to offer loans at 50 to 75 percent of original cost with varying degrees of financing fees and interest rates on a fully recourse basis.
For storage properties expanding in phases, your best refinancing option is your existing lender which has completed the initial homework on you and understands the project’s strengths within the local market. The key is to present documented successful performance of the existing phases.
The best structure for expansion-phase financing is to create a new interest-only loan similar to the original construction loan and have the existing phase demonstrate sufficient cash flow to cover the new debt-service requirements. Keep in mind:
- Construction costs have risen and should be factored into your cost and profitability calculations.
- Overall market supply and demand conditions may have changed since your earlier building phases.
Your lender may not be in a position to meet your financing request or provide any financing at all. (If this happens, seek other local lenders and present your refinancing similar to a construction loan request.)
Increase Leverage/Cash Out
Typically, self-storage investors make an initial equity investment of 20 percent or more when building or purchasing a facility. Many will then want to increase their bottom line and increase their leverage to recapture some, if not all, of their initial cash equity. With conduits currently out of the market, it is now tougher to leverage equity; however, it can still be accomplished.
Your current lender is less likely than others to increase the loan, as they usually want property owners to still have “skin in the game,” but may increase your loan to 90 percent of original cost if the property’s operational performance meets their guidelines. Otherwise, competing banks will likely look at historic operating results and apply a 1.25-1.35 debt-service coverage test to determine a new loan amount.
Lower Interest Rate
Today’s market offers good opportunities to obtain highly favorable interest rates. It is not uncommon to obtain a three- to five-year fixed-rate loan in the low to mid-6 percent range. If your loan currently has a high interest rate, try renegotiating a lower rate and term extension with the current lender. It will get tougher though if your lender does not renegotiate. If you find another lender with lower rates, weigh the cost, time and current lender relationship to determine if running this play is worth it.
This is a cash-flow tactic that is part of the mix in a financing decision. With higher amortization, you lower your monthly principle pay down and improve monthly cash flow. Pre-credit crunch, self-storage deals typically had a 25- to 30-year amortization, and the first several years could be negotiated with interest-only provisions. Now, expect 25-year terms or less.
Lower Personal Recourse
In today’s conservative lending market, expect personal recourse to be a requirement. The higher the leverage, the less willing a lender will be to offer a break on recourse. Some non-recourse loans are now offered at a 60 or 65 percent loan-to-value basis, but come with interest rate premiums of .5 to1.5 percent. If conduit loans return, more competitively priced non-recourse options should be available.
Lengthen the Loan Term
Seek a loan term long enough to avoid placing you in a compromising position caused by market factors, but short enough to not lock you into refinancing that can’t be paid off without expensive prepayment penalties. A three- to five-year loan term is a reasonable position given today’s market conditions. Loans over five-year terms are now being offered at rates in the mid-7 percent range and higher.
Regardless of your position on the refinancing field, you shouldn’t view your situation as fourth and long. While lenders are playing more conservatively and will likely expect you to have a higher equity position, there are also many healthy banks actively lending. Remember, the wind is still at your back with attractive interest rates. Finally, if you need some extra coaching, consider seeking advice from a storage-industry mortgage broker who is on the lending field every day regardless of market conditions.
Neal Gussis is a principal with Beacon Realty Capital, a Chicago-based full-service financing firm and provider of self-storage mortgage services. He can be reached at 312.207.8240; e-mail [email protected].