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Maximizing the Conditions of a Hot Self-Storage Market: Selling Your Facility vs. Cash-Out Refinance

If you own a self-storage business, you may be thinking about selling, as today’s climate offers favorable returns. Alternatively, you could consider a cash-out refinance through a commercial mortgage-backed securities loan. Read pros and cons of each and why you might pursue one over the other.

Gregory J. Porter

July 1, 2022

6 Min Read
Maximizing the Conditions of a Hot Self-Storage Market

Strong investor interest in self-storage properties has pushed capitalization (cap) rates to all-time lows and, subsequently, valuations to all-time highs. It isn’t uncommon to hear of a 3% cap rate on a larger property in a primary market. As this rate decreases, or “tightens,” the property’s value goes up. (Refresher: Value is based on annual net operating income (NOI) divided by the cap rate.)

The thing to keep in mind is investors aren’t the only ones who want a piece of the self-storage action. Commercial real estate lenders have also recognized the value of these properties relative to other asset classes. While investors pay a cap rate based on stability of NOI and the probability of its growth, lenders are focused on cash-flow stability. All things being equal, they would prefer to lend on properties that garner significant investor interest in the unlikely case of foreclosure and the subsequent need to sell. And as we all know, the pandemic improved investor and lender interest in self-storage due to the industry’s cash-flow resiliency and increased demand for the product.

These factors have led to a very robust real estate market, and many self-storage owners are wondering whether now may be a good time to sell, especially as they receive unsolicited offers from eager buyers. However, there are other ways to leverage the value of your asset in this economic landscape, such as a cash-out refinance through a commercial mortgage-backed securities (CMBS) loan. Let’s look at the pros and cons of each option and why you might pursue one over the other.

Selling Your Self-Storage Property

Conventional wisdom tells us to “buy low and sell high,” and today’s self-storage values are remarkably high. Selling your property in the current market is a very good option. You can generally receive maximum funds today, which provides a strong internal rate of return and multiple on your investment. Maybe you’re reaching retirement age and don’t have a family member who’s interested in taking ownership of the property; or perhaps you want to pursue more passive investments, or reduce the work hours or headaches that come with every business.

Just remember there are also drawbacks of selling, and capital-gains tax is at the top of the list for most investors. Federal and state taxes can eat up a large portion of the funds received for a sale. While 1031 exchange is a way to delay these taxes, if your reason to sell is based on cashing out, that advantage is eliminated if funds are reinvested. Furthermore, transferring from a property you know and manage to a new one you don’t know can be frustrating, as new problems and challenges can arise.

In addition, there’s the loss of monthly earnings to consider. Ongoing income provides sustainable compensation for your efforts. It continues and, in many cases, grows into perpetuity for you and your family, especially if the business is handed down when you retire.

Finally, there’s the loss of daily activity and purpose. While some owners decide to sell their self-storage facility due to the work involved, many miss the daily grind. Having something to do every day is beneficial to many, and there are countless owners who’ve sold their facilities and then feel the loss.

Considering a Cash-Out Refinance

While nearly all commercial real estate lenders would love to make a self-storage loan today, this is a good time to consider what a commercial mortgage-backed securities (CMBS) lender can provide. CMBS lenders are typically investment banks or divisions of lending institutions including Deutsche Bank, JPMorgan and Morgan Stanley, and they’re generally more pragmatic than other lenders.

While fresh equity or the equity that exists for an acquisition loan is better than implied equity or the equity created through time and a change in a property’s market value, CMBS lenders still give value to implied equity. As such, they allow self-storage owners to cash out or obtain a mortgage significantly above their current debt and even over their cost basis. This creates a novel new option for in the current environment when valuations are at new highs.

Like traditional lenders, many CMBS lenders provide 75 percent loan-to-value (LTV) for acquisitions or cash-neutral transactions. However, they’ll also offer cash-out refinancing up to 70 percent LTV regardless of the intent. Many self-storage owners have existing debt of up to 30% to 50% LTV based on current values, providing a sizable cash-out refinance opportunity. CMBS lenders understand that “harvesting” the equity a business owner has built is part of the ownership cycle.

There are also owners who are looking to expand their existing self-storage facilities, build new ones or diversify into other investments. While interest rates for CMBS and other types of mortgages have started to increase, they remain at historic lows. CMBS lenders also offer 10-year, fixed-rate mortgages, providing a long-term finance option.

The benefits of a cash-out refinance mean you receive cash at closing, similar to selling a property. While you won’t get all the equity at closing, you’ll receive a large portion of it given how aggressive lenders are today and how strong valuations are; and you won’t have to cut the profit nearly in half due to capital-gains taxes. In fact, your taxable revenue drops when you increase the size of your mortgage.

You also continue to receive excess cash flow and benefit from any additional increases in valuation due to NOI growth or further decrease in cap rates. It’s a way to proverbially “have your cake and eat it, too.” You harvest your equity tax-free to buy or develop additional self-storage facilities and continue to receive revenue and excess NOI.

Another benefit of CMBS mortgages is they’re nonrecourse, so only the facility is collateral for the loan. Most other lenders have recourse obligations with promissory notes in which the self-storage facility is collateral as well as the owner’s other cash and assets.

The drawbacks of CMBS financing are that it can be a complicated process, and some lenders require minimum loan amounts of $5 million to $10 million, which doesn’t help owners of smaller sites looking to borrow less. The good news is an experienced mortgage broker can help you navigate the closing process and identify lenders that are willing to provide financing on mortgages as small as $2 million.

Whichever choice you pursue, do your research. Find an expert real estate or mortgage broker who can guide you through the process. Ask for referrals from other clients and find out how those transactions fared, then determine which option is best for you and your self-storage business.

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].

About the Author(s)

Gregory J. Porter

Summit Real Estate Advisors, Founder

Gregory J. Porter is the founder of Summit Real Estate Advisors, a New York-based mortgage brokerage specializing in self-storage properties. Gregory is a former, 20-year lending veteran with CMBS 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. To reach him, call 917.701.5145; e-mail [email protected].

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