CMBS is BACK
The CMBS bond market is back. After slowly inching its way back to life in 2010, the capital markets now appear to be in full recovery mode, with more than 20 conduit lenders currently active in the market. Recent transactions even provide evidence that this capital is readily flowing to and having an impact on the self-storage lending market. Most notably Extra Space Storage Inc., the Salt Lake City-based real estate investment trust (REIT), recently received an $82 million first mortgage from Bank of America in January 2011. The capital was used to finance a portfolio of 16 of its facilities, the company’s first CMBS loan since February 2007, according to its CFO Kent Christensen. Through the first quarter of this year, CMBS issuance is at $8.7 billion.
As a quick review, Commercial Mortgage Backed Securities (CMBS) are bonds backed by commercial mortgages. A basic CMBS transaction structure starts with lenders who originate and aggregate pools of loans on commercial properties, and then sell the income stream from the mortgage payments to investors in the form of bonds. When the bonds are sold to the investor community, capital is returned to the lender, who is then able to redeploy that capital and make more loans. In this structure, capital flows efficiently between borrowers, lenders and investors; hence the name “conduit” is given to lenders using these financing approaches.
CMBS Annual U.S. Issuance, in Billions
Source: Commercial Mortgage Alert
As the financial markets hit bottom in 2008, liquidity almost entirely dried up and the CMBS market, for all intents and purposes, disappeared. As a result, self-storage operators, along with all other types of commercial real estate borrowers, were forced to use more traditional lenders like local and regional banks; the net effect of this was less capital available at more stringent terms, including: lower leverage; higher debt service coverage ratios (DSCR); more conservative underwriting; and personal recourse.
More specifically, consider that, during the glory days of 2007, CMBS lenders were originating non-recourse debt with a 10 year term and a 30 year amortization at 80% loan to value (LTV) and 1.20x DSCR. Often times the underwriting included credit given to income based on projected future rental increases. In contrast, by the time the market hit rock bottom in 2008/2009, there were no CMBS lenders active in the market, and, those lenders that were still originating loans on their balance sheets were doing so with extreme caution: 60% LTV, minimum 1.50x DSCR, with income underwritten to a strict trailing 12 month historical income and a look-back of two years or more to guarantee stability of the cash flow.
As a result, the self-storage lending market for many small and mid-sized operators ground to a halt, and even the largest operators faced a challenging task to secure debt on their maturing loans. Those in need of loans (whether for construction, refinancing or acquisitions) were left in precarious positions, with properties that were on average worth 20% to 30% less than they had been pre-crash. To make matters worse, loans sized to 60% LTV down from 80% LTV, forced borrowers to contribute a 20% larger stake in their facility, representing a challenging task for many operators. A significant portion of commercial real estate properties, storage and otherwise, fell into delinquency and borrowers were forced to agree to loan terms that some would consider egregious; the alternative was to lose their property.
The emergence of CMBS as a capital source for commercial mortgage lending brought liquidity to commercial real estate that did not exist prior to 1990. As it re-emerges in 2011 and beyond, it should be welcomed with open arms by the banks, insurance companies and other market participants to help balance borrowers’ access to capital. Now, fully three years later, signs of life abound and there is plenty of reason to be optimistic.
Steps Forward
With CMBS origination for 2011 estimated at $40 to $50 billion, up from $12.3 billion in 2010, it’s safe to say that the CMBS market is back. At the Mortgage Bankers Association’s annual conference in February, 27 lending institutions identified themselves as CMBS loan originators, a figure similar to the glory days of 2007. With a larger supply of capital, CMBS lenders are actively seeking quality self-storage deals for the first time in almost three years. Generally speaking these lenders are sizing loans at up to 70% LTV and 1.45x DSCR with rates at 175-250 over the 10 year swap rate. At current swap rates (at the time of this writing) this represents a bottom line interest rate in the 5.50% to 6.25% range. However, CMBS lenders are currently only considering a small subset of the population of self-storage facilities. Today’s active CMBS programs have loan size and other restrictions that do not heavily favor self-storage economics. For example, the $10 to $15 million minimum transaction size presents a major obstacle for many storage property owners and investors, essentially limiting storage potential to portfolios of assets located in larger markets and controlled by institutional quality sponsors
Outlook for $3 to $5 Million Loan Range
There is considerable hope for smaller facilities located outside urban cores. There are several lenders starting to consider loans in the $3 to $5 million range in tertiary markets. As the available capital continues to grow, simple supply and demand dictates that more and more lenders will begin competing for these modestly sized loans.
Additionally, the liquidity that CMBS offers the market will take pressure off the system down the line, freeing up capital at the regional and local bank level. With CMBS lenders providing a much-needed outlet for larger financing transactions, local and regional banks will once again be able to concentrate on a greater number of borrowers, such as storage property owners, with smaller loan needs.
Through the first quarter of 2011, CMBS issuance was $8.7 billion, on track to hit the projected issuance of $40 to $50 billion. As expected, these transactions have smaller dollar sizes and loan counts, with higher DSCRs and lower LTVs. And though 2011projections are just a fraction of the peak levels that preceded the financial crisis, it does indicate positive movement, and the recent CMBS activity represents a significant share of overall lending in today's more cautious environment.
The Role of Self-Storage in the CMBS Market
The proliferation of commercial mortgage-backed securities prior to 2008 made it a desirable financing option. With five- to 10-year loan terms, low interest rates and high loan-to-value financing of 75 percent to 80 percent without a requirement for personal guarantees, it quickly became the #1 option for self-storage operators.
Self-storage has outperformed all other property types in terms of CMBS loan delinquency rates throughout the recession, a fact that will surely resonate with lenders and investors as financing markets improve during the next few years. Additionally, conduits will be attracted by the self-storage asset class, as a more diversified set of properties in the issuance pool is appealing to bond investors looking to minimize asset class risk. It is expected that CMBS underwriting for any new deals will be more conservative than it has been historically. When compared to terms that self-storage operators receive from regional and local banks however, CMBS is often times the better option, if available. Though the process to finalize a CMBS loan includes arduous loan documentation reviews, severe early pre-payment penalties and possible loan size requirements, the positives: lower rates, more amenable terms and non-recourse mortgages; far outweigh the negatives.
For self-storage operators seeking financing, these factors point to a healthier outlook for 2011 and beyond.
Portions of the above article were reprinted with permission from Inside Self-Storage, the premier magazine of self-storage professionals. For information, visit www.insideselfstorage.com.
