One of the top questions self-storage professionals are asking during this recession is, “How are bankers looking at self-storage deals?” The answer is they are looking at loans with the proper level of interest and caution, just as they should always have done.
Over the last decade, there were many loans that shouldn’t have been made. Some deals have turned sour for the investor and banker. Most of these deals haven’t gone bankrupt or even entered foreclosure, but many have not realized the success the developer expected. Some have not broken 70 percent occupancy after four or five years. Anyone want to be invested in a deal that calls for more cash injection? Anyone want a deal in a market that is overbuilt by a wide margin? Anyone?
One of the best “war” stories I have is about a developer in Florida who contacted me about financing. It was around 2004, a time in which a lot of educated people were saying things like, “You just can’t go wrong in self-storage.” The developer had just exited a small apartment deal and decided to build a large self-storage business with approximately 800 units on five acres. This prospective developer, who had a little money in his pocket, said he was doing the deal because “all the competitors were full,” and he “knew the town like the back of his hand.”
Apparently, if I wanted his business, I would be competing with several banks that had already approved his loan. He e-mailed me a two-page loan request that summarized his rather marginal financial position, and two term sheets from competing lenders. When I requested the loan package, he replied, “I sent you my loan package.” No feasibility study. No tax returns. No balance sheet. He believed the project was good and, in his mind, he didn’t need to spend money on a feasibility study. Plus, he was going to get the deal done, whether I participated or not.
I asked the good questions: How would he manage the store? How did he know it would be successful? He did not have good answers. When I informed him I had one project under construction and another in permitting, both within five miles of his site, he seemed to think it didn’t matter. Needless to say, I was not interested in being his lender. But somebody was. The deal happened. He was the last of four new competitors to open in that market.
Not long ago, I was able to reconnect with this store, which was hovering around 60 percent occupancy—well below breakeven. The manager indicated the store had dropped prices by 50 percent since opening, and it had been at the current occupancy for more than a year. Six of its 12 competitors were below 70 percent occupancy. Rates were declining as everyone struggled to survive a severely overbuilt market.
The point is bad decisions make big problems. Who else has war stories like this one? Your banker.
Plan Your Strategy
The financial landscape has changed. When discussing how capital markets responded to the recession, my local banker put it this way, “We didn’t just turn a corner, we jumped off a cliff.”
Before you meet with your lender, you must have a solid strategy for how you will introduce your deal and gauge the bank’s interest in making the loan you need. You’ll likely need to educate the bank’s decision-makers about the self-storage industry, your market, and the expected investment performance of your deal to win a satisfactory approval. Banks are in the risk business, but the banker’s job is to effectively manage and mitigate those risks with the loan he puts in place for your business.
Your job is to provide the lender with as many reasons to do your deal as possible. A banker wants to invest with you after you have found the right deal, invested in the right research, identified and mitigated risks, and put together enough capital to leverage a loan. He also wants to know that when the deal is born, you have the proper team in place to make it profitable quickly.
Banks that have been bitten recently by regulators, deals gone bad and under capitalized clients will pay particular attention to the financial details you present. In this lending environment, it’s best to not discuss any particulars of a deal with a banker until you’re ready to answer the tough questions.
As you identify potential lenders, gauge their interest in self-storage. Some may come right out and tell you they don’t have room for another self-storage transaction. They may want to see the deal first. Keep in mind that most local bankers will have seen maybe only a handful of self-storage deals from the beginning of development.
Just because a bank has self-storage in its portfolio, doesn’t mean a banker will understand the nuances of the business—and it’s those nuances that are important. Don’t send pieces of the deal before you anticipate all of the potential questions a banker might have. Showing a banker only pieces of a deal might raise red flags before you have a chance to fully investigate a project.
After you’ve identified an acquisition or development deal, you need to do your own due diligence before sending any details to a lender. During your feasibility period, identify market trends, supply and demand dynamics, expected costs and financial performance, as well as create a pretty well-defined budget. A lender will probably require environmental studies, particularly if you’re dealing with a parcel that might have been occupied with another use by a previous owner.
Bankers will demand site plans, pictures, surveys, market reports, demographic analysis and pro forma financials related to your project. Put these items together before you sit down to make your presentation and request for financing.
Anticipate the Questions
Bankers want to identify the risks in a deal and be sure there is a counter-balancing mitigating factor associated with those risks. Your feasibility study should clearly identify the market risks or site risk of your project, and enable you to map out the answers to the questions. For example, a new self-storage project might take three years to achieve a stable cash flow or break even. You must be able to present the appropriate mitigating factor to bankers, because when they look at negative cash flow for two years, it will make them cringe.
