As a former member of the Boy Scouts of America, I remember their motto was "Be prepared." It's something that also applies to self-storage owners who are looking to refinance a loan in the current capital markets. The same types of loans exist today as a few years ago, however, underwriting standards have changed, and with these changes come new challenges for borrowers.
In today's market, borrowers face decreased property values and reduced loan proceeds, along with lenders who are now incredibly selective about the properties on which they'll extend a loan. A borrower can feel boxed in, like there's nothing he can do to resolve these issues. But there are ways to position a refinance transaction to make it as simple as possible for a lender to approve.
When it comes to refinancing, starting the process as early as possible can work to your advantage. The first thing you should do is evaluate where the property stands.
With the commercial real estate market still in flux, it's recommended that you contact a mortgage broker, banker or commercial real estate broker one year before the loan is due to determine your property's value. Any of these individuals can underwrite the property to find the true net operating income (NOI) it is producing on a trailing 12 months of income and expense. This is the current industry standard almost every lender will look at to see how the property is performing.
Once the NOI is established and a capitalization (cap) rate is known, there's now a realistic expectation of what the property is worth. The self-storage owner has to understand that the market has changed dramatically during the fiscal crisis that began three years ago. An updated NOI and cap rate establish the true value of the property today, not what you paid for it several years ago.
Of course, the cap rate used in a property sale will most likely be more aggressive than one an appraiser gives for a refinance. If you take a look at the numbers a year before the loan is due, you'll have time to make adjustments if necessary.
What adjustments can a borrower make? Let's start with property taxes. Unfortunately, most properties have diminished in value since the last time their taxes were assessed. Many owners have not gone to their local counties to get their property taxes lowered.
When was the last time a competitive bid was initiated on the insurance for your property? Just because the insurance premiums and coverage were appropriate last year, there's no guarantee they're correct today. Perhaps the insurance environment had become competitive due to the economic crisis. It's important to ensure all money being spent on the property is being spent wisely.
Is there a full-page ad in the Yellow Pages? Would a half-page ad suffice? Is an ad in the Yellow Pages even necessary in today's increasingly online world? In most markets, spending money on Internet-advertising opportunities makes more sense.
Are repairs scheduled for the near future? Can they wait until after the refinance without diminishing the property's value? Are there any one-time purchases that can wait until the refinance is complete?
There's a great reason to wait, if possible. Lenders don't want to take one-time expenses out of the trailing 12 months of expenses. In fact, the lender may not want to take them out of the expense side of the underwriting, thus your NOI will be less, which will equal less loan proceeds. In the current lending environment, the lack of loan proceeds is a major issue for many borrowers.
Another note of caution is how owners repot their salary. Many storage owners/operators typically pay themselves more than the average self-storage manager. The higher the salary expense is on the profit and loss (P&L) statement, the lower the NOI. A preferred accounting practice would be to exclude an owner's salary from the manager's salary on the P&L. Having a separate line item makes it easier for a lender to say the owners are taking a distribution of the profit, thus not counting it on the expenses. Since most lenders will include 5 percent to 6 percent management-fee expenses in the underwriting, an owner/operator could also code owner's pay to the management fee if there's no third-party management company.
Commercial loans today can take anywhere from 60 to 120 days for a conventional lender or up to five months for the Small Business Administration. This time period starts after a lender has completely underwritten the loan request. Based on how many owners/partners there are with more than 20 percent of the property, the lender will require time for collecting information on all the borrowers in the case of a recourse loan. If the property qualifies for a non-recourse loan, the lender will focus more heavily on the property's numbers and secondarily on the borrowers.
In both cases, year-to-date P&Ls along with the prior two years P&Ls, current rent roll and occupancy/management summary reports must be available. A current personal financial statement is also required by most lenders since they're concerned about the borrower having another income or net worth to support the property in the event something happens to the income stream.
In the months prior to submitting financials to a lender or mortgage broker, getting every penny in the door is crucial to the NOI. Past-due accounts can help boost that number. Have the property manager embark on a collection campaign to bring in every last dollar. This could mean the difference in having a $34,000 per month revenue stream vs. $30,000. That's $4,000 additional NOI. If the NOI increased from $300,000 to $304,000, with an 8 percent cap rate on the property and 70 percent loan-to-value, that would equal $35,000 of additional loan proceeds.
By starting early and creating a seamless loan package of financial documents and the pertinent information required, the borrower will show the lender that he is serious about his business. These little efforts could be the difference between obtaining a refinance or not. Too bad they didn't offer a merit badge for "loan preparation" when I was a Boy Scout, only for fun things like canoeing, skiing or hiking. Those were the good old days!
This article has been reprinted with permission from Inside Self-Storage, the premier magazine of self-storage professionals. For information, visit www.insideselfstorage.com.
The BSC Group has been voted Best of Business - Finance for six years running by the readers of Inside Self-Storage.