Inside Self Storage – November 16, 2016
We all want some control in our lives. Whether our health, lifestyle, working environment…it’s good to be in control.
It’s also good to recognize some things are beyond our control: The weather, football kick-off times, our Thanksgiving dinner appetite…we wish we could have a better handle on them.
Similarly, self-storage owners have many things within in and beyond their control when refinancing their properties. With today’s low interest rate environment and compressing cap rates, it’s easy to think you’re in control…and you are to a degree. More importantly, it’s critical to understand factors affecting a lender’s decision so you can be in the driver’s seat throughout a refinancing process.
Forget About It: Factors Beyond Your Control
Global economics and bond markets, combined with the Federal Reserve’s hesitancy to rapidly increase rates, have created a sustained low interest environment. There are indications the Fed will continue to monitor economic conditions and gradually increase short-term rates later this year and into 2017.
If these projections hold true, then variable rate loans tied to the Libor or prime rates will be immediately affected. The Fed historically increases or decreases short-term rates to influence the pace of national growth. Long-term rates are tied to additional factors such as global economics, inflation, and supply and demand, and do not directly move with short-term rates. Expect short- and long-term rate increases over time.
Be prepared for lenders to diligently underwrite and document your loan request. Bank credit committees and compliance departments have remained in check due to conservative regulatory oversight and guidance. Among many regulations affecting commercial real estate financing are those correlating the level of construction loans relative to the lender’s size, as well as guidance regarding a borrower’s ongoing equity.
At the end of 2016, risk retention regulations come into effect requiring commercial mortgage backed securities (CMBS) lenders and related bond investors to retain a portion of every bond deal. Time will tell how these new risk retention rules potentially affect CMBS lenders’ interest rates and refinancing programs.
Property Management and Economics
Despite currently high occupancy and rent levels, every storage facility and sub-market is affected by new storage construction developments. Among other influencing factors are a facility’s relative location, marketing and Internet presence, and local market demand. Even the best positioned properties are likely to experience rent and occupancy pressure with the arrival of new competitors. Rest assured, lenders will consider the new developments’ potential economic impact on your property performance when underwriting loans and determining financing amounts.
While historically high occupancies with upward trending rents bode well when presenting a loan request, lenders can be more cautious with loan terms and leverage if new competition enters or starts building within your immediate locale. Worse, if your revenues decline due to new competitors, lenders will likely make downward adjustments to your income when deriving a loan amount.
You’ve Got These: Factors Within Your Control
Some initial questions we typically ask clients include:
- What loan size are you are seeking?
- How much would you like to leverage your facility?
- If leveraging up from a current loan, how much cash investment will still be in the deal?
- Do you want a variable or fixed rate loan?
- How important is it to have prepayment flexibility with limited penalty?
- Is reducing recourse exposure important to you?
- Do you want to reduce your monthly payments with a longer amortization or interest-only period?
- What is this asset’s credit history, along with the rest of your real estate portfolio?
The answers help determine the type of lender best suited for your refinancing needs. It is hard to have the best of all worlds, so you must prioritize your priorities.
Local, regional and national lenders — primarily banks and CMBS institutions — have embraced self storage as an attractive market. Today, more banks than ever will finance self storage, while CMBS sources have remained steady. As we all know though, talk is cheap and it comes down to a lender who understands self storage and wants to lend by providing aggressive loan terms, versus those who will lend with conservative rates and terms relative to other property types.
Any lender’s policies and portfolio mix change over time based on performance results. A lender who offered aggressive terms on one deal may not necessarily offer the best options for the next one. By creating relationships with lenders, monitoring markets and researching alternative financing quotes, you are more likely to receive competitive terms.
While fixed rate loans are attractive for locking in an interest rate for a defined time period, they often come with prepayment penalty provisions. Consider a cost-benefit analysis of prepayment penalties as you reach the latter stages of your current loan.
Incurring a prepayment fee to refinance your property could offer access to significant equity trapped in the current loan. It also may make sense to pay an existing loan’s prepayment fee to secure new financing with a much larger balance; the resulting cash-out can then be used to redeploy your capital for new acquisitions, development or investments. You can also consider capitalizing on today’s low interest rate environment to refinance into a new fixed rate loan.
Borrowing Track Records and Reputation
Successful real estate owners strive to maintain strong reputations among their financing sources. Remember lenders will examine your entire portfolio’s performance — along with your historic financing/operating track records — from positive and negative perspectives.
For CMBS loans, reporting and historic information are highly transparent. By using reporting vehicles, such as Trepp or Bloomberg, CMBS lenders can access your entire loan history, including occupancy levels, operating performance, payment history and any relevant servicer conversations. Accordingly, if your servicer records a “blip,” then you will likely have to explain its circumstances when seeking CMBS financing related to that asset or another one in your portfolio.
Refinance Planning Horizon
Undoubtedly, you know when your current loans mature and the timetable for examining your refinance options. A few simple tips when planning your options:
- Watch economic and banking markets since they may have as large an impact on your property investment as your daily operations.
- Run your facility considering how your daily operations could affect a refinancing or potential sale.
- Maintain strong banking relationships, yet look for alternative lending options that may be available when you choose to refinance. Consult with a mortgage broker who specializes in self storage and can advise you on current and historical lending environments.
With 25 years of experience as a national self-storage mortgage broker and advisor, Neal Gussis is a Principal at CCM Commercial Mortgage, where he secures debt and equity for commercial real estate properties with a focus on self-storage. He has been trusted by owners nationwide to secure more than $3 biilion of self-storage transactions. Based in Chicago, he can be reached at 224-938-9419 or ngussis@CCMCommercialMortgage.com.