In 2014, commercial real estate borrowers have been presented with plentiful liquidity on the debt and equity side of the capital stack, as well as a multitude of borrowing options. It’s been nothing short of a borrower’s market.

As we head into the fourth quarter, interest rates continue to remain near historic lows. However, with unemployment improving ahead of schedule and inflationary pressures mounting, 2015 may be the year we start to see interest rates creep up.

Regardless, the next year should present self-storage owners with an ideal opportunity to evaluate their options and develop a sound strategy to maximize investments. With plentiful equity looking to invest, cap rates are extremely aggressive, and those looking to sell should find ideal conditions for doing so. Alternatively, investors with a hold strategy will find borrowing conditions to be compelling, particularly for longer-term debt products that’ll insulate borrowers from the looming rate increase. Here’s a look at the lending options.

Commercial Mortgage-Backed Securities

Commercial mortgage-backed securities (CMBS) lenders are among the most aggressive in the market, offering non-recourse loan products with five-, seven- or 10-year fixed rates, and amortization schedules up to 30 years, often with an interest-only period during the initial term. These loans allow borrowers to leverage up to 75 percent loan-to-value (LTV) or higher (85 percent) for larger loans (typically more than $10 million) when combined with available mezzanine-debt products.

As the market has evolved, CMBS lenders have become increasingly more aggressive with their debt-yield targets (net cash flow divided by loan proceeds). Debt-yield minimum of 8.5 percent aren’t uncommon today, with lenders stretching even lower for deals that have strong upward cash-flow trends.

The interest rate for CMBS loans is calculated by adding a risk-spread premium to a benchmark index, known as the swap side offering. For example, the applicable interest rate for a 10-year loan would add the lender’s perceived risk-spread premium to the 10-year swap rate; therefore, if current risk-spread premiums are 200 basis points, or 2 percent, and the 10-year swap is at 2.5 percent, the applicable interest rate on 10-year CMBS money would equal 4.5 percent.

Loan spreads for CMBS have generally remained steady on a slow decline over the past 12 months, while U.S. Treasuries have remained historically low. The end result is a winning combination that presents very attractive all-in rates for borrowers. In fact, as of the fourth quarter 2014, rates for 10-year CMBS loans are well below 5 percent and hovering right around the 4.5 percent range.

A common criticism of CMBS loans is prepayment options are limited to yield maintenance or treasury defeasance. In a rising-interest-rate environment, the implications of these rigorous prepayment options are less significant; however, it remains a factor that borrowers should understand before proceeding with this debt structure. It’s also noteworthy that CMBS loans are assumable, which is a nice feature that can be very valuable in a rising-rate climate.

The closing costs on a typical CMBS deal average $50,000, which includes all required third-party reports, lender legal, ALTA survey, title and other miscellaneous reports. Although CMBS lenders prefer larger deals in primary markets, they’re also extremely competitive for smaller transactions as low as $1.5 million in secondary or even tertiary markets. There are several lenders that offer competitive “fixed cost” programs between $20,000 and $25,000 all-in for loans of less than $5 million.

The aggressive nature of CMBS lenders, combined with their low rates and non-recourse nature, make their loan products extremely compelling. CMBS borrowers are able to lock in historically low interest rates for up to 10 years, thereby postponing interest-rate risk in what is likely a rising-rate environment. For this reason, many self-storage owners find CMBS debt to be the most attractive financing vehicle available today.

Insurance and Life Companies

Insurance companies (aka life companies) are very active real estate lenders who, like CMBS lenders, offer the ability to lock in longer-term rates than are typically available from more conventional lenders. Insurance companies are also among the most conservative lenders in the market, preferring to lend on very high-quality, stabilized assets in primary markets with premium physical attributes. In addition, these lenders prefer owners with high levels of experience and strong personal balance sheets. Many life companies enforce a minimum loan size of $5 million; however, as competition for deals has increased, some are now willing to consider loans below this minimum.

Because insurance companies prefer lower-leverage transactions, they typically don’t compete with CMBS lenders on loan proceeds. Given their more conservative nature, they’re notorious for stressing the cash-flow underwriting and capitalization rates that are applied to determine value, resulting in loan advances of not more than 65 percent of actual value.

