Are you ready for a refinance?
Those seeking a refinance could take a lesson from the Boy Scouts of America. Their motto is “Be Prepared” and they take it very seriously. This motto also holds true today for those self-storage owners looking to refinance a loan in the capital markets. The same types of loans today exist for borrower as they did a few years ago; however, the underwriting standards have changed. With these changes come new challenges for borrowers.
In today’s market, borrowers face decreased property values, reduced loan proceeds, along with lenders that are now incredibly selective regarding what properties they want to extend a loan. The borrower can feel boxed in on every side and often feel like there is nothing they can do to resolve these issues. But there are ways to position a transaction to make it as simple as possible for a lender to approve a refinance.
Obtain a Fresh Perspective
The first thing to do is start as early as possible to evaluate where the property stands. With the commercial real estate market still in flux, it is recommended that one year before the loan is due to contact a mortgage broker, banker or commercial real estate broker for an opinion of the value of the property. Any of these individuals can underwrite the property to find out what the true Net Operating Income (NOI) the property is producing on a trailing 12 months (last 12 months) of income and expense. This is the current industry standard that almost every lender will look at to see how the property is performing.
With an NOI established and a capitalization rate (cap rate) known, there is now a realistic expectation of what the property is worth. The owner of the property has to understand that the market has changed dramatically during the fiscal crisis that began two years ago and continues today. This updated NOI and cap rate establish the true value of the property today, not what was paid for the property several years ago.
Of course, the cap rate in a sale of a property will most likely be more aggressive than the cap rate an appraiser gives for a refinance of a property. If you take a look at the numbers a year before the refinance is due, this will give the borrower time to make adjustments if necessary.
Influencing Factors: Where Does the Money Go?
What adjustments can a borrower make? Let’s start with property taxes. Unfortunately, most properties have a diminished value from the last time their taxes were assessed. Many owners have not gone back to their local counties to get their property taxes lowered. When was the last time that a competitive bid on the insurance for the property was made? Just because the insurance premiums and coverage were appropriate last year, there is no guarantee that the coverage is correct today. Perhaps the insurance environment had become competitive due to the economic crisis. It is important to ensure that all money being spent on the property is being spent wisely.
Is there a full-page ad in the Yellow Pages? Would a ½ page ad suffice? Is an ad in the Yellow Pages even necessary in today’s increasingly online world? In most markets, spending money on internet advertising opportunities makes more sense.
Are repairs scheduled for the near future? Can these repairs wait until after the refinance without diminishing the property’s value? Are there any one-time purchases for the facility that can wait until the refinance is complete?
There’s a great reason to wait, if possible. Lender’s do not want to take one-time expenses out of the trailing 12 month of expenses. In fact, the lender may not want to take them out of the expense side of the underwriting, thus your NOI will be less, which will equal less loan proceeds. In the current lending environment, the lack of loan proceeds is a major issue for many borrowers today.
Many storage owner/operators typically pay themselves more than the average self storage manager. The higher the salary expense is on the P&L statement the lower the NOI number. A preferred accounting practice would be exclude an owner’s salary from the manager’s salary on the P&L statement. Having a separate line item makes it easier for a lender to say the owners are taking a distribution of the profits, thus not counting it on the expenses. Since most lenders will include a 5% to 6% management fee expense in the underwriting, an owner/operator could also code owner’s pay to the management fee if there is no 3rd party management company.
Timeframe and Document Gathering
Commercial loans today can take anywhere from 60 to 120 days for a conventional lender or up to 4 to 5 months for an SBA loan. This time period starts after a lender has completely underwritten the loan request. Based on how many owners/partners there are with more than 20% of the property, the lender will require collecting information on all the borrowers in the case of a recourse loan. If the property qualifies for a non-recourse loan, then the lender will focus more heavily on the property’s numbers and secondarily on the borrowers. In both cases, year to date P&L’s along with the prior two years P&L’s, current rent roll and occupancy/management summary reports must be available. A current personal financial statement is also required by most lenders since they are concerned that the borrower has other backup income or net worth to support the property in the event something happens to the property’s income stream.
Ducks in a Row
In the months prior to submitting financials to a lender or mortgage broker, getting every penny in the door is crucial to the NOI number. Past due accounts can help boost that number. Have the property manager embark upon a collection campaign to try to bring in every last dollar. This could mean the difference in having a $34,000 month versus a $30,000 month. That is $4,000 additional NOI. If the NOI increased from $300,000 to $304,000, with an 8 cap rate on the property/70% Loan to value that would equal $35,000 of additional loan proceeds.
By starting early and creating a seamless loan package of financial documents and pertinent information required, a lender will recognize a borrower that is serious about the business. These little efforts could be the difference between obtaining a refinance or not.
