Much has changed in our economy and financial market in the past year. While there were some positive developments over the past 12 months, bad news still lingers on many fronts. The "other shoe" is now dropping: commercial real estate. Declining property values, coupled with limited access and viability of debt, are contributing to the nation's new financial break point.
In tennis, a break point occurs when you're one point away from losing the game, even though you're serving the ball. Outside the court, a break point can refer to how individuals handle a situation at a critical point.
These days, self-storage owners and investors try to maintain their "serve" by closely managing their businesses to minimize decreases in occupancy that, in many cases, is coupled with lower rental rates. Few property owners are immune to the drastic changes in commercial real estate value and available leverage experienced in the past year. Consider:
Self-storage owners should now strategize their equity positions to best maximize their return on investment. In many cases, this is far from a clear-cut analysis. Begin by realistically examining the property's current value. While you may be shocked by its lower-than-expected valuation, this is your starting point.
Next, if you determine a need to finance in the next 24 months, consider whether you have enough equity to obtain financing without putting up additional proceeds. If you're facing a potential sale, a current valuation helps you address various "what if" scenarios.
When examining these situations, analyze future risks vs. rewards. You might be well-positioned to ride out this economic cycle for several years. On the other hand, the only practical solution may be to sell the property or even return it to the bank.
The need to leverage or finance in the 2010 to 2011 time period will be critical in determining your path to protect your storage investment. This analysis will help you in choosing the best route.
Following are my predictions for the new year:
Relative strength of self-storage. It's important to keep everything in perspective. In most cases, even with a decline in bottom-line income, the self-storage asset class is still covering debt and performing at profitable levels.
Compared to the retail, hotel, office and multi-family real estate sectors, with their higher exposures to vacancy and rental pressure, storage is strong. Self-storage will also be on the leading edge of an economic recovery, as our industry's month-to-month rental format will allow upward rental adjustments in a timelier manner.
As a property type, storage also tends to be on the smaller scale of commercial real estate deals. That's a benefit in a tight market since lenders are more likely to make credit decisions on smaller transactions. Smaller deals also tend to be less complex.
Conservative money/changing risk tolerance. While liquidity will lead the banking sector's recovery, it alone will not initially solve the leverage issues facing many owners. With some exceptions, expect loan-to-value ratios to remain at 50 percent to 65 percent. This low leverage, combined with lower property valuations, will crimp your ability to repay existing debt unless you currently have very low leverage.
Property performance and its ability to cover current and future debt will always be a big part of any banker's decision process. In 2009, many lenders restructured, modified or extended loans. Based on individual circumstances, the tend will continue this year.
Projections indicate approximately $10 billion to $12 billion of self-storage loans will mature in 2010. This amount is similar to prior years; however, there seems to be a shrinking acceptance of the storage property type with local and national capital sources that are able and willing to finance self-storage owners. In today's environment, each bank has a unique philosophy guiding its ability and desire to extend credit.
Most lenders are now trying to work out troubled commercial real estate loans. Many will continue to clean up and maintain current balance sheets and focus on existing clients, thus making lending approvals a highly competitive experience for property owners.
Banking relationships. Maintaining a proactive relationship with your lenders cannot be overemphasized. Let them know how your property is performing-good or bad. Be sure to provide them with required documents in a timely manner.
Unfortunately, you cannot be certain if your relationship with a loan officer or lender will last. We are all aware of the high turnover rate among these professionals. Many have been transferred to their banks' distressed-asset workout units given the increase in property foreclosures.
The other uncertainty is the health of the bank itself. More than 100 banks closed in 2009, with projections of another 200 or more being shuttered and assumed by either the FDIC or other banking institutions before this financial crisis is finally over.
Banking deposits. To close a deal today, property owners must be able and willing to provide lenders with operational deposits as well as some depository facility. Be forthcoming in what you and your partners can offer in the form of deposits. Banks will continue to look for sources of capital, and good old-fashioned deposits are the most basic.
Recourse. With some very low leverage exceptions, most loans will require a recourse element going forward. This presents you and your partners with a new decision: Who is willing and has the wherewithal to sign personally for a self-storage loan? Often, the lender answers the question by requiring all the property's owners to sign recourse.
Before you put your name on the dotted line, though, keep in mind that with many loans being modified and extended, recourse will come into play. As an owner, you'll need to believe in the property and the ultimate ability to refinance it, even if you're able to extend for a one- to three-year period today.
Elastic street rents. If an appraisal is required, it's difficult to peg market rates today. Many owners are pricing concessions into street rents. Actual rent rolls for you and your competitors would reflect an expected rent from occupied units that is higher than if you were to extrapolate street rents currently being quoted.
It's important to stress to lenders and appraisers that rents are elastic and can change daily. They need to take into account a period of time and devise reasonable market data points in determining "market." An appraiser strictly using current discounted market rents will drastically hurt the final appraised value. This may be the difference in whether a deal is financeable or not.
Extend/modify maturities. A phrase frequently heard in the banking sector these days is "extend and pretend," which refers to lenders extending loans while hoping for better times. The real question is whether they are simply kicking the can down the road and putting off the problem to a later date.
Property-loan extensions could very well be the best answer when alternative financing is not available, or if a forced sale in a weak market would result in substantial losses to the borrower and even the lender.
In today's environment, be willing to negotiate. Lenders generally want give and take and expect some additional commitment from the borrower. Often, that arrives in the form of additional collateral, principal paydown, recourse, or additional structure to existing loan terms.
CMBS loans. If you currently hold a maturing commercial mortgage-backed security loan, try to obtain new financing. If you need to work with a servicer, a new rule established in late 2009 allows a master servicer to address a potential extension or modification with the owner prior to the property going into actual default.
Keep in mind that servicers will not write down the loan's principal balance. The typical extension period is for one year at a time, with at least a one-point fee and some principal paydown. Non-performing loans are handled on an individual basis.
Today's market is moving quickly. Given this highly dynamic financing environment, you should consult with storage-lending experts who are in the market on a daily basis and can help you through these trying times.
Ask questions, get advice, and then decide how to best maintain your serve. The players with the stamina and strategy to survive this cycle will still win, even if they are once again facing a break point.
The BSC Group has been voted Best of Business - Finance for six years running by the readers of Inside Self-Storage.