Borrower's Bliss

September, 2014

Flush with cash and eager to lend, capital sources are lining up to invest in self-storage as the industry appears ready to fund a new phase of prosperity.

Owners and operators of all sizes are able to take advan- tage of low interest rates to refinance their properties, plan expansions, and even to dream of new development. From local and national banks to credit unions, and from commercial mortgage-backed security (CMBS) lenders to life insurance companies, more and more institutions appear ready, willing, and able to finance self-storage operations.

Loan originations grew steadily during the past two years, but so far in 2014, more lenders seem to be reaching for the stars. "The floodgates have opened and we are back to very aggressive lending," says Shawn Hill, principal of the BSC Group in Chicago.

It's a striking contrast from recent years, when banks and other institutions were hesitant to lend to anybody. Competition is getting fierce and lenders are more aggressively pursuing deals, allowing borrowers to take advantage of lower rates, less restrictive underwriting standards, and higher leverage.

"CMBS and bank financing have been much more aggres- sive in the last 12 months in terms of underwriting standards and all-in interest rates that they're offering," says Neal Gussis, principal with CCM Commercial Mortgage in Des Plaines, Ill.

Mortgage brokers who specialize in connecting self-storage operators with funding sources go to work each day with renewed enthusiasm. "The financing landscape is only getting better and better," says David Smyle, vice president of San Diego-based Southwest Realty Services. "Banks have so much money they don't know what to do with it. It's making rates and terms very competitive. There's no better time to borrow money for anything. You're missing the boat if you're a long-term holder and you're not refinancing your property now."

Given that interest rates are hugging historic lows, lenders have cash in hand, and the acceptance of self-storage as a preferred risk for investors, the stars appear to be aligned for operators to refinance existing debt and aim high with an eye on expansion.

"Because rates are almost at historic lows and because operators have supported higher valuations for self-storage, many owners are taking advantage of pulling some of their equity out of their projects by refinancing at a larger loan amount than their current loan amount," Gussis notes. "That allows them to have equity to invest in other self-storage properties or existing self-storage properties."

A Galaxy Of Financing Sources

After self-storage's stellar performance following the recession, investors have come to realize the sector can be an attractive component of their lending portfolios. With rental rates on the rise and national occupancy rates headed toward 90 percent, funding sources are focusing their capital on storage.

"We've arranged financing with just about every lender type in the last year," says Steve Libert, CCM principal. "You probably couldn't say that a year ago."

A major trend financing experts report is a willingness of lenders to consider smaller loans. "A sign that the market is becoming more competitive is you're seeing more CMBS lend- ers that are willing to quote smaller loans under a fixed cost structure," Hill says.

Hill recently received seven bids on a small $2.85 million, two-property acquisi- tion in Pennsylvania. He warns, however, that CMBS loans can be expensive-per- haps as much as $60,000 to $70,000 to close a $2 million to $3 million loan.

But CMBS debt can provide terms that are more favorable for borrowers than other sources. "Mom-and-pops today have access to CMBS," Hill says. "They don't have to rely on the local bank and deal with three-to-five-year money because they can go to the CMBS market and get a 10-year fixed rate, non-recourse loan that does not require a personal guarantee at very competitive rates."

If interest rates start to rise a year or two down the road, today's rates will look good when bank loans are due to be refinanced in the future. A borrower could lock in a 10-year loan today in the mid-4 percent range. An operator holding a five- year bank loan may be exposed to much higher rates when that loan comes up for refinancing at the end of the term.

According to a BSC Group report in June, CMBS loans carried fixed interest rates of 4.25 percent and up with terms of five to 10 years. CMBS loans feature up to 30-year amortization and interest only is available.

Construction Financing

While development is not approaching the frenzied level of the last decade, there is evidence that operators have plans on the drawing board for new facilities.

"Construction is picking up, particularly in California, Texas, New York, Florida, and Chicago," Gussis reports. "The sites being selected are heavily being sought after by experienced self-storage operators."

