One of the most serious issues facing commercial real estate investors today is the potential equity gap that can be created upon the maturity of their existing debt. Its no secret that cash flow has been challenged during the last several years as a result of the economic recession. The effect of reduced cash flow from operation, combined with increased cap rates and lower leverage available from lenders, can dramatically impact available loan proceeds and result in the need for an equity infusion into the property upon refinance.

Consider the following self-storage property refinancing examples, which more clearly illustrate this point. A storage facility generating $250,000 in net operating income (NOI) five years ago would likely have qualified at that time for debt of around $2.5 million in loan proceeds (based on a cap rate of 8 percent and available market leverage of 80 percent).

Fast forward five years. Assuming only a modest decline of 5 percent in NOI, combined with a 25-basis point increase in cap rates and new available leverage of 70 percent loan-to-value (LTV) today, the borrower would realize a proceeds shortfall of roughly $360,000, which will be needed to refinance the transaction. Although generic and based on the assumptions used, this is a very realistic scenario many self-storage owners face given todays market conditions.

The simple fact is many owners dont have $360,000 tucked away for a rainy day.  Although a significant problem, an owner faced with this predicament isnt at a total loss. There are options available to try to bridge this equity gap. To better understand those options, lets examine the components of the traditional capital stack in a typical real estate transaction.

The Capital Stack

In the most simplistic form, any transaction has two primary components: debt and equity. The capital stack, therefore, refers to the totality of capital invested in the project, including equity, debt and any hybrid dequity products that sit in between.

Think of the capital stack as a pyramid containing the most risk at the top and the least risk at the bottom. Higher positions in the stack typically require higher returns for capital because of the greater associated risk. Lenders and equity stakeholders are very sensitive to their position in the stack and price their products accordingly.

Typically, the stack has the following arrangement:

Keep in mind that as value and other factors change over time, so too can a relative position in the capital stack. For example, as debt is reduced, the amount of equity increases, and vice versa. Given that sponsor equity (at the top of the pyramid) is essentially the owners cash position in the asset, it can be generally quantified as the propertys current value minus all priority positions lower in the stack. In a declining market, as property value drops, owner equity erodes. And if value declines faster than the debt can be retired, owner equity can quickly wear down.

Subordinate Debt Options

Subordinate debt refers to any additional financing junior in priority to the first mortgage. It is a powerful financial tool for self-storage owners. It can provide additional dollars and higher leverage to help bridge an equity gap created when first-mortgage underwriting standards tighten in response to perceived heightened market risk, when property values have declined, or both. More conservative origination underwriting will limit first-mortgage loan proceeds, but access to subordinate debt provides access to additional capital.

To recap, the order of priorities in the capital stack flows from the pyramids base or lowest risk position (typically the first mortgage), up through any subordinate debt position (in priority), and finally to the sponsors equity in the property. Assuming theres adequate cash flow to support debt service, subordinate debt can allow a borrower with limited equity to refinance an asset without being forced to take on additional equity partners and potentially sacrifice ownership in a property. The two most common types of subordinate debt are junior mortgages (often called B-Notes) and mezzanine financing.

Junior Mortgages

A junior mortgage is a secondary debt position secured by the mortgage property as collateral, but which is junior in priority to the first mortgage or senior note. In a two-note loan structure, the mortgage debt includes a senior first-mortgage note (A-Note) and a subordinate portion junior note (B-Note).

Although the two notes will likely have different loan terms, the payment priority is clear, with the A-Note having distinct priority over the B-Note. Both are secured by the mortgaged property collateral, often under a single loan agreement. In this structure, the subordinate nature of the debt is established through a lender inter-creditor agreement between the A- and B-Note holders.

Mezzanine Debt

Mezzanine debt is an alternative type of subordinate debt in which the loan collateral is secured against an ownership position in the borrowing entity rather than the mortgaged propertyessentially a pledge of the ownership interests in the property rather than the property itself. Mezzanine debt can be particularly useful because it will generally provide a structure that allows a borrower to obtain secondary-debt financing without violating the terms of an existing mortgage loan agreement that does not allow for secondary debt against the property collateral itself.