The cornerstone attribute of life companies is their flexibility. For example, while five-, seven- and 10-year fixed-rate loan terms are most common, insurance companies can offer fully amortizing loan structures between 10 and 25 years. They can also offer the ability to lock the interest rate at application, as well as more flexible prepayment options and overall transaction costs. As of the fourth quarter 2014, interest rates for life-company loans are extremely attractive, typically ranging from 3 percent to 6 percent, depending on the term and overall loan structure.

Local and Regional Banks

Commercial banks are the largest originators of commercial real estate loans, so it should come as no surprise that they’ve traditionally been the primary source of capital for the majority of self-storage owners. Banks are relationship-driven lenders that can provide shorter-term capital used to purchase, refinance and build properties. That said, a borrower’s ability to obtain a loan may require a relationship with the prospective lender. He should be prepared to place his operating accounts and other depository relationships with that bank. He should also expect an extensive credit review analyzing global cash flow, net worth and liquidity.

As with all debt products, interest rates for bank loans are currently very attractive but can vary greatly depending on loan term and size, borrower strength, and leverage among other factors. Current fixed-rate lending parameters for banks are primarily one- to five-year term loans; however, with mounting competition to win business and increase product, some banks are even offering seven- and 10-year fixed-rate term loans, often through the use of a swap agreement. Bank amortization schedules are typically on the more conservative side at 20 or 25 years, with available leverage of up to 75 percent LTV.

Typically, banks require personal-recourse guarantees on almost all loans; however, the amount of recourse may be reduced or eliminated for lower-leverage loans of less than 65 percent LTV. Transaction costs for bank deals are generally very reasonable, and prepayments can be negotiated on a deal-by-deal basis. As competition for deals grows, banks have become a lending leader on higher-risk storage assets, including turnaround properties that may be underperforming or those with a construction component.

Small Business Administration

Small Business Administration (SBA) loan products have only been available to self-storage owners since 2010 but have proven especially beneficial to those in secondary or tertiary markets, where traditional financing options may be more difficult to find or higher-than-conventional leverage is required. There are two SBA loan programs available for self-storage properties: 7a and 504.

The 7a program is typically a variable-rate loan most commonly structured with a prime-based rate that resets quarterly. It’s a fully amortizing 25-year loan, open to prepay after three years. 7a loan proceeds can be used for acquisition or refinance.

The 504 is a fixed-rate program with up to a 20-year term that carries a prepayment penalty for the first 10-year period. The program is currently only available for acquisitions, however, some speculate that refinance may become eligible with Congressional approval—the appetite for which is often dependent on political climate and party agendas.

Rates for 7a and 504 programs vary based on several factors. Borrowers should be aware that the processing, underwriting, approving and closing of an SBA loan can be time-consuming due to the document-heavy nature of any federal program. Overall, access to SBA financing is a positive for the self-storage industry because it injects an additional source of capital and liquidity into the market.

Construction and Land Loans

After being largely non-existent for many years, construction financing regained popularity in 2014, a trend that should continue in 2015. Banks are the logical source, preferring guarantors with very strong balance sheets and significant development experience. Borrowers should expect full recourse, at least until the Certificate of Occupancy is obtained, at which time the bank may allow for a burndown to limited of partial recourse. Lenders are currently advancing up to 75 percent of project cost at very attractive fixed or floating rates, with several years of interest-only amortization.

For a developer who is determined to build and has a viable project in a high-demand trade area, the most likely lending partner is a local or regional bank willing to build a relationship and partner with the sponsor. Given the low-interest-rate environment, limited new development, aggressive cap rates for stabilized facilities, and upward pressure on rental rates, new construction is becoming an evermore attractive proposition. This factor, combined with the increased health of local and regional banks, is making construction loans once again a viable option.

Going Forward

As the economy improves, borrowers should expect volatility and a rise in interest rates. Nonetheless, self-storage owners will have a myriad of loan options. The next 12 months are an ideal time for borrowers to take advantage of opportunities in the market, locking in historically low rates and aggressive lenders looking to put money to work.

Based in Chicago, Shawn Hill is a principal at The BSC Group, where he advises clients on debt and equity financing and loan-workout services for all commercial property types nationwide, with an emphasis on the self-storage asset class. He can be reached at 312.207.8237 or [email protected]. For more information, visit www.thebscgroup.com.