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November 1, 2000

12 Min Read
What's in Store

What's in Store

Getting a glimpse of the self-storage financing future

By Neal Gussis

Thetitle of this article says a lot more than it's initial implication, because thefinancing "store" has changed quite a bit since this publication'slast annual finance issue in November 1999. Banking relationships are different.There has been further shakeout in the conduit marketplace. And mortgage bankersare playing a larger role as self-storage owners find themselves focusing moreon their operations with less time to shop the financing store.

Most owners have first-hand experience in some form of real-estate financing,starting with construction and development loans. For the past few years, therehas been an unprecedented amount of construction and development financingavailable at rates that make investment returns attractive. We've also seen avast array of permanent financing options that were just too good to pass up.Undoubtedly, the financing markets in recent years have opened the door to ratesand terms not seen before in the industry.

Yet with the financing bonanza comes new lender expectations. The days ofloans by handshake are well past us. At today's financing store, lenders look atall aspects of the transaction prior to committing and funding loans. There arealso new terms and conditions that are new concepts to borrowers. The financingactivity flurry started to slow down in the past 12 to 18 months as interestrates increased and underwriting standards adjusted. We have also seensignificant changes in who is lending in this marketplace.

So with all our experiences, there's only one thing we can do, and that ismove forward. We're all better informed and able to match our business financingobjectives with available lenders and programs. And, although the financialmarketplace constantly changes, owners are now in a better position to controltheir next financing transaction.

Let's take a look at your options at today's financing store and see whatmakes sense for your property needs. As you know, leverage or debt comes in manyforms. The most commonly sought loans are construction and permanent orend-loans. For owners with larger property portfolios, you can obtain higherleverage through mezzanine debt and equity participation programs. Let's focuson construction and permanent financing and look at who we can turn to for ournext financing transaction.

Banks and Savings & Loans

Banks and savings and loan associations have traditionally been the largestself-storage financing source. However, most have ceased to exist. Bankersgenerally like to lend on transactions with which they have a wealth ofexperience and the credit decision can be easily supported. However,self-storage understanding varies dramatically among banks based on the loanofficers' and credit committee's exposure to our industry. The bank's loancommittee also must understand that although self-storage properties do not havelong-term leases, future operations can and will be stable. As the self-storageindustry has grown and matured, more banks than ever are consideringself-storage loans for their portfolios.

Many bank loans are "relationship" loans. What this means is thatmuch of the credit decision is based on the strength of the borrower and pastbanking transactions. Traditionally, most bank loans have been recourse orpartial recourse. Banks generally hold the loans they make in their ownportfolio. This gives them more flexibility to negotiate loan terms. In somecases, even more importantly, they can modify loan terms even after the loancloses. If the bank intends to keep your loan in its portfolio, you will havethe benefit of lower closing costs since they may have fewer third-party reportrequirements. Also, a bank's loan documents are typically less complicated andonerous than those of other lenders. Banks will also oftentimes waive"capital reserve" requirements.

Local banks are still one of the only sources for construction financing. Thelocal bank is best equipped to understand the local real-estate market'sdynamics. These loans are typically three years in term, and are designed forhelping the borrower through the construction and lease-up period. Constructionloans are recourse loans requiring personal guarantees, and are generally"interest only" with no principal pay-down for the construction loanperiod. Many banks will provide a mini-perm that allows the borrower to roll hisloan into a permanent or end-loan. These loans will generally have a 20- to25-year amortization with varying term lengths, although a five-year term ismost common.

The banks are still the largest providers of end-loans or permanentfinancing. For loans under $1 million dollars, banks are the primary fundingsource. Typical loans have five-year terms with a 15- to 25-year amortizationperiod with minimum debt service coverage (DSC) of 1.30 to 1.35 to 1. Themaximum loan-to-value (LTV) varies; however, it typically does not exceed 70percent. These loans can be recourse or partial recourse. The interest ratesthey charge are generally not the most aggressive, but if you have a"relationship" and keep deposits or have other loans with the bank,you may have more leverage to negotiate a better deal.

One of your newest options in financing "stores" is a hybrid ofbanks and conduits. Many banks have the ability to provide securitized loans. Inthis scenario, they will provide the same terms offered by traditional conduitsor Wall Street capital sources. They are able to fund the loans from internalcapital. Based on the market, the banks then have the option to sell the loan tobe securitized on Wall Street or keep it in their portfolio.


