Understanding the Use of Bridge Loans in Self-Storage Financing

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Nov 12, 2022 - 23:59

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Understanding the Use of Bridge Loans in Self-Storage Financing

In today’s self-storage climate, fast-paced financing is often desired for property expansions and improvements, building conversions, or management overhauls. In many cases, traditional approaches to bank or permanent debt financing aren’t a good fit. This is usually because those lenders aren’t able to underwrite to the rental rates anticipated upon project completion, or they don’t want to take the risk during the current economic environment.

This is where bridge lending and other forms of financing can step in and save the day. Let’s explore some of these options to see how they may help you complete a vital project designed to achieve higher self-storage income.

An Overview of Bridge Loans

Many bridge loans can be nonrecourse, which means there’s no personal liability if the loan goes into default. However, as a result, property metrics along with the borrower’s experience and financial strength are key considerations for lenders. Accordingly, the higher risk associated with these types of loans is accompanied by higher interest rates and fees.

While most bridge loans require returns to the lender in the high single digits to mid double digits, the cost is often worth the price to get your project up and running. With higher risk comes a higher rate, so a loan needing 80% loan-to-cost (LTC) will command a higher return than a 50% LTC request. For self-storage operators with good track records, multiple properties and strong financials, better-priced capital can be achieved in the mid to high single-digit rates.

Real-life scenarios in which bridge loans have been applied include acquisitions of self-storage facilities with low rental rates due to mismanagement or older properties that need updating. Bridge financing can provide funds to acquire the building and upgrades (security, unit doors, roofs, gates, etc.) typically up to 80% of the total cost of the purchase, plus improvements, as long as the end-loan-to-pro-forma stabilized value is no higher than 75%.

Another common example is when you purchase a retail space or existing structure with the intent to repurpose it for either portable-container storage or traditional self-storage. Interior vehicle storage is also a popular use for large vacant spaces. Whether you’re buying the property or already own it and looking to improve it, bridge loans can typically cover up to 80% of the total cost of purchase and upgrades.

A particularly favorable feature of bridge loans is many programs can close in 30 days or less. Depending on the overall deal metrics, some don’t even require appraisals. Let’s say you’re looking to close on a self-storage purchase and have regular financing lined up, but the seller requires all cash or a quick close. A bridge loan can potentially solve this issue since the lender knows the exit strategy is already in place.

Of course, nothing comes without a price. In a scenario like this, the lender might want either a higher loan fee and/or a minimum guaranteed interest if they’re going to be paid off very quickly. It’s unusual for a lender to require a minimum of three to six months guaranteed interest to go along with their loan fee if the loan won’t be on the books very long. However, if closing is needed in time to meet a 1031-exchange or escrow-closing deadline, a bridge loan can be the perfect vehicle and a life-saver.

Loan Requirements

For lenders to make decisions on bridge-loan requests, self-storage borrowers need to provide a detailed improvement or cost breakdown of their project. This includes the price of the land along with hard, soft and financing costs. Specifics consist of the interest reserve needed and a pro forma profit-and-loss document showing the timeline, as well as the future income and expenses anticipated after the work is complete.

Though an appraisal is generally required, it’s always a good idea to provide valuation and rent comparables up front to support the pro forma. A feasibility study will accomplish the same goal. In addition to reviewing the property information, the lender will want to do a deep dive into your credit history. A financial statement reflecting your entity and personal net worth and liquidity also will be required. Your self-storage experience will be another important consideration.

The decision to lend based on a pro forma comes down to exit strategy. For example, what happens if there are construction delays or the economy falters? Once the self-storage project is complete, will the bridge loan be refinanced with a bank, Small Business Administration (SBA) lender, commercial mortgage-backed securities (CMBS) provider, life-insurance company or another type of lender? Perhaps the plan is to sell the property for a handsome profit. Maybe you’ve pre-sold the asset to a real estate investment trust (REIT). How the loan will get taken out is always a prime factor.

Most bridge-loan terms range from 12 to 36 months, with a typical program being 12 to 18 months, with six-month extensions available for an extra fee. Bridge programs can be provided by banks, debt funds, life companies, some Wall Street firms and private lenders. They may also be available from funds offered by some of the large self-storage operators, if you’re willing to have your property managed by them.

Fees generally run from .5% to 2%. A typical scenario is a 1% fee when the loan closes and another 1% at exit, but this can vary widely. Minimum loan amounts also vary, with smaller programs starting at $500,000, and larger programs wanting a minimum of $10 million to $20 million or more.

Program details vary among the dozens available. Since every self-storage deal is unique, it’s difficult to quote rates and terms without knowing the details of a specific transaction.