Considerations for Subordinate Debt

Subordinate-debt lenders are typically willing to assume more risk than first-mortgage lenders and receive higher interest rates for doing so. Subordinate-debt rates can range anywhere from 8 percent to 18 percent, with the loans typically paid each month along with the first mortgage. Subordinate-debt payments are often more flexible and can be structured to match the assets cash flow.

For example, they might be structured as an interest-only payment with a balloon, or amortized over time via routine interest and principal payments to reduce the debt. In the current market, subordinate-debt lenders will take a position between the first mortgage65 percent to 70 percentup to 85 percent of value.

Managing Event Risk and Equity Erosion

The magnitude of equity erosion often dictates the available solutions. As long as the debt doesnt expire and assuming theres cash flow in place to service it, the equity erosion may only be a temporary situation that effectively creates a short-term paper loss with little consequence for the storage owner.

In other cases, equity erosion may be so severe that the current sponsors equity is wiped out. In this situation, it may be necessary to reach even higher in the capital stack to achieve a solution, effectively forcing the property owner to give up equity ownership or controlling interest in the asset. If a transaction is too far under water, or if there is just too much perceived risk in the transaction, a complete debt restructure (potentially with a new equity infusion) may often be the only option.

In many cases, however, equity erosion is not that severe. If equity erosion is contained, and as long as the owner has cash flow available to service the debt, subordinate-debt options can present a very straightforward and palatable solution for filling the equity gap.

Shawn Hill is a principal at Chicago-based The BSC Group, where he provides mortgage brokerage, financial consulting, and loan-workout solutions to self-storage real estate owners nationwide. To reach him, call 713.517.8504; e-mail [email protected] , visit www.thebscgroup.com .

Self-storage operators often ask me about rules of thumb for our industry, on the development as well as the management side of the business. They want concrete guiding principles that spell success. But what Ive learned over the years is people can get hung up on these rules when looking at their own deals and facility management teams. They use them as actual benchmarks instead of loose guidelines that have evolved over time. Examples of these rules include:

• Only pay 66 percent of the average rental rate per square foot for your land.
• Dont buy land to build on unless there are 20,000 vehicles per day driving past the site.
• Anticipate basic expenses at 35 percent of revenue.
• Expect to lease up at 5 percent per month.

There are countless generalities like this that self-storage professionals should really ignore. They should instead focus on the specifics of their own forecasts, projections and standards based on their personal business philosophy, location and target market.

A Stand for Customer Service

When it comes to the day-to-day management of a store, however, theres one rule everyone should consider as golden. Its a simple imperative that can add a strong customer-service component to your organization. Do you stand or just look up every time someone walks into the office? If all you do is look up, its time to get on your feet.

When you stand up to greet a person when he walks into your office, he knows he has 100 percent of your attention. He sees youre prepared to help himtake his payment or sell him a solution to his storage problem. Add to that a friendly handshake, and you complete a welcome series of gestures that will change the dynamics of the conversation and relationship youll have with that customer.

If all you do is look up because your attention is on something else, the customer can get a youre interrupting me feeling. Yes, there are days when you want to hide behind your counter and computer monitor. But honestly, not that people enter a self-storage office on the average day. So get on your feet, extend your hand in welcome, and be ready to see your bottom line improve.

500,000,000

Thats the number of people now using Facebook. I guess it may not be a passing fad after all. Social networking has exploded over the past five years, but none more so than this medium. If you have a facility with 600 units and you want 95 percent occupancy, you only need to attract .0000114 percent of Facebooks membership to your site. Maybe its worth investigating what it takes to set up a Facebook business site.

