Section 16 • Finance


implemented two quarter-point increases of the target rate in 2017, bringing the target to 1.0 to 1.25 percent. The FOMC may raise rates once more before 2017 ends. While these are not drastic increases, the hikes are significant; 2017 is the first year since the Great Recession in which the Fed has imple- mented more than one increase in a calendar year.


The national rate of unemployment continued its decline


over the last year to its current level of 4.4 percent as of Au- gust 2017; this is down 0.5 percent from a year ago. According to a Sept. 1, 2017, employment survey from the Bureau of La- bor Statistics, total employment gains have averaged 176,000 jobs per month in 2017, which is in line with the 2016 average of 187,000 jobs per month. The Bureau of Economic Analysis reported that GDP increased 3.1 percent in the second quar- ter of 2017, above moderate growth of 1.2 percent in the first quarter. Notably, GDP growth in Q2 2017 was the highest level reported in a single quarter since Q1 of 2015. Despite labor market tightening and strong GDP growth, core infla- tion remains below the FOMC’s mandated target level of two percent. Thus, the Committee maintains its stance that the economy will continue to evolve such that gradual increases to the federal funds target will be warranted.


At the time of this writing, it seems


likely that the Fed will raise rates one more time before the end of the year.


Moreover, it has signaled for three more rate hikes in 2018. It is likely that lenders will continue to seek opportunities to deploy their capital and make loans to credit-worthy borrowers.


As in years past, global economic volatility may have an


impact on interest rates and the health of all lending sources to some extent going forward. In fact, there exists the risk that unforeseen global events could play out and shift the economic landscape in unpredictable ways. However, pre- dicting these sorts of events goes beyond the scope of this section. Instead, borrowers should focus on what they know to be true and what they can control. Interest rates are on the rise, but they will likely continue to increase gradually; large spikes would come as a surprise. At the time of this writing, it seems likely that the Fed will raise rates one more time be- fore the end of the year. Moreover, it has signaled for three more rate hikes in 2018. It is likely that lenders will continue to seek opportunities to deploy their capital and make loans to credit-worthy borrowers. Thus, borrowers looking to lock into longer-term debt and insulate from prospective rate in- creases should find an opportunity to do so in 2018.


160 Self-Storage Almanac 2018


1. Sponsor equity 2. Preferred equity 3. Mezzanine investors (hybrid debt and equity) 4. First mortgage (senior debt)


Just as the value of a real estate asset is dynamic and will


change over time, so too does its relative position within the capital stack; for example, as debt is reduced, equity in- creases, and vice versa. First mortgage debt has priority to cash flow and is easily quantified as the unpaid loan balance. At the top is the sponsor equity position, which is subordi- nate to most other positions. The value of this position can be roughly quantified by subtracting the value of the higher priority positions from the asset’s total value. The required rate of return ordinarily increases as you move up the stack, due in large part to the seniority of the position and the


It can be helpful to envision the capital stack as a pyramid;


its shape is not purely coincidental. Both the level of risk and the required level of return diminish from top to bottom. Put another way, the top of the pyramid is the riskiest position, since those parties are last in line to receive proceeds. The top of the capital stack is where most equity resides. Alterna- tively, the first mortgage (senior debt) lender has priority to the cash flow from an asset and is inherently the least risky position. Lenders and equity stakeholders are highly sensi- tive to their position in the stack and price their debt and equity products accordingly. Typically, the stack includes the following arrangement, from top to bottom:


Breaking Down The Capital Stack A commercial real estate transaction has two primary financ- ing components: debt and equity. The capital stack indicates the totality of capital contributed to the financing of a real estate transaction. This includes the above categories as well as any hybrid “dequity” products in the middle.


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