Capital markets are in flux again: the European crisis, Americas budget debates, slower gross domestic product growth, stubborn unemployment, fears of a double-dip recession, stock-market swings, natural disasters, Middle East uprisings, and the list goes on. Unfortunately, it all has a direct impact on the self-storage owner looking for financing today.
The last few years have been the most volatile Ive seen in my entire career of providing debt and equity to self-storage owners. Just last summer, if you were looking for a 75 percent loan-to-value (LTV), fixed-rate, non-recourse loan under $3 million, you had very few options, if any. In the beginning of 2011, extremely aggressive financing was available through the consumer mortgage-backed securities (CMBS) market, similar to what self-storage owners could have expected in 2007.
Today, the markets are in upheaval again, and lenders are reassessing their underwriting standards. Well have to wait and see how it all shakes out, but its likely that if you financed in the second quarter of 2011, you may have achieved the best rates and terms of the year, if not the foreseeable future. The chart below illustrates the non-recourse, fixed-rate loan proceeds available over the course of the past year if you had a self-storage property generating $300,000 in net operating income (NOI).
Date |
Amount |
Loan Type |
Cap Rate |
LTV |
June 2010 |
$1,950,000 |
Life Insurance Company |
10% arbitrary |
65% |
January 2011 |
$2,470,000 |
CMBS |
8.5% arbitrary |
70% |
June 2011 |
$3,157,000 |
CMBS |
actual |
75%-80%, 9.5% debt yield |
September 2011 |
??????? |
Lenders reassessing underwriting standards | ||
The good news is at the time of this writing (late August), its anticipated the markets will start to settle down and permanent loans will be funded again, but with normalized underwriting. Most likely, this equates to a 10 percent debt yield (NOI divided by loan amount), 70 percent LTV and 1.30 debt-service coverage ratio.
Evaluating Lenders
The first thing a borrower should do when seeking a refinance is determine which lenders to contact. Many have downsized personnel, modified lending programs or simply stopped lending altogether. Its important to work with a professional whos up to speed on current market conditions. The first question to ask is whether the lender has closed a loan in the past 90 days. This will help you determine if its truly in business and lending. Many lenders may say theyre quoting loans but are being conservative and issuing terms that arent competitive with the market.
There are a variety of lenders in the market depending on whether youre looking for a construction, bridge or permanent loan. Additionally, you must decide if you want a recourse or non-recourse loan quote. Some of the lenders who provided specific loan options before the capital market collapse of 2008 may have completely different programs today. To make sure youve identified the right lender for your particular situation, you should at least consider quotes from life-insurance companies, CMBS lenders and commercial banks.
Preparing Your Package
Once youve identified the lenders youd like to approach for a loan quote, youll need to prepare a package for their review. Since many lenders have reduced staff, theyre not prepared to deal with large loan volumes. Your package must be professional in appearance and include all the pertinent information in a synthesized format so a lender can review it quickly to determine its interest. Packages should include:
- Trailing 12-month income and expense statements
- 2008, 2009 and 2010 year-end income and expense statements
- Trailing 12-month occupancy reports (physical and economic occupancy)
- Résumé including a schedule of real estate owned property
- Competitive market occupancy and rents
- One-, three- and five-mile demographics, including population, number of households, income, renter vs. owner, etc.
Negotiating the Loan
Once youve reviewed the varying loan terms and identified the best option for your business, focus on negotiating the loan application. Following are some of the items that should be part of your deal.
Contract wording. Negotiate the precise wording of recourse carve-outs to ensure they are as narrow as possible. This should occur at the application stage, when you have the most leverage. Many so-called non-recourse loans are not truly so since they contain recourse carve-out guarantees. For example, the loan documents may spell out certain situations in which the loan triggers recourse. These situations, normally called bad-boy acts, include fraud, waste, funds misapplication and voluntary bankruptcy filings.
However, the precise wording of these guarantees is crucial since you may be held fully liable for the loan. Be careful of the following language, which some lenders may identify in their recourse carve-out guaranty language:
- Borrower must maintain adequate capital to operate his business.
- Borrower must not admit in writing if he cannot pay his debts.
- Borrower shall be personally liable for unpaid real estate taxes and insurance premiums.
Prepayment penalties. Depending on the type of loan youre requesting, the prepayment options can range from no penalty at all to defeasance, yield maintenance or a declining schedule. Most of the shorter-term floating-rate loans will provide less restrictive prepayment penalties.
Borrowing entity. Fully understand the requirements for your borrowing entity. Some lenders will require a single-purpose entity, which basically states the borrowing entity shall not own any property other than the subject property.
Impounds. Negotiate the impounds the lender will be requiring such as real estate taxes, insurance and capital improvements, and who will be receiving the interest in these accounts, lender or borrower.
Understanding the Underwriting Process
Once youve executed the loan application and posted the good-faith deposit, the lender will start the underwriting process. Its very important at this stage to focus on two objectives. The first is to know who the lender is hiring to complete the third-party reports, including the environmental phase I report, property-condition report, seismic report and appraisal. The companies should be well-respected among their peer groups. When it comes to the appraiser, he should also have a strong understanding of self-storage.
Its important to meet each of these vendors at your property when they conduct their site inspection so you can answer all their questions. You never know what theyll conclude if left to their own assumptions. Its much easier to convince the person preparing the property-condition report that the roof is in good shape while hes on site then to argue with him once hes completed his report.
Its also extremely important that during the due-diligence stage youre in constant communication with the lenders underwriter. This is the person who will be completing the underwriting and sizing your loan for approval with the credit committee. Always keep good records so you can provide the underwriter historical non-recurring and non-property-related expenses that will help him maximize your NOI.
Closing the Loan
Upon loan approval, youll enter the legal-documentation stage. The key here is to have counsel who understands the documents being prepared by the lender. Whether its a CMBS, bank or insurance-company loan, make sure your counsel is familiar with whats standard and whats open for negotiation.
Finally, the most important point to realize in the loan process is your loan is subject to change until its officially approved. This is nothing new, but in todays volatile environment, theres much more that can go wrong. In addition to issues arising such as environment findings, missed appraisals and credit concerns, you can be subject to the whims of the overall capital markets.
The markets are volatile, and some lenders have clauses in their loan applications known as MAC (material adverse change). Basically this clause provides the lender with an out in the event the capital markets change and impact its profitability. This is a serious risk in todays capital market, so its always good to have an alternative lending option identified up until the day you actually close your loan.
At the end of the day, the good news is the risk and effort associated with the loan process in todays market still results in historically low interest rates.
Eric Snyder is a principal of Talonvest Capital, which provides debt and equity to self-storage owners nationwide. He can be reached at 949.636.3365; e-mail [email protected] ; visit www.talonvest.com .