In self-storage, however, a cash reserve, or dedicated supporting income, is a critical development cost. A banker will understand that it takes time to make a project’s cash flow positive. What he might have trouble with is the fact that operations deficit financing is a true development cost. You need a cash war chest in reserve from Day 1 or your project will not work. Quantify this risk with a careful, conservative, month-by-month pro forma, and let your banker see that the loan he is making is secure because you have the cash in reserve to pay the bills and his interest through breakeven economic occupancy.
Any banker who has studied a self-storage project will remember that a seasonal trend in occupancy may occur. Know what impacts seasonality in your market. Is there a college nearby that generates a high tide of rentals in the spring and summer? Are you in a vacation market that derives income from winter visitors? Be sure your cash-flow projections reflect seasonality during lease-up and following “stabilization.”
Many in this industry will build a pro forma for a new project based on leasing a certain percentage every month. Lease-up doesn’t work that way, so don’t try to sell that to your banker. You rent units, not percentages. People move in and move out. You give discounts to win business, and some people won’t pay you. Lease-up is rarely linear, and economic occupancy—the important measurement—doesn’t mirror physical occupancy. When you present a pro forma to your banker, make it tight and accurate and reflective of market conditions.
A good loan package will also include detailed information on the personal or corporate financials you present to support the deal. On the personal side, provide the highest level of detail on individual debts and assets, cash and investments. For example, if you own multiple companies that flow through to your personal tax returns, provide detailed descriptions of those entities, their cash flows, debts and assets, and how they impact your financial position. The more information you provide, the better your application looks to a detail-oriented lender.
Recall that bankers are in the risk business. When a banker looks at your loan application, he will grade it on the risk it poses to the bank. How things can change in a hurry is “top of mind” with lenders these days. Your job is to clarify that your deal, even in a stressed scenario, will perform well. Be certain to anticipate the correct “what if” scenarios, and prove to your banker that the loan he makes to you is secure and safe, even if the market softens, rents decline, interest increases, or leaseup is slower than projected.
A strong analysis is what bankers search for as they negotiate specific deals, so be ready to prove that your deal performs satisfactorily under stress.
Wrap It Up Nicely
The best way to apply for a loan is to provide everything in a nice binder with an easy-to-read table of contents. Bankers are used to asking for documents related to a deal, additional tax returns, or balance sheets that are not provided with the initial submittal. Do yourself a favor by removing this obstacle from the beginning. You need to spend time explaining details to your banker, not faxing tax returns. Here’s an example of a nice flow for your next loan-application binder:
Loan request: Name(s) of borrower(s), property description and address, loan purpose, amount, requested terms, loan-to-value, debt-service coverage ratio, project name, guarantor names and addresses
Detailed project description: Acreage, number of units, cost, engineer, architect, general contractor, project manager, location detail, aerial pictures of site, survey, site plan schematic, renderings of project, descriptions of other nearby significant locations (housing, shopping, highways, etc.), actual unit mix and schematic, office layout, signage
Due diligence: Feasibility study, phase I environmental study, pro formas, financial analysis, rezoning documentation, contract for sale, local governmental approvals
Personal information: Resumes of partners, contact information, borrowing and supporting entity documentation, three years of tax returns (personal and business, with detailed balance sheets with schedules of assets and debts), individual credit reports
Detailed construction budget: Line item budgets, bids and estimates, contracts, names of contractors, and construction draw schedule
Business plan: Marketing strategy, key personnel, training initiatives, management qualifications, third-party management information, goals and objectives, strengths, weaknesses, opportunities, and threats analysis (SWOT analysis)
Once you’ve compiled your loan package and prepared yourself and your team to answer the tough questions, set up the meeting. Allow yourself plenty of time to walk the lender through each nuance of your deal. Prove to him that your loan is a strong one, you’re a strong borrower, and your deal is a good one. Take the time to put together a quality loan package, and the conversations and negotiations over terms and financing options will materialize quicker, be more definitive, and cement a solid professional relationship between you and your lender.
Benjamin K. Burkhart is a principal of BKB Properties and StorageStudy.com. He works exclusively with self-storage owners, developers and managers to develop strong sites, measure and respond to market trends, and maximize financial performance of self-storage operations. To reach him, call 804.598.8742; e-mail [email protected].