The COVID-19 Lending Landscape: Options and Insight for Self-Storage Financing

While government restrictions and health advisories relating to the coronavirus pandemic have paused or slowed many of “non-essential” activities, self-storage owners with near-term loan maturities have no choice but to prepare for refinance. The possibility of a technical loan default, exorbitant default fees, damage to credit history and foreclosure proceedings should never be taken lightly.

That said, the lending landscape has changed during COVID-19, and documentation requirements have increased to deal with new areas of heightened focus. But before we get into loan preparation in this new environment, let’s discuss the current lending options and lender appetites, as they’ve also materially changed.

Commercial mortgage-backed securities (CMBS). As of early June, a reputable CMBS “money center bank” has re-emerged in the debt marketplace and is providing much needed liquidity in the self-storage industry. This is important because CMBS offers non-recourse loans for which only the property serves as collateral, not the owner’s personal assets. CMBS also offers “cash-out” financing, which allows owners to monetize their investment and the imbedded value they’ve created without the need to sell their property and deal with the related tax consequences.

Still, the CMBS market isn’t widely open for business. Also, some unscrupulous CMBS lenders are using the current market volatility to their advantage, continuing with the deceptive lending practice of “re-trades.” A knowledgeable mortgage professional can help you identify and avoid these lenders with poor reputations.

Insurance companies. For the most part, these lenders have rolled back their activity, except when offering the most conservative loan terms. They’re generally in a “wait and see” mode, which they have a tenancy to do during periods of economic uncertainty.

Local and regional banks. These are another lending source for self-storage owners. They provide Small Business Administration loans, which are partially guaranteed by the government, as well as balance-sheet commercial loans. However, at this point, only a portion of these lenders are still active, as some locals have been forced to focus on asset management due to loan defaults relating to hotels and poor performing retail properties.

It’s important to know that nearly all local and regional banks are requiring full or partial recourse, in which your personal assets—including your home, personal investments and savings accounts—serve as collateral for the loan in addition to your self-storage property. And personal recourse simply doesn’t work for some borrowers or institutional sponsors that manage properties on behalf of private or public investors.

Debt funds and specialty finance companies. In general, these lenders have been the most negatively impacted by COVID-19. The evaporation of CDO (collateralized debt obligation) securitizations—which up until the pandemic provided many of these lenders with significant liquidity—has crippled their ability to actively lend. In addition, they’ve been hammered with heavy margin calls by their line or repossession lenders. Consequently, many debt funds and specialty finance companies are conserving cash and not lending to ensure they can make future margin calls and, in some cases, simply survive.

The silver lining for self-storage owners is, relative to other types of commercial real estate, this industry is experiencing fairly high demand by active lenders who recognize:

Storage businesses have been rather unscathed by COVID-19. The basic demand generators continue, and the pandemic has even produced new forms of demand, including the need for space to accommodate newly established home offices or young workers who’ve moved back home with their parents after losing jobs in the retail or hospitality sectors.
Self-storage rental payments are collateralized by storage-unit contents as well as the renter’s credit background.
The storage industry hasn’t experienced the same level of government intervention as multi-family property owners who must allow renters to suspend their monthly payments if they were impacted by COVID-19 and related orders.

Keep in mind that active lenders are still nervous about the economy and are offering less leverage to self-storage owners than before. I suggest you hire an experienced mortgage professional to negotiate on your behalf in relation to:

Newly created six- to 12-month debt service
Real estate tax and insurance reserves (regardless of property performance)
New cash-out limitations, interest-only period reductions and lower loan-to-value requirements

Remember that loan terms are the single most effective way for a commercial real estate owner to maximize his after-debt-service cash flow and return on equity.

There are some new documentation requirements. To start, your lender will ask for evidence to understand whether your rent collection has been materially impacted by COVID-19. One document most will ask for is an aged-receivables report, which wasn’t commonly requested until recently. If your self-storage property has always had some portion of tenants who pay late, even before the pandemic, it’ll be important to mention that in your report.

Some lenders may want to take an additional bad-debt vacancy deduction for delinquent tenants. Generally, there’s a substantial difference between tenants who pay late and those who never pay and must be written off as bad debt. You’ll want to speak to your accountant and property managers to understand the true percentage of bad debt and make your case to the lender. You want to avoid the “knee-jerk” underwriting adjustments lenders are currently making to cash flow, as it directly impacts your loan terms.

Finally, you need to consider the impact of your commercial tenants on revenue. Even if your facility only rents to a few office or retail clients, the lender will likely ask which are open for business, whether they were closed during the pandemic, and if any have asked for rent relief. You must answer these (and all) questions from your lender honestly to avoid later triggering a “bad-boy carveout” relating to fraud in the event of a future loan default. It’s important to manage your commercial tenants and be proactive in coming to a resolution if any have been severely impacted by the pandemic. Another way “dirty laundry” is being aired is by lenders requiring most, if not all, tenant estoppels.

While you can’t control every outcome during a self-storage loan refinance, careful preparation will increase your lender’s underwritten cash flow. This will ultimately help you achieve the best possible loan terms and ensure a successful closing.