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An Overview of Self-Storage Loan Options for 2016: Where to Get Money and What It'll Cost You

Even with an interest-rate increase on the horizon, the market still offers self-storage owners many viable financing options for 2016. Here’s an overview of your loan possibilities for the upcoming year and insight to what money from various sources may cost you.

Shawn Hill

January 16, 2016

7 Min Read
An Overview of Self-Storage Loan Options for 2016: Where to Get Money and What It'll Cost You

With attractive long-term interest rates, strong property values, and an unprecedented understanding and acceptance of self-storage assets by the investment and lending communities, it’s fair to say the climate for industry borrowers has been increasingly favorable in recent years. Although a 2016 rate increase appears imminent, the timing and magnitude are uncertain. Even with increases looming, overall rates are likely to remain relatively low by historical standards.

The market still offers self-storage owners many viable financing options. Investors with long-term hold strategies will find conditions compelling, particularly for longer-term debt products that can insulate from rate increases. Conversely, sellers will find opportunities to trade at record prices, given ample market equity and extremely low cap rates driven by low costs of capital. Let’s take a look at the loan opportunities available to you this year.

Commercial Mortgage-Backed Securities (CMBS)

The issuance of U.S. CMBS grew approximately 33 percent in the first half of 2015 compared to the previous year, on pace to record its highest post-2007 volume. This might give readers pause as they reflect on a still-recovering economy; however, issuance remains below 2005 to 2007, and credit standards are more prudent this go-round.

CMBS lenders offer non-recourse loan products, typically with five-, seven- or 10-year fixed-rate terms, and amortization schedules up to 30 years. These loans commonly feature upfront interest-only periods. Borrowers can achieve leverage up to 75 percent—or higher (85 percent) for loans greater than $10 million—when combined with mezzanine debt.

CMBS lenders are among the market’s most aggressive, thus 8 percent debt-yield minimums aren’t uncommon as they stretch for deals with strong cash-flow growth potential. They prefer large primary-market deals, but also compete for loans as low as $1 million in secondary or even tertiary markets.

The interest rate in a CMBS transaction is calculated by adding a risk-spread premium to the swap-side offering index. For example, a 10-year rate is found by adding the lender’s risk-spread premium to the 10-year swap; therefore, with spreads currently in the 2.25 percent range (225 basis points), and the 10-year swap at 2 percent, the applicable rate on 10-year CMBS money is 4.25 percent. CMBS spreads have generally remained range-bound over the last year, while U.S. Treasuries have also remained low. The result is a winning combination that presents very attractive all-in rates for borrowers.

CMBS loans are criticized for restrictive prepayment options, limited to yield maintenance or defeasance. A borrower’s cost with these options is muffled in a rising rate environment. Even so, he should understand the implications of each.

Closing costs on CMBS deals are typically around $50,000, including all third-party reports, lender legal, ALTA (American Land Title Association) survey, title, etc. Some lenders offer competitive “fixed-cost” programs between $20,000 and $25,000 all-in for loans under $5 million. These programs cover third-party reports and the lender’s legal; however, there are still costs such as survey, title and borrower counsel that fall outside the capped cost structure.

CMBS lenders are aggressive in nature, and with the current combination of low rates and non-recourse offerings, it makes for extremely compelling loan products. Borrowers can lock in historically low rates for up to 10 years, helping hedge against interest-rate risk when rates rise. CMBS debt is also assumable, another valuable potential hedge against rate increases. These loans are presently among the most attractive financing vehicles available to self-storage owners.

Insurance and Life-Company Loan Products

Insurance companies also allow borrowers to lock in longer-term rates on a non-recourse basis. Unlike CMBS lenders, however, life companies are extremely conservative and prefer to lend on very high-quality, stabilized assets in primary markets. This is also exhibited by their preference to lend to highly experienced, well-capitalized borrowers.

Most insurance companies historically enforced $5 million loan minimums as a general rule. As competition flourished, however, some abandoned this standard and are willing to lend lower amounts.

Life companies are notorious for stressing cash-flow underwriting and capitalization rates applied to determine value. This measure typically results in loan advances of not more than 65 percent of actual value. For this reason, and because of extremely selective property and borrower profiles, life companies don’t compete as directly with CMBS lenders for proceeds.

