Section 12 • Finance
refinance what is owed, a self-storage owner might turn to mez- zanine debt to fill the gap.
Consider this self-storage portfolio refinance example that
was commonplace in 2011. Five years earlier in 2006, a portfolio of storage assets generating $2 million in net operating income (NOI) would likely have qualified for loan proceeds of around $26.7 million, based on a cap rate of 7.5 percent and leverage of up to 80 percent loan-to-value (LTV) available in the market.
As seen in Table 12.2, assuming a modest decline of 5 percent
in NOI, combined with a 50 basis point increase in cap rates and new available leverage of 70 percent LTV, the borrower would be faced with a proceeds shortfall of roughly $2.97 million. This proceed gap would need to be filled to refinance the transac- tion at the existing loan’s maturity. The property is not under water, as value of $23.75 million still exceeds the balloon bal- ance of $19.59 million. However, mezzanine debt in the amount of $2.97 million would be required to bridge the gap and refi- nance the new loan.
If value is depressed but expected to increase going forward
because of either growth in cash flow or cap rate compression, the mezzanine lender has a clear out in the form of a tradition- al first mortgage that covers the existing first and mezzanine piece. Mezzanine financing represents a smaller portion of to- tal asset value, and thus mezzanine lenders often require larger deals, generally north of $10 million in value, to ensure profit- ability and account for fixed administrative costs.
Other financing vehicles exist for smaller deals, such as hard money loans. These loans are more costly and will typically com- mand higher interest rates than first mortgage debt. In some cases, the borrower may have to contribute additional equity to make up for the new debt shortfall.
While based on a set of generic hypothetical assumptions,
the implications of the described scenario could be very real for a property owner in the event of a negative shock to cash flow or value. In a climate where cap rates on commercial property are generally very low, property values are high and the above situation is less common, but understanding the implications is important for self-storage owners.
Mortgage Brokers, Consultants, And Intermediaries Enlisting the services of a financial intermediary such as a mort- gage broker puts the experience and expertise of that profes- sional in the owner’s corner. Taking this course of action can
Origination Current
Cash Flow $2,000,000
$1,900,000 130 Self-Storage Almanac 2016 Cap Rate
7.50 percent 8.00 percent
make a significant difference to the financing or loan workout process, especially during times of capital market volatility. A broker’s knowledge of loan programs in the market and appli- cable lenders, coupled with an understanding of corresponding underwriting approaches, can often assist a borrower in target- ing qualified capital sources. This includes banks and insurance companies, or even newly formed funds, of which the loan ap- plicant may be entirely unaware.
A competent broker also knows how to properly package
the loan request and position the transaction with the lend- ing community in a way that helps financial institutions to ef- ficiently understand the asset at hand. Lenders confronted with an inbox full of potential transactions are more likely to engage a succinct, understandable presentation of the financial perfor- mance of the property. Using a broker can free up the owner’s time to pursue value-add strategies, and alleviate the stress of the lending process. Sourcing funds is a full-time job, and often a broker’s expertise not only equates to better execution, it also aids in facilitating the most challenging deals to completion.
Conclusion The year 2015 was another strong year for economic recovery in the U.S., and despite many predictions to the contrary, inter- est rates were unchanged through mid-November. Volatility will likely persist in anticipation of rate movement, and the move- ment of other microeconomic and macroeconomic factors will weigh on pricing and volume.
According to projections by MBA, 2016 will see increased
commercial and multifamily loan origination to the tune of 6 percent. Banks continue to shed themselves of troubled loans that made them hesitant to lend over the past several years, re- sulting in more liquidity in the capital markets. A construction market that was nearly stagnant just a few years ago strength- ened through 2014 and 2015, and will likely continue to present opportunities for owners to develop new projects. If delinquen- cies continue to trend downward, self-storage properties will re- main among the most durable commercial real estate products.
On the securitization front, the CMBS market is aggressively
competing to win business for lower loan dollars in primary and secondary markets. Equity players remain active in the market, seeking profitable ventures for those in need of recapitalization. While self-storage owners should remain mindful of economic indicators going forward, the above paints a generally positive picture for owners looking to acquire new facilities or refinance their existing properties.
Table 12.2 – Proceeds Shortfall Value
LTV
$26,670,000 $23,750,000
80 percent 70 percent
Loan Amount $21,330,000
$16,625,000 $2,965,000 Shortfall
Balloon Ballance (Year 5) $19,590,000
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