Construction Financing Still Strong

Unsettled world events may have an affect later in year

The self-storage industry has been experiencing a financing windfall for several years and most industry experts say it is still going strong.

However, with continuing rise in inflation, gasoline prices, a predicted bump – or several – in the prime rate and unsettled world events in Europe, some experts are wondering how all of this may continue to affect self-storage development.

“Construction is tricky right now due to material costs and the feds increasing the rates,” says Bishesh Shrestha, vice president of self-storage lending and senior loan officer for Live Oak Bank in Wilmington, North Carolina. “We hope that rental rates will continue to go up to offset the extra costs.”

At present, there’s still plenty of money floating around for developments that pencil. “Construction financing remains strong,” says Shawn Hill, principal for The BSC Group in Chicago. “At the beginning of the pandemic, there were concerns with overbuilding within the industry. The pandemic was sort of a magic elixir that remedied many of those concerns because rents and occupancies regained traction during that period.”

Types of Financing Available

The Great Recession proved the resiliency of the self-storage industry and that drew a lot of attention from bigger entities with a lot of money to invest. “During the recession that began in 2008, self-storage was an asset class may people didn’t understand,” says Shrestha, adding that 2016-17 was the turning point in that view. “There was so much opportunity,” he says. “In 2019, the feds hiked the rate and we saw a very slight slowdown. In 2020, we saw how resistant the industry is once again in real time. Occupancy and rental rates remained steady when things were locked down and then we saw growth in a crazy recessionary environment and that information alone got us back to lending.”

“Early in the pandemic, no one was sure of what would happen, and construction took a very brief pause, but self-storage is resilient and has proven good in a crisis, “says Steve Libert, co-founding principal at CCM Commercial Mortgage in Chicago.

“Self-storage construction lending is and will largely continue to be a relationship experience,” says Hill. “Many lenders are looking for sponsors with the track record and wherewithal on their balance sheets, or partners with strong balance sheets.”

Hill explains there are three things to consider when seeking financing:

1. Leverage – How much equity are you bringing to the deal?
2. Recourse – Will you be willing to sign personally for the loan?
3. Cost of capital – What kind of an interest rate are you seeking?

1). Banks and Credit Unions

“Generally speaking, banks and credit unions are relationship driven lenders,” says Hill. “When people call me for construction financing , often times I will tell them that they probably already know the lender.” Hill adds if the developer hasn’t built a project in that market yet, a likely suspect will be a local lender in that area who has a connection to the project or familiarity to the site and the market. “This largely also applies to credit unions, but I wouldn’t necessarily say they’re a big source of construction loans.”

Shrestha says one of the advantages of going through a bank is that you have more flexibility with fees and rates. “It has a lot of advantages, but you have to come to the table with more cash,” he says.

Bank loans can leverage 50-75 percent. Rates are competitive and at the time of this writing was around 3-5 percent.

As for recourse, Hill says every lender requires a “completions guarantee”, which ensures completion of the project. Most bank and credit union loans have some element of recourse, meaning the sponsor is personally signing for the loan. “You can get some banks to consider a non-recourse loan at low leverage, or a recourse burn-down,” says Hill.

Neal Gussis, co-founding principal of CCM Commercial Mortgage, explains that a recourse burndown is when personal responsibility is reduced at certain milestones in the project. “We’ve seen banking recourse burn offs with certificate of occupancy, for example,” says Gussis.

Small Business Association (SBA)

Shrestha says that until 2010, the Small Business Administration (SBA) shunned the self-storage industry. “When the SBA allowed self-storage development to finance through them it opened doors within the industry,” says Shrestha. “A lot of fumbling happened at first and the SBA got a bad rap within the industry, but that’s an old perception.”

Shrestha adds 2020 was a “phenomenal” year for SBA loans with the Paycheck Protection Program (PPP), which was extended through May 31, 2021.

There are two main types of SBA loans.

• SBA 7(a)
The SBA 7 (a) loan can provide 90 percent leverage. “It can include the cost of land as well,”

says Shrestha. He says one of the biggest deterrents for this type of a loan is that it is limited to $5 million for guarantor. “It is considered the best type of loan if the developer doesn’t have as much working capital,” he adds.

• SBA 504
The SBA 504 load is a Certified Development Company (CDC) loan program that conserves working capital as well. Shreftha describes it as a public-private partnership wherein the bank is in the first position and covers 50 percent of the loan, the CDC in the second position with 10- 15 percent and the SBA in the third position with 35-40 percent.

SBA loans are also recourse loans and other disadvantages include 2-2.5 percent SBA fees. However, Shrestha says these fees are considered closing costs and can be rolled into the loan. The interest rates are also typically a little higher on SBA loans. The other major disadvantage for some developers is the wait period. “These really aren’t easy to do, you have to get approved through the bank and the CDC non-profit and then through the SBA,” explains Shrestha.

Debt Fund

Gussis explains debt funds are for higher amount loans and can be non-recourse (keeping in mind that all loans are typically recourse until completion of construction). Hill adds, the trick is that while debt funds are mainly non-recourse, the sponsor is typically exchanging pricing for rectories and leverage. In other words, higher leverage non-recourse construction loans are available from debt funds, but at a higher cost of capital than banks, so the cost of the loan is higher, and the amount of working capital required is increased.”

Debt fund loans typically advance 70-75 percent loan to cost and the average cost of a debt fund loan as of this writing was within the 5-7 percent range.

What the Future May Hold

No one can predict the future, but there are some unsettling things happening around the world that could affect the cost of self-storage development and development overall. The first concern is one developers and loan officers have been dealing with for months: Rising cost of materials and shortages.

“Costs have gone up, but rents have also gone up, which has balanced the rising costs,” says Libert. “I know there are still a number of projects still sitting because the construction costs are too high to warrant the project.”

Libert adds that many lenders are making sure the cost of construction is locked in before they will pull the trigger. “General contractors aren’t holding prices long; I think some are doing it as little as thirty days. I think rental rates are still holding, but it’s problematic.”

Gussis adds that it’s the costs of supplies and rising gas prices to be more concerned about rather than interest rates. “I think the interest rates will move up, but not at the same rate as inflation,” he says.

The third major factor is the invasion of Ukraine, which also has caused gasoline prices to spike. However, that war could have even more of a major impact if NATO becomes fully involved, essentially sparking Word War III. “I think that if something catastrophic happens, it is not unreasonable to expect that the markets could freeze up entirely for some period of time,” says Hill.

Libert adds the markets wouldn’t be expected to freeze for long. “I think it would just be a time out until financial institutions can read what happens.”

No matter what happens, self-storage has proved to be a strong and resilient industry. “If something happens and there isn’t lending on self-storage, there probably won’t be lending in anything,” says Gussis.