Have a Maturing Self-Storage Loan? It’s Time to Explore Your Options

The rise in interest rates over the past 18 months has been the topic of discussion among owners of commercial real estate across all sectors, including self-storage. During this time, loan coupons went from the low 3% range to north of 7% in a meteoric rise that few expected as the Federal Reserve raised rates to combat inflation.

To make matters more complex, interest rates will be further affected by the U.S. government’s ballooning national debt, which recently eclipsed $33 trillion (and counting). The fact is $7.6 trillion of that debt will mature within the next year and need to be refinanced at today’s higher rates—and that’s before considering the deficit spending, which will only increase the amount. Add it up, and the federal government will need to sell close to $10 trillion in U.S. Treasuries in the next year.

Meanwhile, self-storage owners with nearing debt maturities face two options: refinance or sell their property. Let’s explore both.

Refinancing

Self-storage owners with debt maturing soon are caught between a rock and a hard place. They must weigh the pros and the cons of refinancing early, before rates go any higher, or waiting out the remainder of their loan term while enjoying the cash-on-cash returns from their below-market-interest-rate loans, in hopes that rates will drop before they’re out of time. Even if they decide to sell their property, they still won’t escape today’s higher rates given that buyers are underwriting acquisitions and taking today’s financing costs into account in their pro formas.

To quantify the tectonic shift, the weighted average coupon on a commercial mortgage-backed securities (CMBS) loan for self-storage in 2018 was approximately 4.89%. Owners then watched as rates declined to historic lows in the first quarter of 2022, when that weighted average fell to about 3.70%. By comparison, loans year-to-date through September 2023 have been at approximately 6.57%. The historically low rates we’ve seen over the past 15 years have made it difficult for owners to adjust to today’s higher rate environment.

Selling

Self-storage owners who are considering a sale instead of a refinance have also learned that you can run, but you can’t hide. The rate jump has caused a gap between what sellers are asking by way of sale price and what a buyer is willing to bid. The result can be seen in the data reported by Yardi Systems Inc., which provides management software for self-storage and other types of real estate. It shows year-to-date industry sales have declined from 1,346 transactions in the first nine months of 2022 to 495 during the same period in 2023, a 63% drop.

Owners who decide to wait until the bitter end of their loan term in hope that rates will go down may find wishful thinking doesn’t manifest results. As previously noted, the U.S. Treasury is headed toward financing $10 trillion in bonds in the next year (approximately 31% of what’s outstanding). That’s a lot of paper to move. The question is, are there enough buyers for that much government paper at a time when the nation’s federal deficit is close to $2 trillion (twice what was budgeted)? Debt-service expense has skyrocketed, growing from $476 billion in 2022 to $879 billion this year. It’s expected to eclipse $1 trillion in 2024. These headwinds aren’t going away any time soon.

The Strategy

The crystal ball used for interest-rate predictions has never been accurate. There are numerous variables, market dynamics and macro-economic issues at play. But one thing seems to be setting in with self-storage owners: It doesn’t appear likely that rates will be headed back to 3.5%. Likewise, the rise in rates has wreaked havoc on balance sheets as banks sit on unrealized losses in their bond and loan portfolios, hamstringing their appetite to put money out in new loans.

Self-storage owners with leverage have one thing in common: One day, their debts will need to be repaid. In just CMBS alone, there’s approximately $1.78 billion in industry loans coming due before the end of 2024. This doesn’t account for the loan maturities at banks, credit unions and life companies.

All owners hope interest rates will retrench from their current levels before that day comes, but we all know hope isn’t a strategy. If you’re looking down range at a loan coming due, start exploring your debt options and make plans now instead of waiting until the last 90 days of your term. As the infomercial goes, “Act now. Supplies are limited.”

Steve DeRose is a senior vice president of loan originations at Starwood Mortgage Capital, a subsidiary of Starwood Property Trust. Starwood is an active lender of CMBS (commercial mortgage-backed securities) loans, providing fixed-rate, non-recourse, long-term debt options to owners of commercial real estate assets nationwide. In the past decade, the company has financed close to $1 billion in self-storage, with loan sizes of $2 million and up. He can be reached at 305.695.5845 or email [email protected].