Examining the Self Storage Financing Landscape With Talonvest Capital

Co-founder Tom Sherlock on the current financing landscape and what makes the self storage sector appealing.

Tom Sherlock, co-founder, Talonvest Capital. Image courtesy of Talonvest Capital

While COVID-19 challenged many commercial real estate sectors, self storage is still riding tailwinds. Benefiting from pent-up demand, rental rates have substantially improved throughout 2020. As we further move into 2021, the sector continues to see strong growth across the country, offering attractive investment opportunities for industry players.

Tom Sherlock, co-founder of Talonvest Capital, discussed with Multi-Housing News what makes self storage an appealing investment option and what are some of the viable financing options for borrowers. Sherlock also talked about the company’s recent expansion into the East Coast and revealed his top three predictions for the future of self storage.

READ ALSO: Will Self Storage Prosper After COVID-19?

Talonvest Capital has recently opened an office on the East Coast. What are the main factors that fueled your decision to establish an East Coast presence?

Sherlock: Talonvest has been successfully structuring capital solutions for commercial and storage owners throughout the U.S. for many years. Establishing an office in the East and hiring John Chase, a seasoned capital markets expert, to lead our efforts there, means Talonvest can more effectively service existing clients, develop new business opportunities, and build deeper relationships. John was born and raised in the Washington, D.C., area and has spent a large portion of his career operating in the East coast region, that type of on-the-ground knowledge is invaluable when we represent our clients.

Thanks to its recession-resistant nature, self storage has become an attractive investment option. Where do you see the most investment activity across the country?

Sherlock: The recession-resistant nature of the product is part of the attractiveness to institutional capital. However, it’s more than that. Capital has a voracious appetite for attractive risk-adjusted returns and the storage sector has been a consistent leader in both returns generated while having some of the lowest default rates of the various property types. As a result, the activity level across the U.S., especially where there is strong population growth, is very robust.

What type of self storage assets are popular with investors?

Image by Nattanan Kanchanaprat via Pixabay

Sherlock: Not surprisingly, state-of-the-art facilities with high visibility and easy access in undersupplied markets are in high demand. While institutional capital is generally more interested in urban markets, there are large private owner-operators doing very well in secondary and tertiary markets too. Because it is so hard to find existing storage products, development activity has increased again.

You have been involved in commercial real estate financing for four decades, so you lived through many crises and downturns before. How does the current crisis differ from the previous downturns from a financing standpoint?

Sherlock: The big downturns during my career—the RTC crisis, the dot-com bust, and the Great Recession were all liquidity crunches. Capital just was not available, and the markets suffered greatly. The current pandemic, while catastrophic in many ways, was generally not a liquidity problem for the commercial real estate business. Certain sectors, like hotels and retail, certainly suffered; however, capital has remained readily available and continues to flow freely into asset classes like industrial, storage, multifamily, and life sciences.

What are the biggest challenges in the self storage financing landscape today?

Sherlock: Compressing development yields coupled with longer periods of time to reach economic stabilization are creating more risk. For borrowers, another potential concern is that, as cap rates compress and rents/occupancy levels rapidly improve, appraiser valuations may be lagging the market, which could affect construction and bridge loan proceeds.

How have the needs of self storage borrowers changed in the past year?

Sherlock: Over the past year there have been quite a few changes. One is the increased demand for construction financing, especially in the southeast and west.

For more risk-averse owners, we have seen an increased demand for non-recourse bridge financing or permanent loans before achieving full operating stabilization to achieve an early take-out of existing debt.

Lastly, some borrowers are starting to prefer the business plan flexibility inherent in floating-rate loans, even on a stabilized property, pre-payment penalties can be eliminated or reduced so it is easier to monetize future valuation gains through earnouts, refinance, or sale.

What are some of the viable finance options for self storage borrowers?

Sherlock: Pre-stabilization perm loans underwritten at debt yields as low as 6.25 percent are a great way for borrowers to lock in today’s low fixed rates and avoid the risk associated with waiting 12-18 months for a more stabilized NOI.

Non-recourse, C of O acquisition loans are also readily available today at lower rates than before. The cost of that capital is in the low 4 percent range now, down almost 100 basis points since 2020. Banks, life companies, debt funds, CMBS lenders, and credit unions are all very active in the storage sector, so it is a good time to be a construction, bridge, or perm loan borrower.

What are your top three predictions regarding the future of self storage investment?

Sherlock: Firstly, construction activity will continue to increase until labor and material costs outpace expected rental growth.

Secondly, consolidation in the storage sector will continue, as public REITs use their lower cost of capital to acquire portfolios, especially in the urban markets; nonetheless, it will still be a fragmented market.

Finally, self storage will continue to be one of the best cash-flowing assets to own for the long term

You May Also Like