Conduit lenders provide loans through capital sources. These sources willinclude your loan in a pool of loans to be securitized through commercialmortgage backed securities (CMBS). Conduit lenders consist of banks, creditcompanies, Wall Street firms and mortgage lenders that underwrite and close intheir name, but simultaneously sell the loan to one of the previous sources atclosing. The securitization proceeds then replenish the capital source's outlayfor funding your loan. Conduit loans are pooled and sold as debt securities(bonds) to institutional investors. The pooling reduces risk to the bondinvestors and facilitates the more aggressive interest rates.

Many owners have chosen to finance their properties through securitized loansin recent years. These loans offer attractive financing alternatives to ownersseeking long-term fixed-rate financing and who are unlikely to pay the loanbalance off prior to maturity. Today, the most popular loans have a 10-yearfixed-rate term with a 25-year amortization period. These loans are allnon-recourse (with standard carve-out exceptions). As of early September, loanssupported by stabilized properties were being quoted at the low to high 8percent range based on the deal's credit strength. The primary underwritingparameters are generally based on a 75 percent LTV and a 1.30 DSC. These loansconsider historic operational cash flow, and most programs will underwrite yourloan based on the previous 12 months of operations. Loans on lease-up propertiesare generally quoted on a case-by-case basis. Securitized loans usually havevery restrictive prepayment provisions, but do allow a purchaser to assume theloan (generally for a 1 percent fee).

With owners demanding prepayment flexibility and the ability to increase loandollars in the next two to three years, many conduit lenders now offer variablerate loans or float-to-fixed deals. The floating rate deals are generally about1 percent higher than fixed-rate deals. Several conduit programs may not beavailable since many securitized lenders have minimum loan requirements of $2million to $5 million.

Notably, the CMBS lending market has been in a "shake-out" period.With decreased loan volumes and profit margins, several lenders have left theself-storage market, including two of the industry's largest. It is likely thatothers will follow. Industry watchers insist that those who remain will be thestronger players, the ones most likely to remain the dominant lenders for thelong haul.

Conduit lenders have little flexibility in their ability to negotiate termssince all loans in the pool need to have similar structures. Although conduitloans still offer the most aggressive loan terms, underwriting guidelines havebecome more conservative over the past year. The pools are ultimately examinedby Wall Street bond-rating agencies and are rated as to the likelihood ofdefault. There is also a growing concern that badly underwritten loans are underdeeper scrutiny and being withdrawn from the pools at the demand of riskier bondpurchasers (i.e. the B-piece buyer).

Choosing this option entails a trade-off between obtaining a loan withmaximum dollars, longer terms, non-recourse and longer amortization periods vs.inflexibility in loan document negotiations and restrictive prepaymentpenalties. Closing costs are higher than bank loans. Remember, non-bankpermanent loans generally have terms of 10 years or more, which translates intofewer costs over time.

Life Insurance Companies

Life insurance companies are portfolio lenders and often the choosiestlenders in the financing store. Typical minimum loan amounts are $3 to $5million. They also look for facilities built within the last five years that arestate-of-the-art and have stabilized operations. They are typically lessaggressive with leverage, many times requiring a maximum of 70 percent LTV and1.35 DSC. The loan terms feature 10-year terms and a 25-year amortizationperiod, and tend to be non-recourse. Since they do keep the loan in theirportfolio, life companies can negotiate loan terms, but have limited flexibilitysince the loans are non-recourse. The good news is that if you meet theserequirements and are seeking a lower leverage loan, a relatively aggressiveinterest rate awaits you.

Mortgage Bankers

Given their many responsibilities in operating their businesses, self-storageowners oftentimes need a specialist who can communicate with lenders on theirbehalf and get the best deal possible. These mortgage bankers, or loan brokers,understand the market's capital sources, lenders and their many programs.Mortgage bankers frequently arrange with capital sources for the financing feeto be paid to them.

Mortgage bankers play a unique role in our industry at this time. Clearly weare seeing few, if any, lenders currently advertising in the monthly industrypublications and a large reduction of lenders exhibiting at our trade shows. Themajority of capital sources, including GE and Heller Financial, currently themost prominent self-storage lenders, have limited marketing personnel and lookto mortgage bankers to procure a majority of their permanent loan business.

The mortgage banker assists you in preparing a financing package fordistribution to likely capital sources. The mortgage banker adds value bypreparing a package that tells your story and request in an organized andrealistic manner. While we're deeply immersed in our industry, we sometimesforget there are still many lenders with limited self-storage knowledge who neededucation. Therefore, when choosing a mortgage banker to represent you, youshould seek someone with self-storage financing experience.

