We are all hearing about the rising interest rates, right?
Well, let’s discuss it in relation to you getting in the self-storage business or growing your self-storage business.
The current loan environment, in historical terms, is still in good shape. Interest rates may be on the rise after years of historical lows, but it still falls within the category of “gradual increases”.
And there is good news for some self-storage loans.
Types of Loans For Self-Storage Owners
There are basically two main types of loans most self-storage owners are involved with:
- Bank Loans
- Permanent Loans
Or at least those are the main two we are involved with. Each has a few different types and places the loans can come from.
Bank loans, for this episode, are typically local or national banks. They usually have a 20% or more equity infusion requirement, usually have a 3 to 10-year call, and are usually amortized over 20 years (sometimes 25 years).
And yes, there are usually personal guarantees required.
You could get a loan from a Credit Union instead of a “Bank”. But I will call those a “bank” loan for purposes of this episode.
Small Business Administration Loans (SBA) also fall into this category. These loans are bank loans with a twist, the Federal Government guarantees a portion of the loan for the lender.
The main thing with “Bank Loans” is that the interest rate charged is usually indexed to a “Federal Fund Rate”. This is the rate at which banks get their money they lend you.
When the “Fed” (the Federal Open Mark Committee, which meets eight times a year) raises this rate, they then pass it on to you. Prime Rate, is the rate that banks pay for their money.
As borrowers, we usually get from 1.5% to 2% or so above that in our loans. Especially if you have a floating loan (one that goes up with the market), it is most certainly indexed to the Prime Rate.
So when these rates go up .25% (“250 basis points”), bank interest rates usually follow. This is what’s happening now. A few times a year, it looks like the interest rate is going up .25%.
The Fed adjusts interest rates in an attempt to manipulate the economy in a positive way and keep inflation in check.
Theoretically, if we are moving towards “overbuilding”, rising interest rates should “cool down” that movement.
So if you are getting bank loans, odds are your rates are going to be higher today than a year ago.
In your Pro Forma, adjust for this.
This usually means what you can pay for a facility is less if you desire to keep the same profit requirements.
I think this “cooling off” of sales prices and cap rates are going to be coming soon. We may already be starting to see it in some of tier two and lower markets.
If you can, fix your rates. I know in SBA situations, this usually isn’t the case. However, any chance you get, lock in the interest rates.
If they drop, refinance. But odds are the interest rates are going up – slowly, but going up most likely.
However, there is some good news in the interest rate arenas:
Permanent Loans
In the past decade or so, as interest rates have risen, the 10-year Treasury Bill interest rate has remained flat or gone down. For years it remained below 3%.
However, for most of 2018, it has been slightly above 3%. When I checked, it was hovering around 3.18%.
Most Commercial Backed Loans (CMB) are indexed to this rather than the Federal Prime Rate. The majority of the time it is a 2% spread over the 10-year rate, and today some are even quoting between 1.5% and 2% over the 10-year rate.
This is putting many CMB interest rate quotes in the low 5%.
For the first time in ten years, the quotes you can get for a permanent loan are in many cases less than you will get for a bank loan quote.
Defeasance
Now remember, for these CMB loans, these are put on stabilized facilities, usually 65% Loan To Value (LTV), and have a 10-year placement. There is defeasance, or like a big prepayment penalty. You can’t pay them off early. You actually have to replace the loan instrument because these loans are packaged with other income-producing financial instruments and sold for their income.
If you pay off early, it is hard to unwind this one loan from the package. You have to purchase another instrument to finish out the payment of your loan (defeasance) and depending on how long is left on the loan, it can cost a lot.
I have been involved in two deals that did this, and in both cases, it was a $200,000+ expense. So if you use these, make sure you are planning to hold it a long time.
The good news is these loans are usually non-recourse. In other words, there is no personal guarantee involved (unless you break some of the loan covenants).
The Interest Rate Phenomena & Advice For A Brighter Tomorrow
The unusual thing about today’s rising interest rate environment, for me, is that for the first time I can ever remember (I am sure it has before), quotes on the CMB loans are lower than a typical bank loan.
We are being way more careful on our Pro Forma today, and using high-interest rates for interest rate guesses in future years for refinances (7% plus).
Also, given the rising cost of construction, due to the President’s ill-advised protectionist economic policies (the steel tariffs, in particular), we are starting to find it harder to get our yield requirements.
Prices for existing self-storage have remained flat.
Although we have yet to see a drop in self-storage prices, the double wham of rising interest rates and rising construction costs (that are making it even harder to get the type of value-added deals done that we like to do), may soon change that.
Deals can still be done, but be careful. If at all possible, and in as many cases, fix your interest rates for bank financing. If you have to guess on interest rates for future years, go 1% to 2% higher than they are today.
When it is at all possible, use CMB loans.
If we begin to factor for the changing interest rate environment, and still do all the things we know to do, our future is still bright in the self-storage industry. It is still by far the best business there is…period.
