By David Smyle
Over the past couple of years, the big banks were bailed out; smaller banks were sold, taken over or merged with other institutions; and mid-sized banks struggled to work out problem portfolios and keep regulators at bay. Where does that leave the availability of credit for self-storage owners, and how has the overall financing landscape changed in phase one of the recession?
The Recession: Not Over Yet
Yes, there will be a second phase to the recession. It will come during the second wave of residential foreclosures and the first major wave of commercial foreclosures as a result of continued weakness in the leasing market and lack of job creation. There are several factors that might lead to a double-dip recession:
- Enormous budget shortfalls in federal, state and local government, requiring further cuts in jobs and spending programs.
- The huge amount of residential foreclosures forecasted to occur in late 2010 and 2011.
- Under performing commercial-lending portfolios being sold to note buyers whose sole intention is to get control of the properties at bargain prices. This will allow them to offer rents at better rates than neighboring properties and cause competitors to lose tenants or reduce rents to keep the market from deteriorating.
The current administrations policy of spending our way out of a recession might have been more productive if the expenditures went to create jobs as opposed to union and state bailouts. Screams from the other side of the aisle for tax cuts to stimulate the economy may or may not help.
Were in a business cycle, and it will take time to work through. The recession that occurred in the late 80s and early 90s took about five to six years for recovery. Then we had about 10 to 12 years of putting the pedal to the metal before loose underwriting on residential and commercial loans finally came home to roost. We can expect the current recession to last about five to six years, so expect recovery around 2012 or 2013 if the government can stop over regulating and over spending.
Eventually, rates will rise, and with them the Treasury Bills and federal discount rates. You dont have to an economics professor to predict that. Remember, it was only a decade ago that an 8 percent fixed rate for 10 years was considered great, and 7 percent was a good short-term rate. Most of us would gag on those rates today, but over time, 6 percent to 7.5 percent will return as a norm and, in many cases, were already there. Still, three- to five-year fixed rates under 6 percent can be found in the banking and insurance-company world, with longer-term insurance-company money for 10-year fixed rates under 6 percent in many cases for well-qualified properties.
Nationwide lending giant Citibank is reduced to multi-family lending, while many others have limited programs that steer clear of high-vacancy properties such as retail, single-tenant and office. Self-storage lending is viewed as somewhat risky to many lenders today, because they already have a full portfolio of self-storage loans. Hesitation about lending on storage is due in part to vacancies caused by previous overbuilding and economic job loss. Move-in specials abound in nearly every market as facilities complete for the coveted renter.
As banks become more solvent, well see a return to more lending programs and options, and maybe a little loosening of lending parameters and underwriting requirements. Well continue to see banks consolidate and merge as the FDIC works its way through the backlog of failing banks. Big banks will get bigger, and a few new, small community banks will start to show up, but will likely not have any huge lending power in the beginning.
Lending varies greatly from market to market, with conservative underwriting guidelines being a common factor. What once was a loan-to-value (LTV) of 70 percent to 80 percent in most areas is now 60 percent to 70 percent, with 75 percent on occasion to strong borrowers with well-run and occupied properties. The East Coast seems to prefer 15- to 20-year amortization, with 20 to 25 years more common in the West. Its rare to find 30-year amortizations anymore except for an occasional credit union and large conduit transaction (commercial mortgage-backed securities).
The majority of fixed-rate terms have dwindled to three- and five-year periods from seven- and 10-year, with insurance companies, pension funds and conduits providing most of the available long-term fixed rates on better-quality properties. During a recent review of financing options for a New Jersey property, local banks were either not lending on self-storage or limiting amortizations to 15 to 20 years and LTV to around 60 percent to 65 percent. This is not uncommon for many areas of the country.
One of the biggest issues facing borrowers today is reduced occupancy from the downturn. Unless a lender is forced to modify an existing loan, funds are scarce to refinance an under performing property, or to purchase facilities with high leverage or ones that reflect reduced cash flow. Cap rates have risen significantly in the past few years and arent expected to see a major drop. The good news is financing is out there. While not at the low interest rates of the mid-2000s, rates are still relatively low historically and typically lower than cap rates.
In the meantime, expect banks to continue to be the main source of financing, with fixed rates in the three- to five-year range, either as a balloon note or part of a 10-year term. Expect to see amortizations topping out at 20 years, with 25 years being part of a more liberal loan program. Most lenders will top out at 65 percent to 70 percent LTV on a purchase, and if cashout is involved, 60 percent to 65 percent. But operators should have a good reason for the cashout, as lenders are wary about giving cash back if its not going back into the property or to reduce debt.
Also be prepared to possibly move your banking relationship to a new lender. A relationship is becoming more a part of the overall lending transaction. If your property value has declined or cash flow and occupancy have dropped to where refinancing with another lender will be difficult, your best bet is to negotiate with your current lender for an extension or modification to help you through the difficult times.
Keep your seatbelts buckled. Were still in for a bumpy ride a little while longer.
David Smyle is president of La Mesa, Calif.-based Benchmark Financial, a commercial mortgage banker providing financing options for self-storage and other commercial property types nationwide. For more information, call 877.862.7916; visit www.benchmarkfin.com.