Consider asking one of your teenagers to be your Facebook consultant. Start by doing a search on the website for self-storage and mini storage. Ive seen a couple of storage facilities with hundreds of friends. See what folks are doing and learn. It may not be the source of all your future leads, but can it really hurt to give it a try?

What Are My Rights of Privacy?

This is a growing question I want to raise with self-storage owners and managers: What are your rights of privacy when using your companys computer for personal e-mails and other Internet needs throughout the day? What do you think they are and what are they really?

Ive always been an advocate for giving employees Internet access in the store office. My advocacy has been tempered by the belief that everyone should be using computer technology to enhance the business. However, the recent compromised integrity of some employees in high-profile positions, such as those in the U.S. Securities and Exchange Commission, has created a lose-lose situation for employers and employees. Ive come to the conclusion that employees dont have a presumptive right of privacy when using the companys computers for personal use.

Do you have a clear, written corporate policy regarding the use of your computer systems and networks for personal e-mails and other Web activity? If not, nows a good time to consider the issue. Make sure everyone on your management team is crystal clear about your policy and how serious you are about enforcing those standards.

Jim Chiswell is the owner of Chiswell & Associates LLC. Since 1990, his firm has provided feasibility studies, acquisition due diligence and customized manager training for the self-storage industry. He is a member of the Inside Self-Storage Editorial Advisory Board, a moderator on the SelfStorageTalk.com interactive online community, and an instructor of the Self-Storage Training Institute. He can be reached at 434.589.4446; e-mail [email protected]; visit www.selfstorageconsulting.com.

Westbelt Storage, a Columbus self-storage facility near Hilliard, Ohio, will conduct a public auction Saturday, Sept. 18. The contents of seven storage units will be sold to the highest bidder.

A self-storage auction is conducted to sell the personal property of storage customers who do not pay their rent. Unfortunately, some of our customers hit hard times, and for one reason or another decided to abandon their personal belongings, said Kurt Novak, general manager.

Buyers are allowed to inspect storage units from the outside only. They must buy the whole storage unit. The buyer is also obligated to remove the items within 24 hours from the self-storage facility. This auction is cash only and there are no warranties made by the facility. The auction begins at 11 a.m. at Westbelt Storage.

Gina Six Kudo, general manager of Cochrane Road Self Storage in Morgan Hill, Calif., was selected as a recipient of the Gavilan College 2010 Community Spirit Award.

Awarded annually by the Gavilan College Board of Trustees, the Community Spirit Award recognizes  individuals, businesses and organizations who contribute in a positive way to the communities that make up the Gavilan Joint Community College District. Community members submit nominations, and final recommendations are made by a committee of Gavilan College staff and faculty. The winners will be recognized at the Morgan Hill Chamber of Commerce breakfast Oct. 7.

Receiving the Community Spirit Award puts us in with some great company based on the past recipients, Kudo says. For our team, the recognition by our community is truly appreciated. No one needs or is seeking a pat on the back. However, the CSA gives us the inspiration to keep up our efforts. We are thankful to the other unsung volunteers who along with us help to make this a great community to live and work in.

Kudo, an ISS contributor and Self-Storage Talk moderator, was also named a 2009 ISS Humanitarian Service Award winner for her contributions to the Morgan Hill community.

Scottish music trio Local Hero will perform in the lobby of Westy Self Storage in Chatham, N.J., on Sept. 24., 7-11 p.m. Admission is $20 per person, and tickets will be available at the door. The program is intended as a pre-party for the annual Pipes of Christmas event, which will take place Dec. 18 and 19 in New York City.
Attendees will enjoy a complimentary whisky tasting including Oban and Cardhu single-malt Scotch, and a silent auction to help them jump-start their holiday shopping. Items up for bid will include a scotch-tasting event at the winners home, an autographed copy of Sir Sean Connerys autobiography, Being a Scot, and a personal one-hour bagpipe performance at an event of the winners choice.

