With the turmoil in the lending market, finding ways to lock on lower interest rates – or just have a willing lender with knowledge of the asset – have become very important. And often this revolves around doing a loan “assumption” or some type of derivation of that concept. In this Self-Storage University podcast we’re going to review how loan assumption works and give you tips on how to successfully approach it.
Episode 89: The Different Ways To Assume A Loan Transcript
We've all seen that interest rates have gone up enormously quickly since March of 2022. In many cases, we're all scrambling trying to creatively come up with ways to obtain debt and lower interest rates and the prevailing rates today. This is Frank Rolfe, the Self Storage University Podcast, we're gonna talk all about assumptions. Assuming existing debt as an avenue to get a lower rate and as an avenue to get a lower upfront cost and getting the loan to buy the Self Storage facility.
Now, we're gonna break this down into two groups, two different ways to assume debt. The first is going to be regular bank loans, these are loans from banks and credit unions, the typical place is the salt of the earth that make loans on all kinds of real estate, assets including Self Storages. And here's the deal, when you're gonna buy a self-storage facility, one of the first places to look at is the existing debt on that. It may be possible if it's allowable under the bank's covenants to do a wrath note node where you encapsulate and continue on with that loan, and at the same time, get mom or pop to carry a second loan at a higher rate, and that blend will give you an overall lower amount.
Or if you're buying a Self Storage facility that's not doing very well, it's having economic problems. You may be able to go in and actually assume the loan entirely from the bank just to get a better quality borrower on the books. We've done that many times on different properties for the bank is simply spooked because the person who they made the loan to is not doing a very good job. And they see in the financials every quarter, every month, whatever frequency they look and they say. Wow, this person is not very good. I sure wish this... We have someone different, so this loan doesn't go down the tubes.
And they may allow you to step in there into the shoes of that borrower at the exact same interest rate as the existing loan. Other times, you can also get the bank to get you a new loan, so it's not really a true assumption because they're gonna write a whole new loan and a much higher amount and a much higher loan to value. But still it will save you money because that bank knows the property well, so you don't have to do as much as far as reports on it, you don't have to do much to convince them loan is good.
But the bottom line is whenever there's existing debt on any storage facility, you're looking at buying, you would definitely be a fool not to investigate what the options are that you could maybe do to manipulate and do something productively with that existing debt. Not talking to the lender serves you no purpose. Talking to the lender can do a world of good 'cause you never know what may come your way, if you simply reach out to see if the bank would like to continue on.
And don't forget, it's very scary to be a banker making loans on properties can cause you a lot of sleepless nights because you're afraid if the borrower is actually gonna make the payments and if they don't, you might be humiliated or even lose your job. So when you've had a loan on something for years, it does give you much greater peace of mind. All bankers know this, it definitely reduces the bank's risk. So often people will try and go ahead and do those assumptions because obviously anyone likes to have less risk.
Now, the other option is if you've got a Self Storage facility that has a conduit loan. Now, what's a conduit loan? A conduit loan is a loan, it's very much everything a bank loan, it's what we call CMBS, commercial mortgage-backed security, they're sold on Wall Street, they pull all loans together.
And so you have these groups which are originators of conduit loans, but they then sell them as packages and they're not really bank loans after all. Once a conduit loan is sold in pieces, the person in charge, if it is not your bank officer, it's your loan servicer. Different terms, different definitions, and definitely not a bank. Now, conduit loans are always been a great way to borrow money, in all real estate sectors, including a self-storage. But there's one interesting attribute that many people don't know about those conduit loans, and that is those conduit loans are always assumable.
That's because there's no real mechanism to handle it if you pay them off early. They've agreed, whoever bought that loan, pull them off Wall Street to make regular monthly payments of X, but it's not a regular bank so if you pre-pay, they can't re-loan the money, they're stuck. And as the borrower, if you pre-pay, you pay an enormous penalty called defeasance. If you go to the website defeasewithease.com, you'll see the magnitude of that penalty, which can often be as much as 30% of your total loan. So the kind of business is really built around the concept of assumption. They don't change the interest rate, they don't change the terms, you literally just step into the shoes of the existing borrower.
Now, they're not super easy to do, because if you do a conduit assumption, you have to get three layers of approval. The servicer, the special servicer and the master servicer. They do this as a precaution to all those people who bought these things on Wall Street and anticipated a certain groups of loans which they have analyzed with certain borrowers. They don't like swapping them in and out. But never less, it is one of the duties of conduit lending is to allow you, if you will request it, to do a loan assumption.
And in many cases, that's a really big deal. Conduit loans are normally about 10 years in link, so an entire decade. If you locked in an interest rate, prior to the first quarter of 2022, you locked in some of the lowest interest rates in American history. Now, let's say you're only two years in, you have eight years remaining on that super low interest loan. The loan might be so low in interest, it's literally half of current interest rates. So as a result, assuming that loan may be very advantageous to you. Now, there are some problems, of course, if you assume it, you're learning to value may be all screwed up, you pay more for that first property, then what the current owner paid for it, then your loan to value will shrink. 'Cause most conduit loans are done in the theory of 70% loan to value.
If you pay even more money for the facility, you may drop from 70% to 60 or even 50% of value. Which will require more money to come out of your pocket. Also, when you do an assumption, there are significant legal fees required in that assumption process. Now, whether it's pawn by the seller or by the buyer, that's entirely up to you and what you negotiate.
The bottom line, however, is that there are great opportunities in conduit lending to do assumptions, and there's also great opportunities in regular bank and credit union lending to do assumptions. Yet many, many buyers never really look at the assumption options at those opportunities. It doesn't take much to do, there's not a lot of effort required to talk to a bank to check in on the loan to see if an assumption is possible in order to go to the conduit lender to see if you might be able to go ahead and do an assumption of that.
But the key item in the world in which interest rates have gone up the fastest and the highest in 40 years, that we all have to be a little more creative. And sometimes looking at the existing debt is one great avenue to achieve just that. This is Frank Rolfe, the Self Storage University Podcast. Hope you enjoyed this, talk to you again soon.