One of the most impactful recommendations I make to self-storage owners seeking to refinance their loan is that they proactively address deferred maintenance and improve curb appeal at their property before they start the process. This is because there are critical ramifications to not doing so.
Deferred maintenance refers to items in need of immediate repair. While there’s some subjectivity when it comes to what falls in this category, we’re generally talking about a repair that’s gone beyond daily housekeeping, is noticeable to the average tenant, or may have large financial consequences if left ignored. Curb appeal is also subjective and can be impacted by changing design trends; however, it plays a powerful role in the minds of customers as well as prospective buyers, appraisers and lenders.
If you’re looking to refinance your self-storage facility, you can’t afford to avoid deferred-maintenance items or curb appeal. Here’s why.
Regardless of the type of loan you’re pursuing—bank, life-insurance company, commercial mortgage-backed securities, etc.—your lender will have a loan-to-value (LTV) requirement in its term sheet. Failing to meet it will nearly guarantee the lender cuts your proceeds, increases your interest rate or simply declines your request. This will generally occur toward the end of the closing process, since it takes three to five weeks to complete an appraisal report. At that point, significant legal and other due-diligence expenses will already have been incurred. That’s why it’s so important to ensure the highest possible appraised value for your site.
The most cost-effective way to do this is to address deferred maintenance and improve curb appeal before the appraiser even steps foot on your property. While there are market forces that’ll help determine the assumptions that result in your appraised value, the better your property looks, the better it’ll appraise.
The subconscious effect of a property that is clean, attractive and in good repair—or conversely, dirty, ugly or in disrepair—will play a significant role in the appraiser’s mind when deciding your capitalization (cap) rate. This will impact the income approach to value. Your property’s condition will also play a role when your appraiser is measuring your site against comparables and applying adjustments for the sales approach to value. These cap-rate or sales-comparison adjustments create the building blocks of the appraiser’s assumptions, which ultimately result in your appraised value.
While filling a pothole, repairing a fence or painting an exterior wall represent a relatively minor expense, the potential impact to your appraised facility value is significant. Not only will a high value help you meet your LTV requirement and avoid negative adjustments to your final loan terms, if you achieve an LTV that’s significantly lower than the requirement in the term sheet, it may give you bargaining power. This can help you potentially increase proceeds, decrease the interest rate or, at the very least, give you leverage if, during due diligence, the lender uncovers an issue with your property that gives pause. In short, a lower LTV can help offset other risks.
Lastly, remember that you’re able to obtain a copy of the appraisal report post-closing (if you ask), which may be useful if there’s even a remote chance that you plan to sell your property. While market conditions will likely change, it may be advantageous to share those materials with a prospective buyer. Having the highest appraised value will increase the chances the report will be useful in that regard.
Most lenders also require an engineering report, which means an engineer or property-condition specialist will inspect the property. His main focus will be to identify any deferred maintenance and the remaining useful life of your structural components. The last thing you want is for him to uncover deferred repairs.
The lender will generally require an escrow from your loan proceeds at closing equal to 125 percent of the engineer’s estimated cost to repair. Generally, this is a conservative figure that doesn’t take into account careful shopping or deep vendor relationships. In addition, getting funds released during the term of the loan can be time-consuming and frustrating.
Once the loan is closed, the leverage you have as a borrower is limited. Getting a servicer to focus on the release of a reserve can be difficult, and borrowers often receive silly or arduous follow-up requests, such as pictures and new lien searches for even the smallest reserve releases.
Additionally, the more deferred maintenance that’s uncovered, the less benefit of doubt the engineer will give you regarding the remaining useful life of structural items that are older but still in excellent working condition. The lower remaining useful life on critical items, the greater the ongoing replacement reserves will be. Generally, most term sheets or applications indicate that ongoing reserves will be the greater of a predetermined figure and the engineer’s estimate.
Finally, your underwriter, credit officer or at least the loan officer will often inspect the property. Not only will he examine your facility and market, he’ll evaluate the quality of your management. A lender will assume your property always looks like it does on inspection day. If it looks crummy, he won’t presume it’s having a “bad-hair day.” He’ll believe it’s consistently in poor shape and you’re a consistently poor operator.
Remember, the small nuances of these inspections may have a profound impact on the terms of your mortgage. This is singlehandedly the most dramatic way to improve or reduce your return on equity and cash-on-cash return as a commercial real estate owner.
On a larger loan or property, the ideal approach is to have an engineer do an inspection before you begin a refinance. At the very least, you want to comb through the site carefully with your repair person.
Your first focus should be curing deferred maintenance relating to structural items such as roofs or HVAC systems. The condition of your paving including roadways and parking areas (along with striping) make it easy for an inspector to identify problems or acknowledge recent proactive work. Life-safety items including trip hazards or even things as mundane as the inspection dates on fire extinguishers will also represent key focal points of the engineer’s review.
Americans With Disabilities Act (ADA) requirements are critical to lenders given they are lawful. Even if a bathroom is rarely used by renters, it must meet all stipulations including low sinks, grab bars, emergency pull cords and even door handles that don’t require the twisting of the wrist. There are ADA parking spaces required and specific height requirements for your signs, too.
Finally, make sure you’ve addressed any recent tenant complaints relating to repairs. A lender will often require estoppels from even the smallest office tenants. If a customer plans to make a complaint, it’s better to address it proactively on your own rather than have it discovered by a lender and described on its document.
Once key repairs are complete, don’t overlook aesthetic items including new signage, paint or even a powerwash. While an engineer will likely not identify curb-appeal issues unless they’re a major deterrent, addressing them is the most cost-effective way to improve the terms of your loan and the overall process, given the impact to valuation and your lender’s opinion of your property. If you see a piece of trash while walking an inspector through your self-storage facility, pick it up and look confused as to why it’s there. That’s what I would do.