Local Hero, which plays traditional and original Scottish tunes, comprises fiddler Paul Woodiel, flute and bagpipe virtuoso Christopher Layer, and pianist Susie Petrov. Joining the group will be Reinmar Seidler, a special guest cellist from Boston.

Tickets for Pipes of Christmas will be for sale at the Westy Self Storage event. Featured performers will include the Kevin Ray Blandford Memorial Pipe Band from Redlands, Calif., Andrew Weir from the film Braveheart, three-time New England fiddle champion Paul Woodiel, and the Solid Brass ensemble. Proceeds from the evening will benefit the Clan Curries Pipes music-scholarship program, which provides select students with accessibility to schools for Celtic music in the United States, Canada and Scotland.

Stephan Ross, president of Cutting Edge Self Storage Management & Consulting, will present a seminar at the upcoming Inside Self-Storage World Expo in New Orleans and will also present a free webinar next month.

On Sept. 29, Ross and his wife, Tammy, will talk about Rental-Rate Management: How Owners and Managers Can Create More Revenue From Existing Inventory as part of the ISS Expo. Theyll discuss the factors involved in setting self-storage prices, why regular increases are required, when facility operators should implement increases, how much the increases should be, and how to properly and smoothly execute these changes.

On Oct. 13, Ross will present a free webinar titled, Five Things You Must Do to Thrive in 2011 and Beyond. He will discuss the key steps self-storage operators can take to help their businesses thrive in todays hard economy including new ways of marketing, improving customer service, effectively presenting products, providing ongoing manager training, and managing revenue. The webinar will take place at 2 p.m. ET. The registration process can be completed at Ministoragemessenger.com.

Ross began his self-storage career in 1984, working as city manager for Arizona-based National Self Storage. He later worked as regional director of Executive Self-Storage. In 2000, he and his wife launched Cutting Edge, which manages self-storage facilities in Colorado, Florida, Idaho, Illinois, Missouri, Nevada, Texas and Utah.
The ISS Expo will take place Sept. 29-Oct. 1 at the New Orleans Marriott, 555 Canal St., in New Orleans. It will comprise three comprehensive tracks of educational seminars, several networking opportunities, product and service exhibits, and add-on intensive workshops. Show information can be found at www.insideselfstorageworldexpo.com.

PODS Enterprises Inc., a Clearwater, Fla.-based provider of moving and storage services including portable storage, hired John Cameron as its new senior vice president of long distance moving and corporate operations. Cameron, with more than 25 years of industry experience, will manage the companys strategy for long-distance moving and corporate-owned PODS locations. He will be responsible for meeting aggressive long-distance moving goals, creating market saturation in corporate-owned locations and managing operating budgets.  

Cameron previously held positions as executive vice president of operations for DHL Express International and divisional vice president for FedEx Ground Inc. He graduated from Cleveland State University with a degree in operations management.

Founded in 1998, PODS provides moving and storage services nationwide as well as in Australia and Canada. To date, the company has completed more than 200,000 long-distance relocations, exceeded 1 million deliveries, and has nearly 140,000 portable-storage containers in service. PODS containers are constructed of a steel frame and are available in three sizes.

Guardian Self Storage in Poughkeepsie, N.Y., is sponsoring the Dutchess Outreach Susan DeKeukelaere Memorial Coat Drive in October.

The drive is seeking clean, gently used coats for children and adults, including plus sizes. All coats are distributed to families in the Dutchess, Orange and Ulster County areas. Coats can be dropped off at any Guardian Self Storage location from Oct. 1 through Oct. 31. Theyll be distributed in November. The 2009 coat drive netted 6,200 coats.

Family-owned Guardian Self-Storage opened its doors in Fishkill, N.Y., 25 years ago. Since that time the business has grown to 12 locations in New York.

Once-thriving businesses are struggling to survive in todays slow economy. Many are making spending decisions based on What can I afford? rather than Where can I invest my money to make my business grow?

