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From Start to FinishPutting a loan package in order

November 1, 1999

8 Min Read
From Start to FinishPutting a loan package in order

From Start to Finish

Putting a loan package in order

By Joe Fordonski

Finding thetype of financing that best fits their needs is key to self-storage owners today. Giventhe volatility in the commercial mortgage backed securities (CMBS) market over the past 12months, lenders are offering different types of financing to meet their borrower's needs.This type of environment allows the borrower great flexibility.

Fixed-rate financing is still the most common financing vehicle. This structure is mostcommon with those owners looking to hold on to the property for a long time. Fixed-ratefinancing can be achieved through a lender who has a CMBS division. CMBS loans are pooledand securitized on Wall Street and provide some of the lowest-rate financing in themarket. The overall interest rate is determined by adding a spread (also called a margin)to the 10-year Treasury rate. The loan is typically amortized over 25 years with a balloonpayment due at the end of 10 years. Again, this option fits best for borrowers planning tohold their facility for a long period as a fixed-rate loan can contain considerableprepayment penalties.

If you have recently acquired a poorly managed facility or are expanding your facilityand experiencing rapidly increasing net operating income, an earnout structure may betterfit your needs. An earnout loan allows you to qualify for more loan dollars, based oncertain benchmarks, within 12 months of the initial funding. This second funding canprovide you additional dollars once net operating income has increased, although typicallyat a higher interest rate.

There are options available through a non-CMBS division of a lending institution. Youmay want to consider a bridge loan if you plan on increasing the net operating income ofthe facility then sell it in the near future. This kind of loan will usually consist of avariable interest rate and a short term (typically three years). Instead of being pricedover the Treasury rate, bridge loans are priced over LIBOR. Unlike a CMBS loan, bridgeloans have minimal prepayment penalties. In most cases, facilities financed with a bridgeloan are either sold or refinanced with a CMBS loan at the end of their term.

Once you have decided on what type of financing best suits your needs, a financingpackage must be prepared a submitted to the lender. A package should include the followingitems:

  • Brief summary of your financing request and the history of the property;

  • Description of the property;

  • Photographs of the property;

  • Occupancy reports for the previous 12 months;

  • Operating statements for the past 12 months and previous three calendar or fiscal years; and

  • Financial statements and resume of the borrower.

It is very important to provide good historical records and explanations for theproperty. Complete records will benefit you as they assist the lender to adjust income andexpense levels up or down, which, in turn, affects the level of loan dollars available.For example, the facility may have required repairs in 1998 that are not typicallyclassified as "ongoing" or "routine" maintenance. Loan dollars can bemaximized if these types of expenses can be documented. The lender will exclude thesetypes of items from its underwriting, thus enabling maximum loan dollars to be achieved.Failure to identify non-recurring items will affect the amount of underwritten netoperating income.

Once the lender has reviewed and underwritten your loan package, a formal applicationwill be prepared for your review. This application should be reviewed by you so that allthe components of the transaction are thoroughly understood. You should also review the"Glossary of Commonly Used Terms" on page 32. Understanding these terms willhelp you to better negotiate the loan application and better understand the structure ofyour loan.

The two most important qualifications in the loan application in determining your finalloan amount are the loan-to-value (LTV) and debt service coverage ratio (DSCR)requirements. LTV is expressed as a percentage and compares the loan amount to the valueof the property as determined by a third-party appraiser. In most cases, lenders will notexceed 75 percent. Some lenders, however, will lend up to 80 percent. DSCR is a ratio thatcompares annual net operating income to annual service payments. Most lenders require aminimum DSCR of 1.25:1.00.

After the loan package has been submitted and the loan application executed, it is timeto move to the actual loan closing. Typically, this process includes:

  • Submitting due-diligence items;

  • Ordering an appraisal report;

  • Ordering a phase-one environmental report;

  • Ordering an engineering or property-condition report;

  • Ordering a seismic report (depending on property location);

  • Loan document preparation.

The lender will provide the borrower with a substantial list of items required in orderto begin a thorough analysis of the loan request. The lender will require such items asoperating statements, occupancy reports, partnership agreements, management agreements andmany other items deemed necessary for review. At the same time, the lender will engagethird parties to prepare the appraisal, environmental and engineering and seismic report(if required).

