Inside Self-Storage

OCT 2018

Inside Self-Storage (ISS) is an information source for industry owners, managers, developers and investors covering news, trends, facility operation, finance, real estate, construction, development, marketing, technology, insurance and legality.

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T he Small Business Administration 7(a) and 504 loan programs have proven to be reliable, g o-t o funding sources for sel f-s torage owners and developers looking to build, buy or refinance. Hundreds of millions of dollars have flowed to storage operators since the Great Recession and during the extended market expansion that followed. Earlier this year, however, the SBA updated its standard operating procedure (SOP) to include new restrictions for businesses that use thir d-p arty management companies. This change has proven to be an obstacle for some seeking SBA financing. Thankfully, there are alternatives. Factors like ongoing capitalizatio n-r ate compression, a growing population, and changing cultural and societal trends—not to mention an abundance of construction, acquisition, rehab and refinance capital—means an institutional or private owner looking to purchase or refinance stabilized or i n-t ransition properties can take advantage of short and lon g-t erm no n-r ecourse financing through the commercial mortgag e-b acked securities (CMBS) market and other alternative sources. Let's look at when SBA funding still works and a suitable option to consider when it doesn't. SBA Programs First, let's do a quick review of SBA loan programs. Under 7(a), a bank typically makes a loan of up to $5 million, and the SBA provides the institution with a 75 percent guaranty. In some instances, lenders have made larger loans using a "pari passu" structure in which the mortgage is shared between a $5 million 7(a) loan and a conventional loan. Banks can also reduce their guaranty percentage to allow for a larger loan, but this is unusual. Typically, because a portion of their risk is mitigated, banks are willing to structure and price SBA loans more aggressively than they would conventional loans. This equates to higher leverage and longer terms for borrowers. Under the most common structure, a bank will lend up to 85 percent of the value of the property. In this case, funds can be used to purchase land, for hard and soft construction costs, FF&E (movable furniture, fixtures or other equipment), construction/pos t-c onstruction interest reserves, and leas e-u p working capital to fund operating expenses until stabilization is reached. Under a 504 loan, rather than all the money coming from the bank, borrowers receive up to 40 percent of their capital stack through a "debenture," which is effectively a bond sale backed by the U.S. Treasury. This debenture is paired with a bank loan to cover 50 percent (or more) of the project. Together, the loans accommodate up to 90 percent financing. While the SBA's piece is typically capped at $5 million (some renewabl e-e nergy installations can qualify for up to $5.5 million), the bank piece has no limit. This makes 504 loans a viable option for large projects, such as the one detailed in the following table. In contrast to the 7(a) program in which banks typically structure their loans with a floating rate pegged to Prime, the SBA debenture on a 504 is always a 2 0-y ear fixed rate, and banks usually fix their loan for at least five years. The end product is lon g-t erm, fixe d-r ate financing at attractive rates. However, while pos t-c onstruction interest reserve and working capital are eligible to be financed within 7(a), these are classified as an "ineligible" use of funds under the 504. As a result, owners must ensure they have adequate pos t-i njection liquidity to fund debt service and operating expenses until the property achieves stabilization. Another subtle but important distinction is 504 loans undergo far more scrutiny than 7(a) during underwriting. This is because all 504 loans pass through a Californi a-b ased centralized processor known as the Sacramento Loan Processing Center, which can be notoriously stringent and unpredictable during application review. In contrast, the 7(a) program is largely dominated by banks that are designated as preferred lenders, giving them delegated authority to underwrite, approve and fund applications without going through a processing center. MONEY MATTERS Important Changes to SBA LOAN REQUIREMENTS By Mac Dobson Use of Funds Land purchase $2M Construction costs $12M Soft costs $1M Total $15M Source of Funds Bank loan $7.75M SBA debenture $5M Borrower equity $2.25M Total $15M 52 ISS I October 2018 www.insideselfstorage.com

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