28 May 2020
The overall business impact from the pandemic is absolutely unclear at this time. For self storage operators, who rely on rental revenue from their tenants, the question remains whether rising unemployment and business closures will significantly impact the use of self storage. As we have seen in the past, self storage use is often considered "recession-resistant" as customers continue to need temporary space arising from housing displacement or moves, relocations due to job changes or life transitions like divorce, even temporary storage for property from an estate after death.
But if times are tough, especially on operators that may have just opened or were in the midst of a lease up, what options could they consider in the midst of an economic down-turn?
Business owners often integrate the qualities of an entrepreneur (with dreams of growth) and the qualities of an accountant (with clarity as to the pressure of managing expenses with revenue). When times get tough, there is an opportunity to balance what is hoped for with what is needed. Accordingly, many facility operators will begin to review their expenses, re-negotiate current contracts with vendors, consider their staffing needs and explore ways to reduce their static overhead costs. At the same time, operators will look at their marketing approach, where they are focusing their sales energies and oftentimes rework their plans to adopt the best ways to increase their revenue, sometimes "thinking out of the box" discover what will differentiate their business from their competitors.
The desire to re-state the deal on a pending loan will be almost impossible until banks are able to fully calculate their exposure on their outstanding debt. Based on the pandemic and the impact on valuations, it will be a unique opportunity where a bank is willing to defer payments or restructure the payment obligations of its borrowers because of the bank's fiduciary obligations to its stockholders. During the "Great Recession", the banks learned a considerable amount about their lending risks and having to deal with the devaluation of their assets. As a result, there will be a move towards strengthening the base of their capital and avoiding actions that impact their liquidity during this period.
Certainly, as the markets turn, self storage owners interested in exiting their investments will find a large supply of willing buyers. Although it may not have been the plan imagined, if the investment in a facility creates a risk to that owner's or investor's other assets or overall sustainability, looking for an exit with a buyer to cover the cost of the debt and even an opportunity for a return on that investment may be exactly what is needed. The deep pool of buyers in this industry is one of the reasons why self storage, as a real estate sector, has demonstrated one of the lowest foreclosure rates among any type of real estate product. Typically, properties available for sale are within a range of value that can be bought and sold quickly, with minimal due diligence. Based on where CAP rates have been within the last year, it is still likely that sellers will be able to exit their investments, even with lender defeasance provisions, without significant loss and possibly even some gain.
One of the most subtle impacts of the implementation of the Coronavirus Aid, Relief and Economic Security Act (CARES Act) was the passage of the Small Business Reorganization Act (SBRA) which changed the laws for small businesses considering a Chapter 11 bankruptcy ("Reorganization"). The SBRA was modified by the CARES Act to raise the "maximum qualifying debt" for a small business Chapter 11 filing from 2.7 million to 7.5 million (through March 27, 2021). What this means is that for certain small businesses that otherwise would not have qualified for this quicker and more cost effective protection, since its debts exceeded the minimum amount, will now have the opportunity to utilize this filing option as long as its debts do not exceed the higher $7.5 million threshold. Unfortunately, to be eligible, the debtor CANNOT be a single asset real estate company, which would likely exclude a large number of self-storage operators who have organized their businesses under this limited liability structure. There are other obvious downsides as well to any bankruptcy. Under most lender provisions, the filing of a bankruptcy would create a loan default and trigger claims under any personal guarantee that was created.
Again, self storage is a unique business. It is one that seems to survive in good times and bad. It is a bit unclear what the next few months will look like for the real estate industry, but it is always good to plan ahead. It may be time to consider your finances and what lies ahead for your business.
Should you have any questions on operating your business during this unprecedented time, please do not hesitate to contact us.
Stay Safe! Scott
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