Mortgage bankers help you cut through the typical delays and mazes of a largelending institution. You may also get better response time, since the mortgagebanker and his firm may have done several deals with the lender. Themortgage-banking professional is assuming an increasingly important role inhelping owners understand their options and shopping their deals throughout themany stores in the financing mall.

The Internet

Everybody's talking about the Internet as the next big shopping tool, whetheryou're looking to buy a house or computer or negotiate a loan deal. It'sprobably the most organic form of retailing available today, literally changingon a daily basis with new concepts and websites.

There are several loan websites that attempt to unite you with lendersoffering the best rates and terms. Many people I meet think these sites arevaluable for gathering information, but are not currently the answer to theirself-storage financing needs. These websites are still at a very earlydevelopment stage and most likely will go through a "shaking out"period, leaving a limited number of available options.

It is reported that literally thousands of deals are presented to thesewebsites, but only a few handfuls of them are actually closing to date. Also,remember where you might fall in the pecking order of the deals they arereviewing. Many of the deals are mainstream real estate (i.e. office, retail,multifamily properties) with larger loan requests. As these websites improve,they will certainly change the financial landscape and create completely newstorefronts for self-storage financing.

Summing Up

While the self-storage financing store continually changes, some things staythe same year after year. Please keep these thoughts in mind as you considerfinancing:

  1. Make sound financing decisions based on your short- and long-term goals.

  2. Choose the lender or mortgage banker best suited to your needs.

  3. Daily business transactions are generally conducted with people you know and trust, and with whom you have an ongoing relationship.

  4. Accountability is key, especially on large transactions.

There's no doubt that self-storage financing depends on solid relationshipsand personal attention. No matter which store you choose for your loan, look forthat personal touch in any transaction.

Neal Gussis is a senior vice president at Beacon Realty Capital Inc., afinancial services firm that arranges debt for self-storage and other commercialreal-estate owners. Mr. Gussis has funded more than 250 self-storagetransactions totaling nearly $500 million. He can be reached at (312) 207-8240or at [email protected].

Glossary of Commonly Used Terms
Understanding your loan application

Amortization--The number of years necessary to pay the loan balancedown to zero. This includes principal and interest payments. A typicalfixed-rate loan is amortized over 25 years.

Assumption/Transfer Provision-- Most lenders will allow a one-timeassumption of the loan subject to the lender's approval and payment of a 1percent fee.

Debt Service Coverage Ratio (DSCR)--A ratio used to express therelationship between annual net operating income and annual debt service. Mostlenders require a minimum DSCR of 1.25:1.00. For example, if the annual debtservice is $100,000, the annual net income has to be equal to or greater than$125,000.

Impound/Escrow Account--An account used for the deposit of valuableconsiderations such as money. The most common use is for the collection ofproperty taxes and insurance premiums.

Index--The instrument used in determining the base for the cost ofmoney. The Treasury rate is most commonly used for fixed-rate loans while theLIBOR index may be used for variable-rate transactions.

Loan-to-Value (LTV)--The percentage amount borrowed in the acquisitionor refinancing of a property. The value of the property is determined by athird-party appraiser.

Margin--The spread between the index and interest rate.

Mortgage Constant--An equal annual payment, expressed as a percentage,that will amortize the principal and pay interest over the life of the loan. Itis important to look at the application and determine if there is a minimumconstant required by the lender.

Prepayment Premium or Penalty--A penalty for an advanced payment on amortgage. The most common penalty is known as defeasance, which is thesubstitution of Treasuries for the remaining payments on the loan.

Securitization--A securitization involves a lender bundling similarmortgages that are analyzed by rating agencies and then used as collateral forbonds purchased by institutional investors. This type of financing is ideal forborrowers looking for low fixed-rate financing.

Reserves Account--An account to collect reserves for capitalimprovements. Most lenders will require that an account be established tocollect reserves in accordance with the report prepared by a third-partyengineer. In most cases, there will be a minimum collection of 15 cents persquare foot, regardless of the results of the engineering report.

Single-Purpose Entity--A requirement by all CMBS lenders, asingle-purpose entity restricts the borrowing entity from owning any otherfacility other than the property being financed.

Term--This is the period of time between the borrowing date and duedate. In most cases, the term of the loan will coincide with the Treasury bill.For example, a 10-year loan will be priced over a 10-year Treasury bill.

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