Industry Expectations

Interest Rate Projections From The Pros

According to the 2016 Self-Storage Almanac, outstanding commercial mortgage debt increased from $2.56 billion to $2.72 billion between the second quarter of 2014 and the second quarter of 2015. Delinquencies on commercial and multifamily loans decreased during the same timeframe, and some experts are speculating a continued trend throughout 2016. It would mirror anticipated mortgage rates, leaving many vested parties wondering how closely integrated the industry’s interest rates and investment opportunities are.

Owners and borrowers capitalized on 2015’s market, and it was admired for its lower rates, reliable REIT investments, and prime opportunities to restructure debt. Naturally, 2016 arrives with heavy feet.

It is important to remember trending assessments are calculated anticipations of what the industry has seen and where it is expected to go: the experts Mini-Storage Messenger consulted wanted to be abundantly clear that no one can claim to know what is going to happen in the market.

These “calculated anticipations” can, however, be an excellent guide for people in the industry. Here are some expert summaries of the difference between last year’s rates and this year’s projections. Neal Gussis, Steve Libert, Noel Cain, and Curt Fleming help illustrate how much impact the projected increase in interest rates will have on our industry.

Apples To Apples
“2015 was basically the perfect storm,” says Neal Gussis of CCM Commercial Mortgage, LLC, who discusses his viewpoints on upcoming market projections by first offering his 2015 observations. “The storage industry and the treasuries had low rates. The spread on the rates were low. The net effect was low. CMBs, Life Company, all the rates were low.” This created an opportunity for investors to take advantage of the market during a time when many waited for a late-calendar interest climb that never came. And that is why many are looking for the climb this year.

Real estate investors anticipate a general increase in interest rates as well. However, Gussis emphasizes the importance in separating what occurs across general property rates and what happens in the self-storage properties. Whereas residential mortgage rates are driven by Federal Rates, the self-storage industry is heavily influenced by other factors. This is another important reason why the self-storage industry should be monitored independently from residential and commercial properties.

“You can’t always compare apples to apples,” Gussis says. “Not all capital sources are the same. Banks base on internal cost of funds. The treasury and the spread are determined by bond investors.” The volume of market deals, pricing history, and bond products are just a few of the factors that influence the market. “For example, banks base mortgage rates on a spread over their combined internal cost of funds and cost of their operations whereas CMBS lenders base their mortgage rates on the treasury and the spread which is ultimately based on bond investors.”

Gussis continues, “The CMBS spread is determined by the market, and the market is constantly fluctuating.” He explains that the projected increase in the market is never something anyone can predict, but it can be monitored with estimations based on a number of different factors. “A year ago we were looking at the 10-year Treasury Swaps, which were about two percent, and quoted spreads were in the two percent ranges, which resulted in all in rates of approximately four percent.  A year later, 10-year Treasury Swaps are slightly higher in the 2.2 percent range and the quoted spreads are +/- 2.8 percent, resulting in all in rates being quoted now closer to five percent range.”

Easy Does It
“I think this slow steady trend will continue into 2016,” says Noel Cain, managing partner of BayVeiw Advisors, who explains the direction most experts believe rates will take through the rest of this year. “Largely, I think cap rates will start to moderate as investors start to see that interest rates have gone up.” Cain thinks value and cap-rates will have the biggest impact on the market. “We have seen some instances where investors have started to push back on incredibly low cap rates.”

 “We have seen a tick-up in long-term interest rates, which has been expected for a long time,” says Curt Fleming of Knightsbridge Realty Capital, Inc., stating that these projections are based on Federal Rate projections. “Based on what we’re hearing, they are going to ease rates up slowly. I don’t believe that it will have much impact at all on the real estate market and, in particular, the self-storage market.”

Fleming appropriates the self-storage industry as a relatively “safe” venture, which tends to attract a steadier flow of investments. “The public markets, including institutional investors, like the self-storage industry and have come to consider it ‘institutional’ investment quality real estate.”

Fleming seems very optimistic about self-storage 2016 interest rates. “Even with the increases over the last couple of months, the interest rate market is still at a historic low.”

A Volatile Market
One of the biggest concerns a borrower faces with 2016’s projected increased rates: Will this year still allow a sound loan restructure? Anyone who postponed a loan restructure in 2015 (or if restructuring wasn’t a viable option last year) may regret waiting as rates continued to increase. After all, many experts such as Steve Libert of CCM Commercial Mortgage, LLC, will remind everyone that the market is volatile.

It should be worth monitoring the impact of the Highly Volatile Commercial Real Estate (HVCRE) and what sort of costs this upcoming banking regulation will incur for a borrower. In spite of some of these indicators, Libert believes 2016 will remain another sound year for reevaluating loan terms. “When the world economic outlook is poor, and national inflation hasn’t occurred, it makes for a good time to focus on restructuring debts if owners are considering this [for personal or professional gain],” he says.

While the self-storage industry knows the best rates are more than likely behind us, this should not discourage new investors from taking an interest; and current borrowers should feel comfortable with their debt management in 2016. “Most borrowers know the lowest rates are gone,” says Libert. “It’s still a great time to focus on restructuring or refinancing debt. There are very good rates despite the market volatility. This is still a great year to focus on financing and leveraging low.”

Fleming believes owners should stay the course through 2016. “Rental rates, and subsequently net cash flows, are increasing, generally outpacing interest rate increases,” he says. “I don’t see the slight increase in rates changing a small or large owner’s business plans.”

An Exciting Time
The projected rate increases of 2016 also bring questions about one of the primary sources of self-storage investment in the larger Real Estate Investment Trusts (REITs). There are approximately 55,000 self-storage facilities in the U.S. and five public companies own 10 percent of the overall market. During 2014 and 2015, these public self-storage companies were actively buying properties. Of them, Extra Space stood out for acquiring the largest of the portfolios in 2015. And 2016 seems just as exciting with the addition of the fifth major REIT player National Storage Affiliates (NSA).

NSA is the latest self-storage company to “go public” and had their IPO in April 2015. The company was formed by six self-storage operators with decades of accumulative experience. The growing REIT and ensuing impact simply adds to the list of reasons why 2016 remains an exciting time for self-storage investments, and there is room for more public companies because rents and occupancy are trending up.

Self-storage REITs are favored right now by Wall Street, and there are lots of institutions that are looking to invest both in the public markets and with private operators. There remains a lot of active buying and selling of self-storage properties in the market.

Fleming is optimistic about the self-storage REIT market in 2016 in spite of the projected increases in the interest rates. “Going forward, the market looks good,” he says. “Long-term interest rates have moved up a bit, but are still at historic lows. The market is continuing to be driven by the cheaper cost of capital; CAP rates stand a good chance of staying compressed as we’ve seen in the general real estate markets over 2014 and 2015.”

Nevertheless, it is still important to remind ourselves to be cautious. “Don’t try to second guess where the market is going,” says Fleming. Investors should trust their advisors and keep educating themselves on the rates. Their development is fluid and constantly evolves.

“If you like the self-storage business, you like the way the company is run, and the dividend yields meet your expectations, there is no reason not to invest in that company,” Fleming says. “Overall, the strength of the industry makes it a good time to invest.”

2016 still holds promise for investors. Gussis reminds everyone that self-storage is exciting because of the unique atmosphere for investors. “Self-storage should be somewhat insulated in many respects,” he says. “Self-storage is resilient; and most owners should be poised to maintain and increase rates this year based primarily on the demand for storage. The potential change in interest rates should have no effect on self-storage operations.”

Khris Golder is a freelance writer based in Phoenix, Arizona.