Self-storage is finally a favored property type in the financial community, but that wasn’t always the case. Just 10 years ago, lenders often viewed it as inferior to other commercial real estate assets like office, retail, industrial and multi-family. Loan rates and terms—if offered—weren’t particularly attractive, so borrowers or their brokers often had to educate lenders about the business’ upside.
Today we have an ever-increasing number of lenders that understand the tremendous value proposition self-storage offers. The vast amount of historical loan-performance data supplied by rating agencies and others demonstrates that loans secured by industry borrowers have consistently experienced some of the lowest delinquency and default rates of any commercial real estate. It’s also proof that the self-storage sector withstood the tests of the Great Recession and COVID-19 pandemic significantly better than other property types.
As a result, a multitude of lenders has gravitated to self-storage over the past decade. Of course, not all are created equal, so it can be confusing to know where to go for financing. Let’s examine the options so you can decide what may best meet your needs.
Matching Your Purpose
Your choice of self-storage lender is often dictated by why you need financing. Typical objectives include a property acquisition, refinancing of an existing loan, construction of a new facility or the expansion of a current site. Breaking down the purpose of the loan helps to narrow your options. Even within a primary purpose, there are questions to ask:
- Acquisition: Is the property stabilized (occupancy and rents), or in lease-up or transition? Is the loan for a small or large property, or perhaps a portfolio of assets?
- Refinance: Is your primary objective to lower the interest rate, extend the term or provide cash-out in excess of the existing loan amount?
- Construction: Is it a new, ground-up development or the conversion of an existing property?
Other important criteria to consider include the loan amount, your financial strength and experience as a borrower, any personal guarantees you can provide, and your geographic proximity to the property. These factors and others can determine which type of self-storage lender you should approach.
Now, let’s take a look at some leading lending sources available to self-storage borrowers in 2023 and the borrowing scenarios they favor.
Banks are still the most common type of lender for self-storage acquisition and construction financing as well as refinancing. They come in many shapes and sizes ranging from small, community banks to larger local banks to those with a regional and national presence. Many smaller institutions have loan-size limitations and are better suited for financing in the $1 million to $5 million range. Larger banks with greater capacity are better equipped to handle bigger transactions, though they may still be limited by a maximum total loan amount to any single borrower or guarantor.
Many community banks focus on local relationships. Even if a self-storage facility is in their geographic footprint, they may choose not to lend to a borrower who lives outside the area. Similarly, banks that lend on a local property often won’t service the same borrower if that borrower chooses to purchase or develop a facility in another market.
It’s important to note that the appetite to lend on self-storage isn’t constant. It ebbs and flows with the economy, the concentration of industry loans on a bank’s balance sheet, and other lending policies or factors that may be unique to each lender. If a bank provided very aggressive and favorable financing for your purchase last year, don’t be shocked if you come back to finance a new property this year and the terms are less favorable or the bank isn’t at all interested in the deal.
Typical bank-loan terms are five and seven years with a 25-year amortization and a maximum loan-to-value (LTV) of 75%. In recent efforts to compete with other lenders, an increasing number of banks now offer 10-year, fixed-rate loans with amortization schedules as long as 30 years. While they analyze self-storage real estate and financial operations very closely when underwriting a new loan, they tend to have a stronger focus than other types of lenders on the financial strength of the borrower and individual(s) providing personal guarantees.
An increasing number of credit unions have become very good sources for self-storage financing and provide loan terms similar to banks. However, they don’t typically offer construction lending. Instead, they focus on existing properties with stabilized cash flow.
In contrast to other commercial real estate lenders, federally chartered credit unions are prohibited from charging prepayment penalties on loans that are paid off prior to maturity. This can allow a borrower to take advantage of a falling interest-rate environment before their loan matures. You can simply refinance at a lower rate without incurring a penalty.
Small Business Administration (SBA)
SBA loans are partially guaranteed by the government and allow lenders who originate the financing to lend at a higher leverage without bearing all of the related risk. Though leverage on conventional bank loans is typically limited to 75%, requiring a 25% equity down payment, on SBA loans, it can be as high as 90%. This allows a borrower to purchase or develop a self-storage facility with as little as 10% down.
Loan terms can range from 10 to 25 years, which is significantly longer than typical bank terms. Though fees are higher than for most other loan types and the paperwork more intensive, the lower down payment and longer terms may outweigh these disadvantages for many borrowers. Also noteworthy is SBA lenders are more likely to finance borrowers with little to no self-storage experience, providing a good entry point for those who are new to the industry.
Commercial Mortgage Backed Securities (CMBS)
CMBS loans, also referred to as conduit loans, are pooled together with other financing and ultimately sold into the capital markets as securities. The underwriting is primarily focused on the underlying commercial real estate and related cash flow and less on the financial strength of the borrower.
Accordingly, CMBS loans are best-suited for properties with stabilized cash flow or borrowers with less personal financial strength. They provide limited personal recourse to the borrower, with the exception of “nonrecourse carve-out provisions” related to fraud and other potential bad acts by the debtor. Many borrowers are also attracted to CMBS because they can get a 10-year fixed rate with interest-only payments, thereby increasing current net cash flow.
Some disadvantages of CMBS borrowing include voluminous loan documentation, high transaction costs and legal fees, and onerous prepayment penalties. Also, the interest rate is calculated by adding a spread to an index related to treasury yields. While the spread is what the lender commits to at the time of the loan application, they have no control over the fluctuation of the index, and the interest rate isn’t locked until the loan is closed. As a result, during the 45- to 60-day period from the loan application to closing, the exact interest rate won’t be known. In turbulent economic times (like much of 2022), the treasury-index rates can be volatile, and CMBS financing may not be the best fit for all borrowers.
Finally, because these loans are sold into a larger pool and ultimately handled by a third-party servicer, there’s very little opportunity for flexibility or loan modification post-closing. This is an important and distinct difference from a more relationship-oriented lender, where the loan is serviced by the originating lender and kept on its balance sheet.
Commercial real estate loans made by life-insurance companies offer some of the same advantages as CMBS financing, such as limited personal recourse, long-term fixed rates and interest-only payments. These loans are also similarly focused on stabilized properties with in-place cash flow.
Unlike CMBS lenders, many life companies have the ability to lock in the interest rate at the time of loan application. However, most tend to limit their focus to larger loans ($10 million and up), properties in top-tier and secondary markets, and newer facilities. Leverage is typically limited to 65% LTV.
Bridge lending has been around for a long time but has become much more prevalent for self-storage owners during the past several years. As indicated by the name, these loans span the time from when a property is constructed or acquired until it achieves stabilized cash flow. This could apply to a newly constructed facility in the initial stages of lease-up or an acquisition in the process of value-add activity such as rate increases, expense reductions, occupancy growth or property expansion.
By design, bridge loans are shorter in term (one to three years) and offer mostly floating rates. In many cases for non-bank lenders, they also have limited personal recourse to the borrower. In the past, bridge lending was limited to large loans of $20 million or more; however, with an increasing number of lenders entering the self-storage space, these loans can now be as small as $5 million.
Plenty of Options
Overall, the great news is self-storage owners and investors have more lending options and providers from which to choose in 2023. The critical thing is to establish clear financing objectives and then explore the path to successfully achieve your goals.
Steve Libert is co-founder of CCM Commercial Mortgage, a mortgage banking firm whose principals have provided more than $5 billion of financing to the self-storage industry since 1993. For more information, call 224.938.9419.