ccording to Trepp, a leading provider of data and insights to the commercial real estate market, around $2.81 trillion of commercial real estate debt is coming due by 2028. This debt is scheduled to be repaid or refinanced in four years, meaning that companies in the real estate market will need to make payments or find alternative financing arrangements within this time frame.
The upcoming $2.81 trillion in commercial debt will impact the self-storage sector’s financial landscape, too. To understand the best practices for self-storage companies, Modern Storage Media spoke with industry professionals to gather their insights.
According to Gussis, most commercial loans have maturities that are from five to 10 years from the time of origination, so the debt coming due by 2028 is expected. “Waves of maturities are somewhat predicated on the ups and downs of past origination volume based on interest rates and availability of capital,” he adds.
The principal and founding member of The BSC Group, LLC, Shawn R. Hill, also shared his opinion on the self-storage industry’s financial landscape with the upcoming debt and said that there’s no reason to panic. “Despite current headwinds that are affecting rates and occupancy, self-storage remains a favored property type amongst the lending community due to its strong historical performance and recession–resistant characteristics,” he says. “As a result, I think there will continue to be ample liquidity for the asset class in both the debt and equity markets.”
Gussis agrees. “Self-storage, like all commercial real estate sectors, is exposed to adverse market conditions, however, historically, self-storage has proven to be more resilient than almost all other commercial real estate,” he says.
However, there are some challenges in the financial sector of the self-storage industry, according to Gussis. “As we all know, the self-storage sector had a phenomenal performance during the pandemic years. Now, post-pandemic, owners are competitively battling over new customers by discounting new customer rates.” In his opinion, self-storage owners need to compete for available capital from capital sources.
“The self-storage sector is still appealing to capital sources due to the many unique positive attributes of self-storage, however, the current industry trends are leading to underwriting challenges and relative appeal,” says Gussis. “Banks and other capital sources may choose to be much more selective about which property and which sponsors they want to pursue.”
In Hill’s opinion, there are many opportunities in the market, as well as plenty of liquidity, to refinance maturing loans or permanent debt products.
R. Christian Sonne, the executive vice president of Newmark Valuation & Advisory, and national practice co-leader for the Valuation & Advisory’s self-storage specialty practice, also believes that there are opportunities to refinance loans. “Pretend and extend is the strategy now. Banks are having higher regulatory scrutiny now and terms and rates are challenging, so many are extending existing loans expecting lower rates in the fourth quarter of 2024,” Sonne says.
Gussis believes that there are many factors to consider on whether an owner of a self-storage company should refinance their loans. “In terms of the factors that are most relevant to refinance current debt, owners must consider the current interest rate environment, availability of capital, the prepayment provisions of the current loan, and the operating performance of the property,” he says, adding that “extending a loan needs to be negotiated and is usually done when circumstances are that the current loan can’t be paid in full at maturity.”
The negotiations can be based on several factors, including the owner being able to reduce the credit risk of the lender. “The significant rise in interest rates has caused debt payments to rise. Loans are based on a debt service coverage of having operating income be at some level higher than the debt payments,” Gussis adds.
According to Gussis, lenders would like to see a debt-service coverage ratio (DSCR) of 1.20 or higher. “If an owner has not experienced enough operating income growth since the last loan was originated, a new loan may not be enough to pay off the existing debt,” he explains.
Keeping that in mind, sometimes extending a loan might not be the best idea. “Owners must consider their tolerance to maintain ownership and management versus asking whether it’s the right time for them to sell,” Gussis says.
Hill states that it’s also important to consider interest rates because some loans may need additional capital to be contributed to meet the underwriting criteria of the lenders. “In some situations, the ownership may elect to sell the asset rather than contribute additional equity capital to rebalance the capital stack.”
Lenders usually rely on historical performance to project the cash flow going forward, as well as the size of the loan. Because of that, “Borrowers should be aware and be prepared to optimize the cash flow performance of their assets by maximizing revenue and minimizing unnecessary expenses before a maturing debt event,” Hill advises.
In his opinion, the challenges an owner may face also depend on how long they have owned the property and when the property was built. Properties purchased since 2020, for example, “may have been purchased with assuming projected operating income to aggressively which were online with the non-sustainable operating increases being achieved when the property was purchased.”
“Developers with projects opening in the past couple of years could have never projected the current interest rates or increased cost of material and labor, or the current street rents. Thus, there must be owners who will face challenges when they need to refinance their current debt,” Gussis explains.
In difficult situations, he believes that it’s important that self-storage company owners and leaders maintain great banking relationships, which can be a lot of help, especially when the company is going through financial challenges. “If you know that your loan is going to face loan covenant issues or challenges at payoff, be ready to start a dialogue with your lender and start discussing potential mitigants and solutions,” says Gussis.
Hill advises to be mindful of the fact that the market is dynamic and constantly evolving. “There are many different types of loans and lenders out there, so it pays to work with a professional that can help optimize the debt package for the deal depending on the unique circumstances of the transaction as it pertains to the property and ownership dynamics.”
When banks aren’t able to support loaners with refinancing, lending, or extending loans, Hill reminds borrowers that there are other options. “Banks are constantly under pressure from federal regulatory changes, which can definitely impact their willingness to lend. Banks are a major source of liquidity to the market, but thankfully there are many other types of capital providers and loan programs that also provide significant liquidity to the market without the same regulatory scrutiny.”
In summary, it’s important to analyze each case to decide, however, there are many possibilities for self-storage companies to refinance or extend their existing loans expected to mature by 2028.