Preparing Your Self Storage Property for a Refinance
Image by bryanpearson via Flickr
Written by: Joseph Cacciapaglia
What Self Storage Lenders Like to See
Self storage owners often ask me what, if anything, they should do to prepare their property for a refinance. I usually get this question 2-3 months before the owner is interested in refinancing, but unfortunately most of my suggestions work best when implemented 12-18 months prior to the refinance. Most lenders today are looking at a trailing 12 month financial statement when underwriting new loans, so changes made just prior to the refinance have less impact than those made earlier.
The borrower’s goal should be to maximize the property’s NOI for the 12 month period prior to the refinance. At first glance you would think that this is always the borrower’s goal, but often borrowers have reasons to minimize their NOI for tax or other reasons. Alternatively, borrowers might siphon off some of their profit from the property through artificially high wages or other profit centers related to their global business. While this may make sense in certain circumstances, it always creates problems when attempting a refinance.
Maximizing Your Self Storage Facility’s NOI
Over several years of looking at self storage financials, I’ve seen many ways where borrowers have hurt their ability to refinance because they hadn’t maximized their NOI. Here are a few common examples, and some ways to avoid them:
Inflated Wages - It is very common for borrowers with large portfolios to pay corporate level wages out of their better performing properties, rather than dispersing profits to the corporate entity and paying wages at that level. Often this practice started when the borrower had just one or two properties, but ended up continuing because nobody realized it was a problem. When a lender looks at the P&L’s for the property, it appears that there is a very large payroll burden, and the property is not operating well. Backing the inflated payroll out of the property level financials becomes a point of contention with many lenders, and can potentially reduce the proceeds that the borrower is able to receive.
Charitable Unit Rentals - Many borrowers have ‘donated’ units to local non-profits. This is admirable, but not the best way to go about doing business. When looking at the rent roll, these units are usually either listed at $0 rent or as down or vacant. This hurts the property’s occupancy and NOI. One suggestion that I received recently to deal with this problem, is to have the borrower rent the unit to the non-profit at the fair market rental rate, and then have the borrower pay the rent as a donation each month. The net effect on the borrower’s cash flow is zero, but the NOI at the property level remains intact.
Inflated Maintenance/Management Expenses - Many borrowers have a complex web of entities related to their self storage portfolio. Often these entities include both a maintenance and management company which have their own separate staff and overhead. I’ve often see borrowers carry these additional entities with their better properties, while many of the expenses should have been allocated elsewhere. This is another situation where it is difficult for a lender to back out some of the expenses to see the true NOI of the property.
Poor Collection Practices - Some borrowers find the process of collections and evictions distasteful, and therefore, will put off these activities until absolutely necessary. I’ve spoken with some borrowers who only have one auction a year, even though a large percent of their units go unpaid each month. Many borrowers believe that this isn’t hurting them unless their occupancy is very high. They rationalize that if they evicted these tenants, the unit would just be vacant anyway. However, this practice creates artificially high collection losses at certain points in time, and also creates large swings in occupancy levels as well. Many lenders will perform a trend analysis, so these swings make a facility look much weaker than it may actually be. Staying on top of collections and evictions will eliminate this issue. Not to mention that it’s just good business.
Not Capitalizing Expenses - Often borrowers will complete large capital projects that should be depreciated over time, but are included in their R&M expense line item. Lenders don’t want to guess which expenses were capital items and which were really for repairs and maintenance. It is very difficult for a lender to back out capital expenditures if the borrower has included them above the line in their P&L’s. It’s important for borrowers to properly classify these expenses in their general course of business.
Not Recognizing Prepaid Expenses - This is slightly less common than the issue of capital expenditures, but it is very similar. Occasionally borrowers will prepay their insurance, lease, or marketing expenses to receive a discount. Often these prepaid expenses are reported in a single period instead of being allocated over the periods in which they are used. This increases expenses in some years, and reduces it in others. Borrowers should report these expenses when the benefit is received, not necessarily when they made their payments.
Reporting all of your income and property tracking expenses over time is extremely important when preparing your facility for a refinance. If you are thinking about refinancing your self storage facility, and would like other suggestions regarding your P&L’s, please drop a comment.
Please keep in mind that I’m not a CPA or tax attorney. I’m not telling you how you should report and pay your taxes.