Section 10 • Finance
construction loans, banks prefer guarantors with very strong balance sheets and significant development experience. Bor- rowers should expect full recourse, at least until the Certificate of Occupancy is obtained, at which time the bank may allow for a burn down to limited of partial recourse. Currently, lenders are advancing up to 75 percent of project
cost at very attractive fixed or floating rates with several years of interest-only amortization. Generally speaking, construction financing is limited to those with very strong balance sheets and with significant development experience. Construction loans are inherently more risky than are other
types of loans because there is no cash flow during the con- struction and lease-up period. Federal regulators are requiring lenders to keep additional capital reserves available for riskier assets, which will increase the cost of construction financing. Significant equity requirements and rigorous underwriting and monitoring standards, including a comprehensive global cash flow underwriting on the borrowing entity, add additional ob- stacles to the process.
During the downturn, the effect of reduced cash flow from operations had a dramatic impact on a
borrower’s ability to meet and repay their loan obligations.
Bridge Loans In situations where an asset is in transition or a sale or refinance is expected in the near term, a bridge loan can be an attractive financing alternative that effectively allows the borrower to ac- cess flexible loan proceeds for a short period of time, typically no longer than three years. In the current market, bridge loans are commonly used as a financing vehicle for assets that are still in lease-up and not yet fully stabilized or when the asset is in some other form of transition, such as a distressed recapitaliza- tion scenario. Many lenders offer short-term bridge loans for commercial
properties, including self-storage. As a borrower, it is important to understand that in a bridge scenario the lender will be look- ing for a clear “exit strategy” to be certain that the loan will be retired through either a sale or refinance of the asset during the term of the loan. Bridge loans are often open to prepayment and are commonly offered for terms of 12 to 36 months on a fixed- or floating-rate basis, typically with an embedded extension op- tion that can be exercised for a fee so long as the property is performing according to the terms of the loan agreement. Rates for bridge loans can vary greatly and range from 3 per-
cent to 10 percent, depending on the structure and perceived risk of the transaction. Many lenders charge 1 percent at closing and 1 percent at repayment, but in many cases this is negotiable. Non-recourse bridge loans are available in the market today.
104 Self-Storage Almanac 2015 In the current lending environment, bridge loans are being
underwritten somewhat aggressively and are often sized using existing cash flow in place, with some credit given to a borrow- er’s pro forma projections as long as they are clearly viable. In many cases, it is loan-to-cost (LTC) that is the ultimate constraint. For example, if a distressed property is purchased at a discount, borrower proceeds will be constrained by 80 percent of cost, re- gardless of in-place cash flow. In some instances, the lender may require additional collater-
al, such as a cross-collateralization structure with another asset or a posted letter of credit from the borrower, in order to provide additional credit enhancement and comfort for the lender. Be- cause of lessons learned during the economic downturn, lend- ers are more risk-averse relative to pre-recession financing and are increasingly concerned with the current and terminal value of their collateral, as well as their exit strategy.
Distressed Real Estate During the pinnacle of the recession from 2009-2011, there was a lot of talk in the market about distressed self-storage properties. Yet, as operating fundamentals have returned and as cap rates continue to compress, the subset of distressed deals is growing smaller by the day, making traditional first mortgage refinance vehicles the path of least resistance for many previously dis- tressed assets. During the downturn, the effect of reduced cash flow from
operations had a dramatic impact on a borrower’s ability to meet and repay their loan obligations. In addition, more conser- vative cap rates and lower leverage financing impacted a bor- rower’s ability to refinance the entire outstanding loan balance and often resulted in the need for an equity infusion into the property upon refinance. As evidenced below, the various price indices have shown
significant growth over the past four years. After bottoming out in mid-2009, values are now meeting or exceeding their pre- recession values from 2007. Thankfully, for those owners whose assets are distressed, there are a multitude of options available to bridge the gap. Subordinate Debt And Equity Options The extent to which a property declines in value and the re-
sulting impact to the capital stack typically delineates the solu- tions available to the property owner and borrower. As long as the debt in place is being serviced and does not expire, the eq- uity erosion may only be a temporary situation that effectively creates a short-term paper loss with little consequence for the storage owner or lender. In situations where additional leverage is required, borrowers may have debt options available to help them reach their needs, as long as there is cash flow available to service debt. Subordinate debt is a general term that refers to any addi-
tional financing lower in priority to the first mortgage and is a mechanism that can provide more capital and higher leverage to help bridge an equity gap. In the current market, subordinate debt lenders will take a capital position between the first mort- gage cut off and reach up to 85 percent or more LTV.
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