When payroll and other expenses take priority, the advertising and marketing budget is the first to go. Lacking the resources of large corporations, small- and mid-sized businesses find it particularly challenging to keep their heads above water. In addition, theyre struggling with lower-than-average sales, difficulty getting loans, rising interest rates, and the ever-present threat of increased taxes and government regulation.

Self-storage operators know that the key to success in any economy, good or bad, is the ability to connect with customers. Operators who are firmly established in the community will be in a good position to weather economic storms and will excel when the economy recovers. To be among the leaders, you have to get your name out there.

So how do you attract attention, get new customers and maintain customer loyalty with a limited advertising and marketing budget?  

Get Creative

Take stock of what you have to offer your customers and come up with a plan to stand out from the crowd. Customers are expecting more from their hard-earned cash and will find it easier to spend money where theyre getting the best customer service. For example, the owner of a coffeehouse has set up a system that helps her and her employees remember their regular customers' names. Customers appreciate the exceptional service and feel welcome and at home in the coffee shop.

An art gallery and frame shop attracts customers by hosting art shows featuring local artists. It gets the word out for the show through local advertising and e-mail newsletters. The kickoff for each show is a party open to the public and includes live music and hors d'oeuvres. There are many ways you can amplify your connection with your community.

Offer Incentives

Offering coupons as incentives is a tried-and-true way to get people in your door and spending money. The coupon industry is exploding because consumers are actively looking for ways to save. A survey conduced by Harris Interactive in 2009 found that a growing number of consumers will not make a purchase without a coupon. However, many small businesses simply dont have the budget for the printing and distribution of coupons.

Instead of going the traditional route, use companies that specialize in doing the hard work for you. These coupon companies specialize in creating and managing coupon campaigns for other businesses, at little or no cost, and with surprisingly fast results. By providing your information and the details of your special offer, these organizations will generate a coupon campaign for you, and allow users online to search via ZIP code, product, company or service to find your deal. 

Establish Your Online Presence

Operators who don't already have a website need to get one. It's a sign of credibility todayeven if your site doesn't attract much attention, you'll lose business if you don't have one. Many if not most people will choose a business with a website over one without.

Websites don't cost thousands of dollars anymore, and there are many tools available to people who want to create one themselves. Yet many small businesses are still daunted by the perceived costs and difficulties associated with having a website. Using a free open-source content management system like Wordpress, Joomla or Drupal, it's easy to create excellent sites, and there are many free templates and online support for these systems.

Professional website templates, including sites that support flash and other advanced features, are available for as little as $60 and can be hosted for around $5 month. Companies like HostGator.com and GoDaddy.com have competitive hosting prices and offer good products that will get you up and running quickly. You can check online for other companies and packages to make website creation simple even if you have little or no experience.

Savvy self-storage operators are also taking advantage of online social-media marketing. Accounts on sites such as FaceBook and Twitter are free and easy to set up, and can yield big dividends through increased exposure.

Organize a Fundraiser

Its difficult for many people to give to charity in this slumping economy. When the community sees businesses participating in fundraising events and helping the needy, it leaves a lasting positive impression. Even simple things like putting a sign in front of your facility telling the community you collect canned goods for the local food bank can positively impact your company.

Or join with other businesses in your community to organize something bigger. Local newspapers and media outlets may be willing to publicize worthy events, which will add more exposure for your business. Be sure to publicize the event with your current and past tenants through fliers and your newsletter.

These are just a few ideas for surviving and even thriving in a slow economy. Be creative. Offer exceptional customer service. Give your customers incentives. Actively post content on social-media sites such as FaceBook and Twitter. Be involved in the community. Get your name out there and youll be in a great position when the economy recovers.

CherryPlanet.com was founded to help local businesses attract customers by providing a platform for businesses to create coupon campaigns for free. The site offers businesses a way to save money on advertising and marketing while helping customers save money while shopping and doing business locally. Cherry Planet is committed to donating 10 percent of its profit to worthy charities. For more information, visit www.cherryplanet.com.