Obtaining a self-storage mortgage is a critical process that requires skill. It also tends to occur more often than you’d imagine.
Not only do you need a loan when you first acquire a property (assuming it isn’t an all-cash purchase), you’ll need to refinance once the balloon comes due, which can happen anywhere from five to 25 years. For example, if your term is five years on a 25-year amortization schedule, you’ll need to refinance as many as five times to fully pay off the loan. In addition, many self-storage owners have realized that a cash-out refinance is a novel way to harvest the equity in their property without the need to sell and pay capital-gains taxes.
The most powerful way to increase your asset’s cash-on-cash return and internal rate of return is through your mortgage terms, which can range significantly. While everyone knows to shop for the lowest interest rate, there are other key factors, such as leverage (loan amount), fees (points), credit spread or coupons, amortization schedule, reserves, term length, and recourse vs. nonrecourse.
Consider amortization, for example. One banker may insist that a 25-year amortization is very aggressive, while other local banks offer 15 years. Faced with that, how would you feel about a 10-year, fixed-rate loan that’s interest-only for the entire term? The impact on your return would be dramatic, and the long, fixed-rate coupon would provide better bond-like annuity.
As you can see, it’s important to go after the best self-storage mortgage terms possible. And securing those terms depends heavily on your personal financial standing.
Your Financial Statement
When offering loan terms, most mortgage lenders heavily focus a self-storage property’s net operating income; however, the financial wherewithal of the borrower is also extremely important. It’s the area many owners tend to overlook. In fact, the most common mistake made by first-time and highly experienced self-storage borrowers is they don’t carefully update their personal financial statement.
On most loans, borrowers (or sponsors) use “dated” valuations for their commercial real estate assets. By dated, I mean they typically enter the original purchase price as the value. What you should provide is the most current operating statement and management summary for the property. The bulk of your net worth is tied to your holdings, so failing to reflect the current, marketable value of your assets affects the lender’s assumption about your financial situation. Even your personal residence should reflect current value.
Updating your personal financial statement not only provides the lender with a more precise picture of the property you’re trying to mortgage, it more accurately reflects your fiscal means. When updating this statement, don’t stop at the values of your commercial real estate holdings. Make sure you carefully update your liquidity, including cash and marketable securities.
Why Lender’s Care
The reason self-storage lenders will analyze your financial strength when reviewing a mortgage application is two-fold. In the case of a recourse loan, which typically requires the execution of a promissory note, your assets provide additional collateral for the loan. In the unlikely event that you default, the lender will use the court system to take receivership of your self-storage facility and eventually foreclose on the property.
However, the process generally doesn’t stop there. After foreclosure, the lender will typically sell the property as quickly as possible because they aren’t in the business of operating commercial real estate and are negatively impacted by regulators for their REO (real estate owned) schedule. This quick-sale process, coupled with the legal, late and default fees that get added to the loan balance, can create a major problem for the lender. If there’s a shortfall, they’ll sue the borrower to obtain a deficiency judgment.
This is why your net worth is important to recourse lenders. The higher you accurately reflect your net worth, the better your loan terms will be.
In the case of a nonrecourse loan, only the self-storage facility is reflected as collateral against “bad boy acts” like fraud, misappropriation of funds and waste. In the event of a default, you hand the keys off to the lender and walk away. Still, your personal assets do provide the equity and liquidity to weather the storm if your self-storage property experiences a peril or short-term negative impact. This could be something like a formidable competitor entering your direct submarket with lower rates, which forces you to drop your prices or face the negative impact on occupancy.
For all of these reasons, even nonrecourse lenders will provide better loan terms to borrowers who exhibit a strong financial profile. In terms of benchmarks, most require you to have a net worth equal to or greater than the loan amount as well as liquidity equal to or greater than 10%. The stronger your net worth and liquidity compared to the requested mortgage, the better your terms will be.
If you’re on the market for a self-storage loan, whether it’s a new mortgage or a refinance, do yourself a favor and properly update your financial statement. Thorough, accurate information will improve your ability to obtain the best possible terms, which will impact the long-term performance of your property.
Gregory J. Porter is the founder of Summit Real Estate Advisors, a New York-based mortgage brokerage specializing in self-storage properties. He’s a 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. He has approved or originated more than $800 million in self-storage mortgages. To reach him, call 917.701.5145 or email [email protected]