Using CMBS to Refinance Your Overleveraged Self-Storage Property or Secure More Attractive Loan Terms

Due to the recent escalation in interest rates, some self-storage investors may now find themselves overleveraged with a looming debt maturity. In this case, a commercial mortgage-backed securities (CMBS) loan could be a good choice for refinancing because it offers a large amount with reasonable payment terms and no personal liability if the debt isn’t repaid. These loans can also be used to fund stabilized projects, with potentially lower monthly payments than what you might get from a traditional lender.

Let’s see how this self-storage loan option can offer unique advantages, from flexible refinancing to long-term financial stability.

What Are CMBS?

CMBS are like bonds that are backed by commercial mortgages and sold to investors. Certain lenders make loans to commercial-property owners with the goal of grouping those mortgages and selling the payments as bonds. When the bonds are sold, the lenders get their money back and can use that capital to make more loans.

This system helps money move smoothly between borrowers, investors and lenders investors, which is why these lenders are called “conduits.” Historically, conduit lenders have provided a tremendous amount of capital to the commercial real estate community.

The CMBS market was created following the savings-and-loan crisis of the 1980s, a challenging time in which liquidity was stressed by the widespread failure of financial institutions across the United States. Since then, it has continued to evolve and thrive despite market disruptions, such as the bursting of the dot-com bubble, the horrific events of 9/11 and, most notably, the Great Recession of 2007 and 2008. This resiliency is a testament to the efficiency and ingenuity of this debt instrument during times when liquidity is challenged.

Benefits to Borrowers

There are many benefits associated with CMBS loans that self-storage borrowers may find attractive:

Five-year flexibility. Given the interest-rate environment over the past few years, some self-storage borrowers have been hesitant to lock into long-term deals. Lenders have responded with a five-year product that’s open to prepayment during the last six months. This option is remarkably similar to the existing 10-year loan, only with a shorter term and a small pricing premium.

By offering this short-term product, the conduit market has addressed a big downside of getting a CMBS loan. One of the primary complaints is the expensive penalty for paying off a CMBS loan early, which usually involves complex processes like defeasance and yield maintenance. Being able to pay off the loan after four and a half years is much more appealing than waiting nine and a half.

Maximum proceeds, minimum payments. The payments for CMBS loans can be lower than those for bank loans when you’re only paying interest at first. The “loan constant” is a way to measure how much of the total loan is paid off each year. You can figure this out by dividing your yearly loan payments by the total loan amount.

Following is a basic comparison between a CMBS loan, where you only pay interest for the entire term. The tables shows how each option affects cash flow. It’s important to point out that this isn’t an apples-to-apples comparison, but rather a situation in which a borrower might initially think the bank loan looks like the better choice.

Despite a slightly higher interest rate, the CMBS borrower can tap into much higher proceeds and enjoy a lower annual debt-service payment. Spread this savings of $70,000 across a five-year term and there’s an interest savings of $350,000 over the life of the loan. Additionally, cash-out proceeds from a refinance aren’t taxed like capital gains from a property sale, as those funds are part of a loan that must be repaid over time.

It’s important to note that with five- and 10-year CMBS loans, self-storage borrowers can save money by paying extra upfront for a buydown, which lowers their interest rate. This can also allow them to borrow more money overall because it improves their ability to repay the loan. The math on rate buydowns equals 25 basis points in interest-rate savings on a five-year loan and 15 basis points on a 10-year loan for a 1% fee. Applying this math to the above example will result in additional savings reflected below. 

Another benefit of rate buydowns is they allow you to use a CMBS loan, especially the five-year option, as a temporary bridge loan, which can free up money that would otherwise be allocated toward fees like interest-rate protection. Though CMBS is explicitly not a loan product intended for funding construction, it can be a great lifeline for a self-storage project that is close to stabilization but not fully leased up and, therefore, not ready for other forms of permanent financing. If the property’s income can meet the required payment levels, CMBS might also be a smart option for those looking to refinance soon.

While a CMBS loan isn’t the answer in every situation, this financing option continues to adapt and rise to the occasion to meet the needs of thousands of self-storage borrowers. As interest rates have receded from highs of well above 7%, there are compelling offerings in the marketplace for many situations. Whether you’re conducting the analysis alone or with the help of an advisor like a mortgage broker, it’s worth preparing a simple comparison when weighing borrowing options.

Shawn Hill and Adam Karnes are principal and vice president at Chicago-based The BSC Group, which arranges debt and equity financing for commercial real estate investments nationwide. They provide mortgage brokerage, financial consulting and loan-workout solutions to self-storage owners nationwide. You can contact Hill at 312.207.8237 or [email protected]. Contact Karnes at 262.527.0528 or [email protected].