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Eyes Wide Open: 4 Reasons Why Lenders Are Actively Pursuing Self-Storage Investments

Previously, many commercial real estate lenders kept their eyes tightly shut when it came to self-storage loans. Today, their eyes wide open as they’ve awoken to our industry’s vast potential. Here are four reasons why.

Previously, many commercial real estate lenders kept their eyes tightly shut when it came to self-storage loans. They didn’t understand the asset class, had little interest in learning more about the industry, and instead focused their vision on more familiar property types.

Today, their eyes are open—wide open—as they’ve awoken to our industry’s vast potential. In fact, they’re aggressively pursuing financing for qualified storage properties. For instance, it’s not uncommon for commercial mortgage brokers to get calls from lenders saying they’re over-allocated on multi-family deals and want to complete more self-storage transactions.

Even with the storage industry’s massive success and growth, some lenders still focus on financing the “four food groups” of commercial real estate: industrial, multi-family, office and retail. Underwriting standards for these property types often emphasize the certainty of revenue based on the length of the lease term, underlying provisions and tenant credit. The key difference for lenders who actively underwrite self-storage deals is they understand the concept of property value rather than tenant value.

There’s a wonderful saying that “beauty is in the eye of the beholder.” So, why do some lenders gaze upon self-storage with such a loving view? Here are four key reasons.

1. Diversification

Lenders have come to realize that a storage facility’s tenant base provides extraordinary insulation. Unlike the main groups noted above, self-storage offers a diversified mix of renters, which mitigates credit risk of losing significant revenue from just a few larger tenants. With hundreds of individual customers—none of whom independently compose a meaningful percentage of the rent roll—the loss of any given renter won’t cause major cashflow disruption.

In addition to having a large tenant base, a storage facility’s customers have different reasons for renting, such as relocation, change in family status and long-term storage needs. There’s also a mix of commercial and residential users. This diversification offers further insulation against a drastic change of occupancy due to a single macroeconomic event, such as a recession.

In essence, the risk profile of storage facilities is dramatically lower. The storage industry is well-hedged for economic changes and highly attractive to lenders who are accustomed to bankruptcies and other business developments that can adversely affect their deals with industrial, multi-family, office and retail clients who don’t offer such diversification.

2. Lending Exposure

With time comes experience. As the storage industry has matured, lenders have been exposed to—and come to appreciate—its success and viability. Countless lenders from capital sources including local, regional and national banks; credit unions; commercial mortgage-backed securities (CMBS) lenders; and life insurers have made loans to small, mid-size and large operators who’ve grown to become real estate investment trusts.

It’s a well-known fact that the storage industry has had the lowest default rate of all CMBS commercial property types for more than 20 years. Thanks to the support of capital providers, storage owners have expanded their portfolio holdings. Their lender relationships and experiences have proven strong through good economic times as well as during recessionary periods when storage fared much better than other commercial property types.

Experienced lenders have also come to understand that although storage tenants are on month-to-month leases, the length of stay is statistically predictable, with residential tenants often averaging more than a year and commercial tenants staying longer than two years. In addition, a month-to-month rent roll offers owners great flexibility in managing occupancy and revenue, being able to change existing tenants separately from new customers.

3. Underwriting

Compared to other commercial real estate assets, storage facilities have fewer physical improvements and are operationally less complex. For example, there’s no need to assess lease expirations and account for planned build-up of reserves for tenant improvements and leasing expenses. Addressing tenant turnover is routine and requires little-to-no capital.

Historically, many lenders would use more conservative underwriting parameters when analyzing self-storage loans and pricing would be costlier than other commercial real estate sectors. Self-storage is underwritten and quoted at more aggressive terms than most other commercial property types—other than multi-family properties, which can be financed through government-subsidized agency-lending platforms.

4. The Need for Space

Along with many property owners, lenders are grappling with the changing nature of real estate uses and viability. Consider the drastic decline in regional malls. Once vibrant real estate, they’re now being torn down for alternative uses or, ironically in some cases, being partially converted into self-storage properties. While other commercial types are scrambling to find new ways to lease their space due to changes in how people shop, work and live, self-storage is thriving because its underlying fundamental needs are consistent.

Development Underwriting Hurdles

Lenders cast a different eye when it comes to providing construction loans. Often it’s with a wary glance on the unique timing attributes related to lease-up, as they expect a portion of the property to be pre-leased before completion.

This isn’t the case for self-storage, which has a longer lease-up cycle and no pre-leasing. Accordingly, experienced lenders have learned to provide a longer interest-only period for storage properties, which can reach 36 months or more (not to mention extension options), compared to 12 to 24 months on other commercial properties. Given the lease-up time, self-storage loans often have larger reserves built in to cover the operating shortfall and interest-shortfall reserve.

As we’re now in the ninth year of economic expansion, lenders are more cautious of providing financing to borrowers seeking construction loans. However, even with the large amount of industry development during the past few years, construction money is very much available for storage properties that offer strong sponsorship in economically feasible locations.

With its unique attributes, self-storage has caught the eye of lenders and is now a preferred property type with many financing organizations. I recently told my teenage daughter, who was looking at college options, “Now it’s up to you.” She had the grades and admirable qualifications, but through the admissions process had to sell herself and ensure she found a college with the dynamics and academic program that was the right fit. For self-storage operators, there are many capital sources willing and able to financing options. Like colleges, there are many lenders in the market; it’s up to you to seek the right one for your needs.

With more than 25 years of experience as a national self-storage mortgage broker and advisor, Neal Gussis is a principal at CCM Commercial Mortgage, a mortgage-banking firm that secures financing for self-storage owners nationwide. He specializes in securing debt and equity for self-storage owners nationwide. He can be reached at 224.938.9419; e-mail ngussis@ccmfinancing.com; visit www.ccmfinancing.com

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