Financing is among the most important decisions you’ll make in operating a self-storage business. The right lender and loan type helps position you to meet current and future goals, and your loan terms will have a significant impact on profitability.
There are various types of loans available to owners, each with specific strengths and weaknesses. One will likely fit your needs more than the others, so it’s important to understand the differences between options. Here’s an overview to help you make the best choice.
Local banks are a common choice for self-storage. They’re easy to find and offer significant flexibility. With standard prepayment penalties like “5-4-3-2-1” countdowns, banks provide a great option if you need a short-term (two- to three-year) bridge loan to resell or flip your property, or you need a few years to renovate or enhance a property before improving cash flow and refinancing to a long-term, fixed-rate option.
Flexibility is why local banks are also generally the best choice for construction projects, which require draw schedules and, at times, a rebalancing of reserves. Local lenders also understand your market, which is important for construction or construction-to-perm loans.
One major drawback is banks are typically recourse lenders. This means not only are your property and business collateral for the loan, so are any personal assets you own, such as your house. In addition, banks generally limit loan length to only a five-year, fixed-rate term. Some will tell you they offer a 10-year loan with a “reset” after five years. It’s a five-year loan, plain and simple. The lender can and will adjust the interest rate and remaining terms at the five-year mark, or may even decide not to extend any terms.
Small Business Administration (SBA)
SBA loan programs like the 7(a) or 504 are another option for self-storage. The best feature of these products is high leverage. With the U.S. government guaranteeing a portion of the loan, it increases the combined leverage to a loan-to-value (LTV) ratio of 80 percent to 85 percent. This can be great for individuals looking to acquire a property with a low, upfront payment. Another benefit is a long, fixed-rate term of 20 years.
Potential disadvantages include high upfront fees and interest rates. Typically, there are multiple “points” paid to the lender and the mortgage broker, and coupons for SBA loans are generally around 7 percent today, which is high compared to other loan options. There’s also significant paperwork involved, and SBA loans are recourse, putting your personal assets at risk. In addition, they’re offered only for acquisitions, which limits their use.
Commercial Mortgage-Backed Securities (CMBS)
CMBS are loans made by Wall Street lenders and specialty finance companies, sold into CMBS bond offerings. Their notable features are low, 10-year, fixed-rate terms with coupons currently hovering around 3.85 percent for self-storage properties, depending on leverage. They offer “cash out” financing, which local banks and SBA loans typically don’t offer. They can also offer a 30-year amortization schedule, which provides a higher return for your business vs. the 20- or 25-year schedules offered by local banks or the SBA (albeit at the cost of having to repay your loan over a 30-year period vs. 20 or 25).
CMBS loans are also non-recourse, which means as long as you don’t commit “bad boy acts,” like fraud or waste, you can simply hand the keys back to the lender and walk away without the risk of your personal assets being seized. This can come into play if there’s a property or market event that limits your ability to make debt-service payments and you default. It’s an important feature for institutional owners with many properties, as well as owners focused on estate planning who have children inexperienced at self-storage operation.
Drawbacks include a strict prepayment structure of yield maintenance in which you’re essentially responsible for the 10 years of interest payments whether you pay the loan off early or not. While CMBS loans are assumable, and a good mortgage broker can negotiate favorable assumption fees of a half-point or less, these are longer-term products. If you’re planning to own an asset for four years or less, CMBS is likely not your best option.
Some lenders have also gained a bad reputation for retrading borrowers or changing the loan terms from the original application prior to funding. While CMBS is a highly liquid instrument that has more volatility than other loan, there are many lenders you should avoid, as they can use the volatility in their favor, for example, by charging additional spread and/or cutting proceeds. The creates a turbulent closing process for borrowers.
With CMBS, it’s critical to choose the right lender. A great mortgage broker with significant experience can help you choose one for your project and navigate the closing process in the most efficient, painless way.
A Creative Solution
Finally, there’s an interesting finance segue that uses SBA and CMBS products to create an extremely efficient finance path and business plan. An SBA loan can offer high initial leverage to acquire a property with the least down payment. You might consider using one to acquire a facility and then refinance to CMBS once the property appreciates enough in value to qualify (75 percent LTV).
This can be a great strategy to effectively use the available loan types in your favor. It allows you to begin with maximum leverage before improving your return. This is accomplished by lowering your interest rate and switching to a non-recourse option by refinancing with a reputable CMBS lender.
Gregory J. Porter is the founder of Summit Real Estate Advisors, a New York-based mortgage brokerage specializing in self-storage properties. Gregory is a former, 20-year lending veteran with commercial mortgage-backed securities lenders such as Deutsche Bank and JP Morgan, where he was a senior underwriter. He also served as the chief underwriter at Barclays PLC, with a $100 million signature authority. To reach him, call 917.701.5145; e-mail firstname.lastname@example.org.