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The decision to refinance
your self-storage facility may seem as complex as the proverbial and
thought-provoking phrase “To be, or not to be.” Shakespeare and
philosophy aside, there are some general guidelines to assist your
decision-making process.
How do you know when to refinance? Here are a few circumstances that
might suggest an opportunity to refinance your facility:
• Current debt is nearing maturity
• Exit from construction or bridge financing and facility is approaching
stabilization (i.e. 80% to 90% economically occupied)
• Present interest rates and terms allow you to secure more favorable
debt, or
• You want to access equity to purchase existing partnership interest,
expand an existing facility, acquire a new facility or fund other
projects
In today’s market, the most aggressive terms and pricing are found with
permanent, fixed- rate, non-recourse notes. These debt instruments are
also referred to as commercial mortgage backed securities (CMBS), or
conduit loans. Plainly put, the reason why CMBS loans are so popular is
because they offer the best leverage at the best pricing, on a
fixed-rate basis for a long period of time.
The decision to refinance ultimately depends on your circumstances. If
you do not plan on selling your facility within the first five to seven
years, the decision is often a simple one. Alternatively, if you are
contemplating whether to sell or hold the facility, the economic cost
must be weighed against the benefits. Here, we will examine refinancing
goals, timing and costs.
Goals: When defining your self-storage
facility financing goals, here are a few items to consider:
How long do you intend to hold the property?
CMBS instruments are available with typical five, seven, and 10-year
terms, and to a lesser degree with 15 and 20-year terms. 25 to 30- year
amortization schedules can be obtained for good quality assets. Fully
amortizing 15 and 20-year notes are available to a limited extent;
however, by shortening the amortization period, debt service payments
are often increased to the point where a lender’s minimum debt service
coverage ratios cannot be maintained, thus fully amortized debt is
better for lower leverage loans.
Do you want to maximize cash flow?
Many CMBS lenders will supply an interest- only period for up to two
years of the initial loan term. Longer periods of interest only may be
obtained, yet there may be a premium added to your interest rate.
Do you intend to sell? If so, when?
Your debt will generally be assumable for a 1% fee as long as the new
borrower is acceptable to the loan servicer. Note that a CMBS execution
will not typically allow for secondary financing, meaning in an
assumption situation, the new borrower may need to approach the deal
with a high level of equity to make the deal work. However, many CMBS
lenders today will allow for mezzanine loans (a loan secured by company
stock).
Do you want to secure permanent fixed rate financing prior to a
property reaching stabilization?
Select lenders may provide long-term fixed rate loans today prior to
stabilization by underwriting the most current month of income on an
annualized basis to size a loan, provided the property has maintained a
strong lease-up rate. In doing this, lenders are trying to capture the
current operating performance of a facility that is sustainable going
forward. Some very aggressive lenders only require that the current
month of net operating income generates a “break even” debt coverage
ratio as long as within three to six months of loan closing, the
stabilized net operating income will generate a 1.20 debt coverage
ratio. For a property six months or more from stabilization, lenders may
provide the option to obtain a loan leveraged at 75% of stabilized value
by securing the “shortfall” of income with a letter of credit. Under
either of these situations, the loan will take 60 to 90 days to fund,
and during that time it’s critical that the lease-up rate maintain an
upward trend. These aggressive loan structures are mostly available for
A-quality developments in prime locations where the lease-up rate has
been strong and consistent. It would be difficult to obtain this type of
financing if the property’s leasing performance has struggled or there
are plans for new self-storage developments in the market.
Timing: An obvious time to refinance is
prior to your current loan maturity date, whereas other timing choices
are not as apparent.
With today’s low cost of capital, many owners choose to refinance
existing debt prior to their current loan maturity because they sense
long term interest rates may be escalating in the near term. When
choosing to exit from a loan prior to its maturity date, I recommend
that you review your loan documents to fully understand lock-out periods
and exit costs. After the lock-out period expires, a CMBS instrument
will typically be subject to either defeasance or yield maintenance up
until the last 90 days of the loan term expiration. With a loan subject
to yield maintenance or defeasance, the current interest rate and bond
environment will ultimately dictate costs for exiting your debt. With
defeasance, there are useful tools available on the Internet to assist
you with estimating exit transaction fees and costs. Under yield
maintenance, your loan documents will contain language dictating fees
and the method by which costs are calculated.
For newer properties that are leasing up, a smart time to consider
refinancing is when your facility nears stabilization. This sometimes
creates an issue for those owner/operators who have phased developments.
For example, suppose you presently have 45,000 rentable square feet of
self storage that is 85% economically occupied with $1 per square foot
rental rates, meaning $38,250 in effective gross rental income. You also
plan to open an additional 15,000 rentable square feet prior to your
anticipated funding date. When you open those additional 15,000 rentable
square feet, your economic occupancy will drop from 85% to 64% (i.e.
$38,250/$60,000).
Remember that lenders are motivated to lend on stabilized properties. In
addition to the economic occupancy issue, you will also incur higher
utility, maintenance and insurance costs, and these will negatively
affect your underwritten net operating income. The moral of the story is
to allow plenty of lead time and consult with a self-storage mortgage
professional who can offer helpful suggestions to guide you through the
process.
When contemplating a CMBS transaction, start the process early. The loan
will typically take anywhere from 55 to 65 days to close after the loan
application has been signed. If you have an imminent loan maturity date
and note that must be refinanced, bear in mind that prior to issuing an
application, additional time has already been expended on preliminary
underwriting and negotiation of the application.
Costs: The representative fees and expenses
for permanent fixed rate non-recourse financing are as follows:
• Loan origination fee—1% of loan proceeds
• Third party fees—estimated costs range from $25,000 to $35,000 for
appraisal, Phase I environmental, property condition report, survey,
seismic report (if required), lender legal costs, lender travel and
lodging to conduct property visit, credit reports, cash flow
verification, zoning report, aerials, due diligence costs, and
miscellaneous costs.
• Note that some lenders may agree to put a cap on third party expenses;
however, the lender may include a small premium on the loan interest
rate.
• The borrower will also incur costs for their own legal expenses, title
and escrow fees and survey.
• When considering a refinance option, be sure you understand any
potential impact the transaction may have on recording fees, transfer
taxes, and future real estate taxes.
When contemplating “to refinance, or not,” realize that one day you’ll
likely be faced with choice of whether or not to refinance your
self-storage property. Loan terms and conditions are constantly evolving
to meet market demands, and it is in the borrower’s best interest to
seek the assistance of a mortgage professional with an expertise in the
self-storage industry to help make educated decisions and create a
borrower-friendly process.
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