Sponsored By

Falling Interest Rates:That's Good, Right? So Why Aren't We Smiling?

January 1, 1999

3 Min Read
Falling Interest Rates:That's Good, Right? So Why Aren't We Smiling?

Falling Interest Rates:

That's Good, Right? So Why Aren't We Smiling?

The following is reprinted from the Argus Self Storage Sales Network MarketMonitor newsletter.

Interest ratesare at all-time lows, which is good if you're a consumer, but something odd is happeningin the financial markets that is making the purchase of commercial real estate difficult.Investors that invest in the financing of real estate are getting a little concerned asthey compare the risk they are assuming to the reward they are getting. If the stockmarket has been the focus of the nightly news of late, the bond market is where the realstory is unfolding, and it is not encouraging for our business.

First, a brief primer on how most of the long-term lending gets done in self-storagetoday. Almost all of the long-term loans (five years and up) are generated by firms thatpackage your loan with loans of other borrowers for all types of real estate, and sellthem on Wall Street through a vehicle called commercial mortgage-backed securities (CMBS).Once your loan is combined with other loans in a large package (usually in the hundreds ofmillions of dollars) one of the Wall Street firms "chops" up the package intoseveral tranches or parts--usually three--then sells them to investors. Each trancherepresents a different level of risk based on the priority of the principle and interestpayments coming from the entire pool of loans. Thus, the first level has the greatestsecurity and the lowest return, the second tranche has more risk and a higher return, andthe last tranche has the highest risk and possibly the highest return, but it is veryspeculative.

Going through all of these gyrations has made the whole package more attractive toinvestors and has generally broadened the investor market, which, in turn, has also madelending easier and cheaper for the borrower. The CMBS system has worked very well inrecent years and has allowed great access to the credit market for all types of realestate, including self-storage.

Financing Going Up

So, if the system works so well, why are interest rates dropping while the cost offinancing is going up? First, the stock market and the international financial situationhave made investors, in general, very nervous. They are thinking, "Do I really wantto lend my money at these low rates for such a long period of time?" Alsocontributing to the situation is the fact that the group of potential second-trancheinvestors has all but dried up because they believe that their level of security in thepool of loans does not justify the return. Another factor in this issue is that many ofthe packagers of these loans got caught with a large inventory of loans when the"music stopped" and lost a lot of money before they could sell their loans toWall Street.

So, what now for the self-storage owner? Despite the fact that interest rates are goingdown, rates on self-storage loans are going up because the lenders are charging a largerspread (the difference between U.S. Treasury rates and loan rates) to help compensate forthe perceived risk. The really bad news is that many of the lenders are simply pulling outof the market and waiting to see what happens. Generally, those lenders that remain willnot lock up a rate until closing, and the underwriting process (i.e. loan review) will betougher than ever.

Don't Wait

If you are currently thinking about getting a loan, do not wait. The general thinkingamong our friends in the financing business is that things are more likely to get worsebefore they get better. Likewise, if you are thinking about selling anytime in the nearfuture and believe that your buyer may need a loan, now would be a good time to getstarted in the selling process. Since no one saw this coming, it is also clear that no oneknows exactly what will happen in the future.

Subscribe to Our Weekly Newsletter
ISS is the most comprehensive source for self-storage news, feature stories, videos and more.

You May Also Like