One
of the long time Argus Broker Affiliates and facility owner, C. William
Barnhill, CCIM, Ph.D., has done some interesting research on some loans he
was re-financing for his own account.
Bill’s awareness and understanding of the financing markets from an
owners and brokers standpoint is valuable to all Argus clients. Bill, thank you for your diligence and for
sharing this valuable information with our readers.
The
following is a brief interview, conducted by Bill Barnhill, with John Mazyck
of Merchant Capital and Paul Oberkirch of Union Planters Bank to
discuss some alternative financing solutions.
One such alternative is Variable Rate Demand Taxable Note financing
(VRDN’s).
Barnhill: John, would you tell us what a “VRDN” is and how it
makes an effective alternative for some self-storage financing situations?
Mazyck: When financing or refinancing a self-storage facility a
borrower has the choice of taking out a traditional commercial loan or
issuing taxable Variable Rate Demand Notes (VRDN’s). In a traditional commercial loan
transaction, a bank lends its deposits to the borrower at a spread above LIBOR
or Prime. In a VRDN issue, the bank
issues its letter of credit for a fee to support the borrower’s corporate debt
offering. The VRDN’s will bear interest
at LIBOR equivalent rates and may be pre-paid in part or whole with no penalty
at any time. While the interest rate on
the VRDN’s approximates LIBOR, the effective rate of borrowing is LIBOR plus
the cost of the letter of credit (1%) and other annual fees totaling
approximately 20 basis points. In
today’s interest rate environment, the effective rate calculation of VRDN
financing is: LIBOR (1.8%) + annual costs (1.20%) = 3.00%. LIBOR rates are floating rates.
To access the VRDN market, a borrower (or Project)
must obtain credit support in the form of an investment grade letter of
credit. While the most likely
candidate for this letter of credit may be your existing bank, there are a
number of banks across the country (including Merchant Capital) that are
especially interested in the self-storage industry. A cap on the rate can be purchased if one is concerned about
rates going higher.
Barnhill: Another less complicated but equally attractive type
loan is the variable rate bank loan with a maximum or ceiling interest
rate. The initial interest rate is
typically somewhat higher than with
“VRDN’s” and often carries the advantage of a reasonable ceiling rate.
Paul, tell us about some of
the typical self-storage deals you are doing and the advantages of these types
of loans.
Oberkirch: As most investors are aware, the dramatic decrease in
interest rates over the last year and a half has prompted a lot of new
commercial loan activity and refinance activity for banks. During this time period of interest rate
volatility, there has been a sizeable difference in the pricing of short-term
interest rates and longer-term interest rates from financial institutions. The shorter -term interest rates such as the
Prime rate of banks, the Treasury Bill or the London Interbank Offering Rate
(LIBOR) have been very attractive to investors, while longer term rates in the five-year
maturity time frame have remained relatively high due to investors concerns
over inflation and the expectations of future increases in interest rates.
To take advantage of these refinancing
opportunities, some banks have been pricing longer-term real estate loans based
on short-term interest rates, with a ceiling.
For example, an investor with a self-storage project could be able to
get a twenty-year amortization with a five-year balloon at a floating rate of
LIBOR plus an interest rate spread, usually with a ceiling. The required spread over the pricing index
depends on the amount of risk to the Bank, but has typically been about 250-300
basis points( 2.5% -3.0%) over the thirty day LIBOR rate, which would have an
effective rate of about 4.30% - 4.80% in today’s market. In this scenario, the loan and the payment
amount could change each month with the fluctuation of interest rates. The typical interest rate ceiling for this
type of product, depending on the bank, has been anywhere from 7.5% to 8.00%.
The Borrower is able to take advantage of the extremely low short-term rates, which provide lower payments, and help provide better cash flow coverage for relatively new projects. The Bank is able to provide floating rate pricing, which will be important to the Bank’s return on assets as interest rates start to rise. As an added benefit to the customer, the Bank is providing a maximum interest rate ceiling, which gives the customer confidence about his/her interest rate risk in the project.
Barnhill: Both of the above financing solutions provide
substantial interest savings. With
interest rates at a 40-year low, it makes economic sense to take advantage of
this exceptional opportunity to refinance.
The following chart illustrates the interest cost
savings obtained by refinancing with a 5-year maturity, 20-year amortization
loan at 7.5%.
|
|
OLD LOAN |
TRADITIONAL BANK LOAN |
*VRDN |
|
Loan Amount |
$3,500,000.00 |
$3,500,000.00 |
$3,500,000.00 |
|
Interest Rate |
7.5% |
4.3% (Ceiling of 7.75%) |
3.0 |
|
Amortization Period/Term |
20/5 |
20/5 |
20/5 |
|
Monthly Principal & Interest Payment |
$28,196.00 |
$21,767.00 |
$19,411.00 |
|
Monthly Savings |
|
$6,429.00 |
$8,785.00 |
|
Annual Savings |
|
$77,145.00 |
$105,421.00 |
*With no ceiling rate
The current annualized interest savings of $77,145.00 to $105,420 can be applied to principal or used as spendable income. Obviously, the longer rates remain low the greater the cost savings. The ceiling rate of 7.75% assures that the monthly payment would never exceed $28,733.00 during the term of the loan.