Most types of investments won’t allow the use of high leverage using the securities themselves as collateral. This makes real estate investing somewhat unique in its use of financing. The use of leverage in real estate investments is a proven method to accelerate returns and create wealth. But one must be careful not to over-leverage. As we examine a few of the various types and sources of financing available for self storage facilities, I will also point out the dangers that can result from over-leverage and pitfalls of various financing structures.
There is a wide array of financing vehicles available from an assortment of institutions and intermediaries. What was once a short order menu in the financing arena is now a smorgasbord of products that can be mixed and matched to accommodate almost any project. There are trillions of dollars in real estate mortgages issued each year in the United States alone. It has been estimated by the US Congressional Budget Office that approximately 76% of the nation’s wealth is in some form of real estate ownership or securities backed by real estate. That dwarfs the investment in all other industry sectors combined.
In the past twenty five years, the financial industry has rolled out a myriad of mortgage products designed to make real estate ownership available to all segments of the population, and in recent years, it has repealed a few.
A common and often times preferred source for financing self storage facilities is some form of seller-held financing. There are many advantages to using seller financing to fund a portion or perhaps 100% of your investment. Typically this includes no points, no fees, no appraisal, no survey, and no need to educate the lender about the facility. In addition, I can negotiate directly with the seller (financier) to structure a loan that is attractive enough to convince them to hold some or all of the financing. The most common use of this technique, and one I try to utilize on each and every one of my deals, is to get the seller to hold back a second mortgage to fill the gap between the sales price and the first lien being provided by the lender.
Seller financing can be either short or long term, interest only or amortizing, with or without a balloon. In many cases, seller carry backs can be sold on the private market to create cash at closing to the seller if the structure and terms of the note are marketable with standard commercial terms.
Wealthy individuals, or what many in the industry call “Country Club Money”, are often used as sources of financing, but may be hard to come by. Low interest rates as of late have caused many wealthy individuals to consider lending money for real estate simply because the returns are much higher than CDs or bonds and the debt is secured by a tangible asset, the facility. The total loan amount will vary based upon the individual and his or her wherewithal. Typically, interest rates can range from 6% to 20% depending on the deal, current market rates, timeframe, risk, amount, etc.
There is no governmental or regulatory oversight of private lending so rates and terms are negotiable between the parties involved in the transaction. As with seller financing, the terms are generally more flexible than other lending sources and may not require extensive third party documentation and fees, and are relatively quick to close. Most private lenders prefer a short time frame to be paid back, typically one to three years, with the loan being amortized or interest-only with provisions for rate adjustments if interest rates begin to rise.
Mortgage Bankers are mentioned frequently throughout my home study system, “The Complete Guide to Finding, Evaluating, and Purchasing Self Storage Facilities”, as this is my preferred funding source. It is important though to remember that a mortgage banker is not synonymous with a mortgage broker. The simplest way to describe the difference is that a mortgage broker works with multiple banks, and the mortgage banker works solely for the bank in which they are employed. The benefit to a mortgage banker is that they typically possess years of experience and education required to represent a firm as a mortgage banker. In comparison, a mortgage broker can get started with no experience whatsoever.
The mortgage banker may have outside relationships with additional sources of funds such as life insurance companies, pension funds, and private investors, and may bring them in to participate on a loan to complete the deal, but this is the exception not the norm.
In practice, both the mortgage banker and the broker fill the same role to the borrower. They specialize in mortgages and only mortgages. The mortgage banker has a small advantage in being able to warehouse a loan, meaning they can close the loan by advancing the banks own funds, and wait for the security of the facility until a later date. This can make all the difference in funding a particular loan for your time sensitive deals. Once you have proven yourself to these banks, you will have access to some of the most flexible financing available anywhere.
There are literally Dozens of ways to structure the financing on your Self Storage Facility that we could discuss, but I’ll just cut to the quick and present the way I have structured nearly all my deals, which is a combination of the 3 ways I just presented. Lenders Love Self Storage, and given the system I have created to find the real sweet deals, my banks have no problem approving an 80% LTV Loan. I will then combine that with the aid of either a seller Carrying Back the remaining 20%, thereby making 2 payments to him, or by partnering with some of the “Country Club Money” we discussed earlier in this article.
However, I will caution: I do not recommend or approve of 100% financing, or the “no money down” deals that you have seen on TV or preached by other gurus! That being said, I have done several deals that have proven to be very successful projects which were purchased with no money down. The difference was that the deals were SO good, and the upside SO incredible, that I felt safe in leveraging them higher than my usual 80% threshold.
The investor that can put deals together by marrying a good loan with their community lender, structuring a 2nd loan from the seller, or from wealthy individuals can win in today’s turbulent credit markets. But remember, the deal must be bought well enough that the cash flow must support both loan payments and still provide a decent return to the investor. And trust me, they’re out there! I’ve made a fortune by following those simple guidelines, and you can too!