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How Will Self-Storage Owners Survive the Credit Crisis?

Borrowing will be more difficult for everyone in 2009, including self-storage developers, who will have to work extraordinarily hard to obtain commercial real estate financing. The good news is interest rates are still reasonable and some banks are still making loans on self-storage properties.

January 25, 2009

7 Min Read
How Will Self-Storage Owners Survive the Credit Crisis?

Somehow we survived Black October 2008, but now found ourselves in the worst credit crisis since the Great Depression. Americans are stressed out. Investors have seen their savings and 401k accounts shrink to unimaginably low levels. It’s estimated that as many as 30 percent of Americans owe more on their house than its worth. All sorts of what-if scenarios are bantered about, with worst-case predictions openly contemplated by business news pundits on a daily basis.

As a nation, and as individuals, we are closer to the breakpoint than we have been in more than a generation or two. What exactly is the “breakpoint?” When you are playing tennis and are on the losing side of a breakpoint, you are one point away from losing the game, even though you’ve been serving the ball.

That sounds eerily similar to our nation’s economic position and the situation many storage owners find themselves in at the outset of 2009. We had been easily holding serve with property financing for several years thanks to historically low interest rates and generous loan program terms.

But as the residential subprime mortgage fallout gained momentum through 2007 and 2008 to morph into a full-blown credit crisis, we found that holding our serve was much more difficult, even if our self-storage businesses were performing well operationally. What became readily apparent is that we need to constantly be cognizant of how macro market conditions can make us more vulnerable and force us into a breakpoint situation.

Working Hard for the Money

The U.S. government has joined with nations worldwide to fashion multiple solutions to the financial crisis. One of the main objectives is to shore up the banking system to better support lending to businesses and consumers. As we’ve seen, the crisis will not be solved overnight and will likely take several months (maybe even years) with many twists, turns and wild gyrations in the stock and bond markets along the way.

Undoubtedly, borrowing will be more difficult for everyone in 2009 and you will have to work extraordinarily hard to obtain commercial real estate financing. There is good news though: For the most part, interest rates are still reasonable and some banks are still making loans on self-storage properties.

Today, banks are controlled by their risk management, with even the strongest institutions scrutinizing loan-request packages more closely than they have in a decade. Lenders are evaluating borrowers’ risk profiles primarily on two main factors:

The ability to borrow based on the credit and financial wherewithal of the borrower and his partners. Banks now review actual credit and balance sheets for reasonableness of values. They’re also giving more weight to liquidity, as they view cash on hand through liquid investments as a positive sign of your ability to repay the loan.

Lenders are examining the historic performance of a property to size up a borrower’s new loan. Remember, though, lenders today use stricter guidelines than in the past, which curtails loan dollars. Therefore, on a case-by-case basis, a borrower may be exposed to a lender denying a request because of credit, or providing him with a loan quote that is less than the current outstanding loan.

Many owners have become accustomed to being able to take additional proceeds out either beyond the current loan amount or, in some cases, beyond the initial costs. Pulling additional equity out in the form of debt will be increasingly more difficult in 2009.

On top of it all, we are dealing with volatility on steroids. Market movement in a single day can be more than we have seen in a previous year’s worth of time. It is impossible for any of us to make predictions on what lies ahead. You can only position yourself to reduce your risk and stay as far away from the breakpoint as possible.

Who You Know

One way you can possibly avoid reaching a breakpoint is by establishing depository relationships with your current banks. Let’s not fool ourselves: Capital sources today are trying to obtain as much capital infusion as possible. By the same token, you may want to diversify your banking relationships.

The banking system is in the middle of a de-leveraging period, or trying to reduce loans to many customers. Many banks are facing regulatory closure and others are consolidating. With all this movement, your well-established banking relationship could disappear overnight, or from a more positive perspective, it could prove to be the difference in receiving a loan.

It is also very difficult to know which lenders are in the self-storage market at any given point. Therefore, in addition to your banking connections, you may want to seek professional advice from a mortgage broker you can trust to provide you with current and objective market information.

How Close Are You to the Breakpoint?

If you own a stabilized self-storage property investment with long-term financing that matures in five or more years, you are as far from the breakpoint as you can be. That’s a good spot.

If your stabilized property has a loan maturing in three to five years, you need to stay aware of markets and potentially refinance to lengthen your loan’s maturity. You may want to start by visiting your current bank, drawing upon your banking relationship, and renegotiating the term length.

If you are on a construction loan and have the ability to convert into a mini perm in the next 12 to 18 months, you probably will be in a situation where going into the mini-perm portion of the loan is your best option. The only caveat is if there are certain operating hurdles to achieve.

If you have a loan coming due in the next two years, it would be prudent to start shopping for new financing now. It takes a lot longer to secure new financing today than in years past. The market is no longer homogenous and each lender will look at each loan request differently.

One of the major changes resulting from the demise of commercial mortgage-backed securities lending is the availability of non-recourse financing. You should expect to receive a recourse loan unless you are seeking a loan-to-value of around 50 percent. Even then, you’ll have limited non-recourse options.

If you have a construction loan maturing in the next 18 months, you should also start planning ahead on your loan take-out strategy. Most developers were able to get highly leveraged construction loans in the recent frothy lending environment. It was not uncommon for construction loans to be made at 80 to 85 percent of cost.

The real challenge for those developers will be to have operating performance that is strong enough at the end of two to three years to justify a take-out loan at the same level. Many of them will be at a breakpoint where they will need to infuse equity in order to obtain a new loan. If the lease-up has not been strong, they also risk facing a challenging market to obtain a new loan at all.

Regardless of where you are in the breakpoint continuum, you must also manage your operations in addition to your financing risks. Your customer base is probably acting differently by now: Looking at their shrinking pocketbooks and cash flow, residential and commercial tenants are making choices about whether they should continue renting their storage spaces.

No need to sugarcoat the truth; these are not the best of times. In fact, they’re quite humbling times.

Here’s some advice: “Staying power will help us stay in the game.” Try that for your New Year’s resolution. Even in the economic downturn, self-storage has again proven to be one of the best real estate investments available and one of the most recession-resistant. That sense of staying power should inspire you to stay in the game.

Through these tough economic times, be mindful of keeping life in perspective. Appreciate all the good around you, as well as all the good you can bring to others ... especially those who may be reaching their own breakpoint.

Neal Gussis is a principal at Chicago-based Beacon Realty Capital, where he directs the firm’s self-storage group. He can be reached at 312.207.8240; e-mail [email protected].

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