Finance • Section 12 Bridge lenders learned several hard lessons from the last re-
cession, and are thus more risk averse relative to the pre-crisis financing climate. These loans are often structured with earn- outs, future funding, and heavy reserves to ensure success- ful execution of the borrower’s plan. As noted above, they are increasingly concerned with the current and terminal value of their loan collateral, as well as their exit strategy. As a result, some may require additional collateral, such as a cross-collater- alization structure with another asset or a posted letter of credit from the borrower to provide additional credit enhancement and comfort for the lender.
Distressed Real Estate The effect of the crisis on cash flow from operations had a dra- matic impact on many borrowers’ ability to meet and repay their loan obligations. As property values increase and cash flow grows stronger, much of the conversation surrounding distressed deals has been muted. The large subset of distressed deals that manifested during the crisis has decreased signifi- cantly over the last few years. In today’s climate, traditional first mortgage refinance vehicles are seen as the path of least resis- tance for many previously distressed assets.
Chart 12.7 (Commercial/Multifamily Property Price Indices)
depicts what has seen generally steady growth in values over the past five years. After bottoming out in mid-2009, values are at or above pre-recession levels from 2007. Thankfully, for those owners whose assets remain distressed, there are a number of options available to bridge the gap.
Subordinate Debt, Mezzanine And Preferred Equity With distressed real estate, if the debt in place is being serviced and does not expire, the equity erosion may only be temporary. This situation effectively creates a short-term paper loss with little consequence for the storage owner or lender. If additional leverage is required on a property that still produces adequate cash flow to service the loan, subordinate debt may be a viable course. Subordinate debt is a general term that refers to any ad- ditional financing lower in priority to the first mortgage. This type of debt product can provide more capital and higher lever- age to help bridge an equity gap. Subordi- nate debt lenders in current market condi- tions will take a capital position between the first mortgage cutoff, reaching up to 85 percent LTV, and sometimes even higher.
130 120 110 100 90 80 70 60 50
Subordinate lenders are taking on an
inherently more risky position within the capital stack, a position for which they are paid higher interest rates than first mort- gage debt. Interest rates on subordinate debt typically fall in the range of 10 to 20
Moodys/REAL CPPI NCREIF TBI GSA CPPI
Source: MBA Databook, Q2 2014; source data from Mortgage Bankers Association, Real Capital Analytics, Moody’s Investors Services, National Council of Real Estate Investment Fiduciaries, and Green Street Advisors
2016 Self-Storage Almanac 129
percent, on a transaction by transaction basis. Subordinate debt lenders are often flexible in their willingness to structure pay- ments to match the cash flow projections of the specific asset; for example, the payments might be structured as interest only payments with a balloon, or amortized over time with routine interest and principal payments to reduce the debt.
The two most common subordinate debt products are
mezzanine financing and junior mortgages (B-Notes). Mezza- nine lenders provide subordinate debt that is secured against an ownership position in the borrowing entity, rather than the mortgaged property itself. B-Notes take a secondary debt posi- tion that is secured by the mortgaged property as collateral for the loan. This mortgage is junior in priority to the first mortgage or senior note (A-Note), hence the nomenclature.
There are situations where cash flow and equity erosion may
be so severe that there is no longer adequate cash flow available to service the debt, and in even more dire situations, the com- mensurate value decline may be so severe that the current spon- sor’s equity has been completely eroded. In these situations, the sponsor may need to infuse new equity in to the transaction, and if the sponsor does not have the equity, this can be achieved through an equity joint venture. Joint venture equity is typically available to commercial property owners in transactions where there is a significant upside in the transaction, often stemming from a development or recapitalization scenario and resulting in enhanced cash flow and consequent value.
Capital Stack Example If property values are declining in a depressed market, the abil- ity to refinance out the entirety of outstanding debt can be problematic for some self-storage owners. If value deteriorates to the extent that available debt in the market is not sufficient to
Chart 12.7 – Commercial/Multifamily Price Indicies (January 2007 = 100)
JAN 2007 MAY 2007 SEP 2007 JAN 2008 MAY 2008 SEP 2008 JAN 2009 MAY 2009 SEP 2009 JAN 2010 MAY 2010 SEP 2010 JAN 2011 MAY 2011 SEP 2011 JAN 2012 MAY 2012 SEP 2012 JAN 2013 MAY 2013 SEP 2013 JAN 2014 MAY 2014 SEP 2014 MAY 2015
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