In addition to ground-up construction, a favorable financing environment is expected to spur more conversions, expansions, and remodeling projects.

"All aspects of the self-storage trans- action market are active: refinances and acquisitions, as well as development deals encompassing both conversions and ground-up," says Dean Jernigan, CEO of Miami Beach, Fla.-based Jernigan Capital and former head of CubeSmart, a real estate investment trust. "Development lending is more limited than acquisition and refinance lending by sponsor strength and sponsor equity requirements."

For operators considering construction projects, local banks will be the best source of funding because they have knowledge of the area's market and they are the largest originator of commercial real estate loans for self-storage. Plus, banks are more willing to offer construction loans now than in 2013.

"CMBS debt is causing local banks to re-evaluate where they can put money to work and that is helping to open up other avenues of construction financing," Hill says. "If you have a track record developing self-storage and you have some equity behind it and have components of a deal that would make sense, people are willing to talk about construction financing." Bankers have a strong desire to maintain comprehensive banking relationships with their customers and as a result, borrowers should have operating accounts or other depository relationships in place with the lender. In addition, banks will look at the borrower's track record in self-storage. "Borrowers have to have experience in constructing self-storage projects and have at least a small number under man- agement," Libert says. "If today is your first foray into the self-storage world, it would be very tough to get a self-storage con- struction loan if you don't have any experi- ence building or operating one."

Bank loans have terms of five-to-seven years and loan-to-value (LTV) is capped at 75 percent. Fixed-rate deals are in the low 4 percent range and interest-only options are available.

For conversions, where a property is being converted from a warehouse or big-box store to storage, bridge lenders could be an alternative financing source for developers. "They're going to be higher rates than a bank would be on a straight construction loan, but if the bank wouldn't do it, maybe a bridge lender would," Smyle says.

Bridge loans in June were available from $2 million up to $50 million, with one-to-three-year terms with extension, according to BSC.

While the outlook for new construction is getting brighter, don't expect to see "Grand Opening" signs spring up across the country immediately. That's because there;s a lag time between the financing and project completion. Sites have to be rezoned and permitted before construction can begin.

"The projects that may be funded today you'll see come out of the ground in 2015," Gussis says. "There's probably a six- to 12-month lag in the availability of money to seeing those projects out of the ground."

Other Lenders Stepping Up

Credit unions have emerged as another source of storage lending. Credit unions' growing size and strength have made real estate a more compelling investment.

"Traditionally, a commercial loan would be a large loan for them given their balance sheet, and many of them stayed away from lending on commercial real estate," Gussis notes. "It's a risk they're willing to take because their balance sheets have become larger."

Like banks,, credit unions also are relationship-driven and the borrower is expected to have depository accounts with these institutions. Credit union loan programs have five-to-10 year fixed rate terms with rates of 4.25 percent and up, according to BSC.

In 2010, self-storage became an approved property type for Small Business Administration (SBA) loans. SBA lending has grown as bankers have become more familiar with the industry, although this lending source represents only a small fraction of self-storage financing.

"SBA is more active on storage after several years of being exposed to the product," Hill says. "Those lenders that have embraced storage definitely understand the product type more and have evolved. SBA is not the most competitive product but depending on a borrower's situation, it certainly has merit."

SBA programs offer fixed and variable rates with terms in the three-to-10-year range. BSC reports that LTV is available up to 85 percent. "SBA plays most time for smaller operators who may want to get into the business with a secondary or tertiary site," Gussis says. "When you get to construction financing, a lot of banks will want to go the SBA route if they can."

Life insurance companies continue to be growing players in the storage space, although they prefer larger deals, lower leverage, and owners with experience and strong financial statements.

"Life companies can go 25 years on a fixed rate if it's the right deal, the right location, and right leverage," Smyle says, "if you're in a major metropolitan area and you've got a beautiful Class A build- ing, you're at 65 percent loan-to-value, and you've got a good history and good occupancy."