The appraisal will be used in determining whether or not the loan-to-value requirementhas been achieved as presented in the application. The engineering report will identifyany immediate repairs required and will also verify the amount of reserves the lender willbe required to escrow. The phase-one environmental report details any environmentalconcerns at the property. In the event the phase one uncovers items that require furtherinvestigation, the borrower will required to have these completed prior to the funding ofthe loan. Depending on where the property is located, the lender may require a seismicreport. The seismic report will determine a probable maximum loss (PML) percentage. Inmost cases, if this number exceeds 20 percent, the lender will require an earthquakeinsurance policy be issued prior to closing.

Once all the reports have been received and the property visited, the lender willreview the due-diligence items submitted and submit a credit committee package summarizingthe deal. This package will be reviewed by individuals within their lending institutionwho have authority to approve a loan. Typically, once the loan is approved, an approvalletter is sent to the borrower, and legal counsel will be engaged to prepare loandocuments. Following review and negotiation of the loan documents by the borrower'scounsel, the loan should be in a position to close within a few weeks.

It is important to remember that the loan process can be rather time consuming.Substantial information must be gathered prior to closing. It will benefit you to maintainthorough and accurate records at all times. This will enable you to obtain optimumfinancing for your facility. The "typical" loan process takes approximately 90days. Allow 30 days to prepare the loan package and identify a lender whose program bestsuits your needs, and another 60 days for the loan to close. The key to the whole processis identifying up front what your exact financing needs are.

Joe Fordonski is responsible for the analysis and negotiation of self-storage loanrequests at FINOVA Realty Capital (formerly Belgravia Capital) in Irvine, Calif. For moreinformation, call (949) 442-8000; www.finova.com

Glossary of Commonly Used Terms
Understanding your loan application

Amortization--The number of years necessary to pay the loan balancedown to zero. This includes principal and interest payments. A typical fixed-rate loan isamortized over 25 years.

Assumption/Transfer Provision--Most lenders will allow a one-timeassumption of the loan subject to the lender's approval and payment of a 1 percent fee.

Debt Service Coverage Ratio (DSCR)--A ratio used to express therelationship between annual net operating income and annual debt service. Most lendersrequire a minimum DSCR of 1.25:1.00. For example, if the annual debt service is $100,000,the annual net income has to be equal to or greater than $125,000.

Impound/Escrow Account--An account used for the deposit of valuableconsiderations, such as money. The most common use is for the collection of property taxesand insurance premiums.

Index--The instrument used in determining the base for the cost ofmoney. The Treasury rate is most commonly used for fixed-rate loans while the LIBOR indexmay be used for variable-rate transactions.

Loan-to-Value (LTV)--The percentage amount borrowed in the acquisitionor refinancing of a property. The value of the property is determined by a third-partyappraiser.

Margin--The spread between the index and interest rate.

Mortgage Constant--An equal annual payment, expressed as a percentage,that will amortize the principal and pay interest over the life of the loan. It isimportant to look at the application and determine if there is a minimum constant requiredby the lender.

Prepayment Premium or Penalty--A penalty for an advanced payment on amortgage. The most common penalty is known as defeasance, which is the substitution ofTreasuries for the remaining payments on the loan.

Reserves Account--An account to collect reserves for capitalimprovements. Most lenders will require that an account be established to collect reservesin accordance with the report prepared by a third-party engineer. In most cases, therewill be a minimum collection of 15 cents per square foot, regardless of the results of theengineering report.

Securitization--A securitization involves a lender bundling similarmortgages that are analyzed by rating agencies and then used as collateral for bondspurchased by institutional investors. This type of financing is ideal for borrowerslooking for low fixed-rate financing.

Single-Purpose Entity--A requirement by all CMBS lenders, asingle-purpose entity restricts the borrowing entity from owning any other facility otherthat the property being financed.

Term--This is the period of time between the borrowing date and duedate. In most cases, the term of the loan will coincide with the Treasury bill. Forexample a 10-year loan will be priced over a 10-year Treasury bill.

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