Self-Storage Observations for 2011

Self-Storage Observations for 2011

As with all real estate asset classes in recent years, the self-storage industry has experienced challenges to financing both for existing properties as well as sourcing funds for new projects. Developers who were ready to build suddenly found their funding resources dry up. In addition, a decade-long rapid-build phase had led to overbuilt markets, giving lenders yet another reason to pull the plug on self-storage lending.

However, there are still underserved markets around the country and available land ripe for self-storage development. Plus, the recession left behind hundreds of empty commercial buildings that are ideal for conversions. This year, lenders are returning their focus to proven borrowers with solid backing, and once again considering loans for an industry that has proven to be resilient.

One of the brightest rays of hope is the industry’s new eligibility status for Small Business Administration (SBA) loans. While it’s too soon to evaluate what affect this will have on the overall market, the announcement alone has the industry buzzing. CMBS (commercial mortgage-backed securities) loans are also creeping back into the self-storage lending arena. Real estate investment trust Extra Space Storage recently obtained an $82.2 million CMBS loan from Bank of America/Merrill Lynch.

Financing

The financing market has improved throughout 2010 and should only continue to improve with time. A lot of the lenders who came back into the market in 2010 were mainly focused on larger transactions and cleaning up their books. The expectation is that over time, loan amounts will come down and loan-to-value (LTV) will begin to creep up as competition for deals increases. There’s also a lot of excitement, obviously, about SBA coming into the storage market. We expect to see more meaningful volume in this sector as lenders and the SBA start to figure that out.

The state of general availability for funds remains heavily dependent on large and regional commercial banks, and some credit unions. Some limited insurance portfolio lending is coming back online, which is attractive to corporate borrowers with stable class-A properties with low leverage. Banks are still relying upon a “global cash flow” analysis when they look at a borrower, and favor borrowers with multiple sources of repayment and income. Interest rates remain low and generally attractive despite the lower leverage. Generally, a borrower can expect 65 percent LTV, 20- to 25-year amortization, and interest rates from 6 percent to 7 percent, with some opportunity for lower rates. There are even CMBS lenders back in the game. Interest rates range from 5 percent to 6 percent—great, low rates—and LTV is typically at 65 percent, up to 72 percent. Sponsorship (or the lender) must be very strong with a solid balance sheet, and this financing mostly applies to properties that have a stable operating history.

SBA Loans

The SBA programs for storage are pretty new, and most folks are trying to understand the nuances of these transactions. The expectation is this will happen in the first half of 2011. At that point, these programs should become a viable source of capital for smaller (less than $5 million) transactions. By nature, the SBA favors deals where the owner is heavily involved in the business, so this should be a great source of capital for transactions where the business is the borrower’s primary source of income. This is an area that has been somewhat undeserved by banks during the recovery because often times the risk in these deals is perceived to be higher. Finally, in deals where there’s strong cash flow, but maybe a bit of an LTV mismatch relative to many lenders stated requirements (i.e.: a maximum 70 percent LTV), the SBA programs should present a good fit as they will allow some flexibility to climb up the leverage ladder. This is a great help to smaller regional banks that can write a smaller loan for local storage operators with support from the SBA. While this all sounds promising, until some deals are actually completed, no one knows.

New Development

Obtaining constructions financing for new projects remains very difficult. There are many distressed opportunities out there that still need to be flushed through the system, and lenders are going to be focused on solving these problems before they’re willing to talk about starting new projects.

The interesting thing about the development dilemma is the problem sort of solves itself. If a proposed transaction and the associated return make sense under an intensive equity scenario, which is essentially what you’ll need to succeed in this environment, then that deal probably makes sense and can get done. Alternatively, deals that would rely heavily on leveraged debt to make sense probably will not qualify for funding. Regardless, any new self-storage development MUST have an ironclad credit-tenant in place to fully lease the property upon certificate of occupancy in order to secure financing. The age-old truism applies – cash is king! Have plenty of it and seek a relationship with a local bank. Right5 now, self-storage construction is estimated to be down 65 percent to 75 percent over the last two years. This lack of new, ground-up construction has been attributable primarily to restricted financing and the dramatic reduction in residential and multi-family development in most markets. There has been an uptick in conversions as a number of infill locations have a significant amount of properly located and zoned vacant existing space available.

Role of Conversions

For the very reasons cited above re: new construction, the lack of reasonable financing for new construction is forcing owners to look elsewhere to build their storage business. One of the alternatives is converting existing buildings into self-storage. Conversions have advantages that many new construction projects don’t have in terms of good retail locations, easy access and, in many cases, a larger customer base―as well as less money needed than with new construction, so long as the property is already acquired.

In some cases, one can get into the business faster by developing a conversion. The challenge is to make sure the retro-fitting doesn’t run over budget as a result of trying to convert a building that requires too many reparations that are too expensive. Converting vacant infill buildings to self-storage makes the most sense since the presence of distressed many commercial and industrial buildings present opportunities in good markets. With the slab and shell already in place and, in most cases, fire sprinklers and mechanical equipment also in place, most sunk costs were already spent by the previous owner.

The Future

If our economic recovery remains sluggish, ground-up development of self storage may be expected to maintain its current pace in 2011. However many industry experts predict a significant increase in conversions as vacancies in many asset classes continue into 2011. Although the future of self-storage still remains healthy, it’s safe to say that the market needed a correction, and a correction it got. Many current operators reading this would agree. That being said, self-storage development still continued in these very difficult economic times. This industry has proven its resilience, and life conditions dictate that people will continue to use self-storage. If you have the right site, this may be your time to take advantage of those low construction costs.

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