Life companies have undertaken some major transactions in the self-storage space. Prudential Mortgage Capital provided $131 million in June to Lock Up/ Evergreen Storage in Chicago for 18 properties. "Life companies typically are more conservative than CMBS or bank options," Gussis says. "They usually offer very aggressive rates and are non- recourse. For institutional clients that have lower leverage requirements, life companies are a good option."

Insurance companies are looking to lend $1 million and up with terms ranging from five to 10 years. Rates start at 3.5 percent with 30-year amortization.

The maximum leverage offered in the current environment is capped at 75 percent LTV on most loans, with the remaining 25 percent representing the property's equity or other sources. Mezzanine capital is available to increase the LTV to 85 percent. Mezzanine financing is limited to large loans because investors are looking to put at least $500,000 into the transaction, according to Hill.

The mezzanine would sit between the equity and the first mortgage debt to elevate LTV up to 85 percent. "You're talking about a $10 million deal where it would be big enough to absorb that mezzanine piece," Hill says.

Sky-High Rate Rise?

The current interest rate environment is the perfect incubator for self-storage financing, but nearly everyone expects rates to rise in the future. It figures that what goes down certainly must go back up. "We've had very low rates for quite a while, and that is not sustainable indefi- nitely," Jernigan says. The engine driving this environment of course is the Federal Reserve, which has held down interest rates for years. The Fed has indicated it will start to raise the federal funds rate in the near future, and many expect that action to take place in early 2015.

In addition, the Fed has tapered its quantitative-easing program by continu- ally reducing its purchases of Treasury bonds by $10 billion a month. The Fed reportedly will stop its bond-buying program in October, which could trigger a rate rise. Although the Fed has said rates would remain near zero for a "consider- able time" after the end of its bond purchases, many experts believe rising rates are inevitable.

"Fed tapering is presumably priced into the market; however, when we actually witness the completion of the tapering process, it may impact the market and we may see rates begin to rise," Jernigan says. "Geopolitical instability and conflict in places such as the Ukraine and the Middle East seem to be having a damp- ening effect on expected interest rate increases. So taking into account these conflicting trends and their impact on rates, I expect a steady but manageable increase in rates beginning within the next year, and continuing for a time."

Others in the industry expect gradual rate hikes in the future; it's a matter of how soon and how high. "I'm a believer that interest rates are not going to go up significantly mainly because our government can't afford high interest rates because they're paying them as well," Gussis says. "They're going to keep inter- est rates at a reasonable level."

Hill doesn't expect rates to skyrocket during the next year, however, he thinks it's very likely that in the next three-to-six years rates could be in the 6 or 7 percent range.

"Rates can only get pushed down so far so lenders are finding other ways to differentiate themselves and they're doing that through structure: lower closing costs and interest only," Hill says. "It's a borrower's market because not only are rates among the lowest they've ever been, but lenders are aggressively trying to figure out how to win deals and they're willing to push on structure, which is a benefit to the borrower."

As anyone who has gone through the refi process on their home can attest, the bank still makes you jump through numerous hoops, even with dazzling credit. The same can be said for commercial loans.

"The process of getting a loan is prob- ably the only thing that has gone the other way," Gussis says. "To go through the trips and traps of the loan process is harder than ever before. To have an expert to guide you through that process not only will save time but perhaps save on money in negotiating and certainly helping in positioning themselves in understanding how to respond to lenders."

Banks are much more open to lending since they have cleaned up a host of delinquent loans in recent years and their own balance sheets have become much stronger. Combine that with the increasing value of self-storage properties and rising rental rates, and that makes this an ideal time to look for financing.

"I can't think of a better time in my career than right now to refinance a project," Gussis says. "All indicators are aligned perfectly for self-storage to refi- nance property. Interest rates are low, val- ues are high, and self-storage is regarded as a premium property type now and lenders are looking to lend. I don't know how you can better align the stars."

David Lucas is a freelance writer and editor based in Phoenix, Arizona

Mini-Storage Messenger September 2014

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