By Richard Schontz and Matthew Weckesser
Successful investment in self-storage can be accomplished through several strategies, all with varying levels of risk and reward. Below are three creative options to explore: commercial condominium acquisitions, bridge-loan financing and joint-venture equity partnerships.
The creation of a condominium structure can allow for flexibility when investing in a self-storage property that also includes a retail, multi-family or other use component. This concept was recently used to execute the sale of a multi-use property in Cherry Hill, N.J. The former big-box retail site had been converted into three distinct spaces: a 98,000-square-foot, climate-controlled self-storage facility and two retail spaces occupied by regional tenants.
This unique asset provided a challenge for retail investment groups who weren’t interested in owning and operating a self-storage facility as well as self-storage owners who didn’t have interest in retail space. Prior to going to market, the seller was advised to create a condominium structure to allow flexibility in the marketing process. The property was offered as a single asset or as individual assets, which afforded access to the appropriate buyer pool for each use. While fairly time-consuming to set up, the condominium structure allowed separate investors to acquire the assets that best fit their specific investment strategy.
The self-storage portion of the property was acquired by a publicly traded real estate investment trust (REIT), and the two-unit retail condominium was purchased by a private, regional retail operator. The separate purchasers agreed to a formal structure that dictated the rights and responsibilities of each owner. Ultimately, the condominium separation led to a substantial self-storage investment that would’ve been otherwise unachievable. Execution of this type of transaction takes patience and creativity but can serve as a good way for investors to acquire in-fill properties in retail locations without having to purchase significant interest in an asset that doesn’t fit their core strategy.
Bridge loans are a flexible source of debt, as these lenders aren’t constricted by the same occupancy and cash-flow requirements faced by permanent loan lenders. They can be the solution when purchasing a self-storage facility that has expansion capabilities, needs to be managerially repositioned or isn’t yet economically stabilized. This type of financing can provide future funding for significant capital expenditures and construction with floating, fixed or hybrid structures that can be tailored to each borrower’s needs.
Some of the biggest advantages of a bridge loan can be:
- A sub-1.0 debt-service coverage ratio (DSCR), as most permanent lenders will require an initial DSCR of 1.25 or higher
- A high loan-to-value (LTV) ratio, sometimes upward of 85 percent, as traditional permanent financing won’t exceed 75 percent LTV on a self-storage property
- The ability to alleviate potential prepayment issues such as costly yield-maintenance or defeasance penalties
Although there can be risks involved, such as an interest-rate increase in a floating rate structure, there’s significant value in the flexibility a bridge loan can provide for specific investments that allow an owner to finance the future potential of a value-add property.
Performance-based joint-venture (JV) partnerships have become more common as institutional equity continues to expand within the self-storage sector. Penns Trail Self-Storage, a 50,000- square-foot facility in the Philadelphia suburb of Newtown, Pa., recently sold to a JV that exemplifies the continuously growing interest of institutional equity in this bourgeoning real estate sector. Let’s look at how this marriage of an operator, equity partner and debt financing created maximum value for the sellers while allowing interested investors and operators to acquire high-quality assets at a suitable cost to achieve their required returns.
Penns Trail went to market unpriced with an initial call for offers set for 30 days. Due to its location, strong historical occupancy and premium demographics surrounding the asset, the property received strong interest from a large spectrum of buyers including private, regional owners; larger, national private owners; pension funds; private-equity providers; and REITs. It received 10 offers from qualified purchasers.
During the beginning phases of the marketing process, the broker’s capital-markets team was able to match a regional operator that was aggressively working to expand its portfolio with a boutique investment-banking firm that was looking to take a programmatic approach to placing equity in the self-storage sector. Equity capital can represent the most critical and difficult component of any real estate transaction; but through several meetings, the team was able to create a plan that allowed the equity group to grow its self-storage ownership while allowing the operator to graduate from syndicating each acquisition with “friends and family” to using institutional equity sources. This would help the investor be more competitive and streamlined in its approach to growth.
The brokerage worked with its debt-placement teams to keep buyers informed of the best financing terms, producing quotes from commercial mortgage-backed securities lenders, regional banks, life-insurance companies and other sources. Its experience with these lenders allowed interested buyers to aggressively dial in on their underwriting pro formas via inclusion of a fixed, interest-only financing period, increased leverage, or lower debt-yield requirements. In turn, providing this feedback to the ultimate buyer and its potential equity-investment partner allowed the recently formed partnership to offer the best possible terms based on its required return thresholds.
This unique scenario allowed each party to each party to achieve its goal. The sellers were able to achieve maximum pricing by having “real-time” access to both the debt and equity markets. Meanwhile, understanding how to manufacture an acceptable return through the debt and equity markets allowed the buyer to win the deal. The equity structure made this buyer competitive where it hadn’t been historically due to the higher yield thresholds a typical “friends and family” syndication requires. In addition, the combination of the minimal co-invest along with aggressive debt, including full leverage and several years of interest-only, allowed the operator to pay a sub-6 percent capitalization rate while exceeding the initial preferred return.
Going forward, we expect to see continued interest from new equity sources in self-storage as it becomes increasingly difficult to find acceptable returns in other investment types.
Richard Schontz is a managing partner and Matthew Weckesser is director of acquisitions for City Line Capital LLC, a self-storage acquisitions and management firm formed this year in a partnership with CSG RE, the real estate acquisition arm of New York investment bank CSG Partners LLC. The group intends to acquire $200 million in self-storage property this year. For more information, e-mail [email protected] or [email protected]; visit www.citylinecapital.com.