The cornerstone attribute of life companies is their flexibility. They offer among the lowest interest rates available depending on structure, and borrowers can generally lock the rate at application. Furthermore, while five-, seven- and 10-year fixed-rate terms are most common, fully amortizing structures between 10 and 20 years may also be available.

Finally, life companies offer flexible prepayment options and generally reasonable transaction costs. In other words, they’re extremely selective, but those who do secure a loan are in a strong position to negotiate a very attractive package.

Construction and Land Loans

Commercial construction in 2015 built on momentum from 2014, following several years of nearly dormant construction activity in the wake of the financial crisis. For a developer with a viable project in a high-demand trade area, the most likely lending partner is a local or regional bank willing to build a relationship and partner with the sponsor. Full recourse with a completion guarantee is typical of construction financing, at least until the Certificate of Occupancy is obtained, after which a burn-down to limited or partial recourse may be allowed.

Currently, conventional lenders are advancing up to 75 percent loan-to-cost at attractive fixed or floating rates, with “breakeven” interest-carry often built in. Jernigan Capital, a specialized self-storage lender, recognizes the need for new product in select markets and is willing to offer up to 90 percent of construction costs on a non-recourse basis under a participating debt structure for qualified projects. Alternatively, borrowers may find higher leverage available with Small Business Administration (SBA) financing.

When negotiating a construction loan, it’s critical to structure an interest-only period that mirrors the timeline required to bring the property to breakeven occupancy. In addition, be sure to factor the necessary interest-carry into the budget. These structural features help minimize the stress associated with the financing.

The key element in a construction-loan request is planning. Budget construction costs and the development time frame carefully to isolate the appropriate loan structure and help ensure the success of the project.

Local and Regional Banks

Commercial banks are the largest originators of real estate loans and have been the primary source of capital for most self-storage owners. Banks are relationship-driven, thus borrowers should be prepared to place their operating and other depository accounts with the bank. Banks will also conduct an extensive credit review analyzing global cash flow, net worth and liquidity.

Banks will lend up to 80 percent loan-to-value (LTV) and have historically funded loans ranging from one- to five-year terms. More aggressive seven- and 10-year packages have become popular amid mounting competitive pressure—packages which are often made possible with a swap agreement.

Furthermore, banks typically offer amortization schedules of 20 to 25 years. They commonly require personal-recourse guarantees, although the level of recourse fluctuates with leverage and can sometimes even be eliminated for loans below a 65 percent LTV. Depending on the variables above, rates offered by banks can fluctuate significantly but can be very attractive.

Transaction costs are typically very reasonable, and owners can often negotiate prepayment provisions. Banks have also recently taken on higher-risk storage assets such as underperforming properties, particularly when there’s a turnaround story, some planned construction or a sponsor with a track record of success. This is another advantage for owners of increased competition to win business.

SBA Loans

SBA loans are relatively new products available to self-storage, having helped secondary-market owners secure financing they might not otherwise have accessed. Through 7a and 504 programs, borrowers have been able to secure fixed- or floating-rate loans when they require above-average leverage. The following briefly outlines the two programs:

Self-Storage SBA Loan Options***

As with many federal programs, SBA loans are document-intensive and can be tedious. When applying, seek a lender that’s certified with the SBA Preferred Lender Program, allowing it to approve loans on behalf of the administration, which can speed up the process. Contact a district SBA office to learn which lenders are certified.

Going Forward

The combination of low interest rates and staggered new development, as well as aggressive, stabilized cap rates and upward pressure on rental rates, creates an allure to act. Whether you’re refinancing, acquiring or planning new development, there are many loan products available. Do the research to select the right program, and get the dollars and structure needed to position for long-term success.

Based in Chicago, Shawn Hill is a principal at The BSC Group, where he advises clients on debt and equity financing and loan-workout services for all commercial property types nationwide, with an emphasis on the self-storage asset class. For a succinct summary of terms available by loan program, Shawn can be reached at 312.207.8237; e-mail [email protected]; visit www.thebscgroup.com/loan-programs.php.

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