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Welcome to the Self-Storage University Podcast, where you will learn the correct way to identify, evaluate, negotiate, perform due diligence on, renegotiate, finance, turn-around and operate self-storage facilities. And your host is a partner in one of the largest real estate portfolios in the U.S. with nearly $1 billion of holdings, Frank Rolfe.
Regular bank lending has rarely been as unappealing as it is right now for self-storage owners. Interest rates are high. A lot of lenders are very picky. It's called flight to quality, and reasonably so because there's been a lot of upheaval in self-storage, a lot of defaults, issues going on, operators who got too giddy with excitement and overpaid, or in markets where there's too much oversupply. But in these troubled times in self-storage borrowing, one of the safe havens, one of the best fallback positions is now and has always been seller financing. Seller financing is where the seller of the storage facility decides to go ahead and also be the lender. They wear two hats. They're not only the person that grants title to you, but also the person who grants the mortgage, but the problem is many self-storage buyers, particularly new people to the industry, they don't understand what some of the minimum parameters are for a decent seller carry note. This is Frank Rolfe with the Self Storage University podcast. We're gonna go ahead and explore the world of seller carry and what you have to have in that seller carry note for it to be successful.
Now, let me first say on the front end, we've always liked seller carry. Seller carry is one of our favorite things in all of real estate. So, it's a great idea, but yet there are certain things you have to have in your seller note to make it actually work. The first one is, it's got to be at least five years or more, or is it really a note at all? Because when you go and buy a storage facility, assuming you're trying to buy it right, you probably have to do some things to the occupancy or the rent level or the cost cutting to take the value to the next level. And it's very unlikely you're gonna get all that done and then season those numbers, which typically for most lenders, it wants to be two to three years. If you don't give yourself at least five years, what have you actually accomplished? You'll be right in the middle of your turnaround when the next loan is due. You will have very little time to actually execute on your plan, and that's gonna cause you all kinds of problems when that note is coming up and yet you can't get another bank to take that borrower out. So it's very, very critical you try and get at least five years.
Now, I don't think five is even good enough. I would try and shoot for 10. If you can't get 10, see if you could get at least five with the ability to buy a two-year extension. The two-year extension doesn't cost you any money upfront, but it gives you the right at the end of the fifth year, if you want to, to extend that for two more years by paying down some of the principal on the note. That saves you from moments when the entire market is in absolute shambles. And right now, as bad as the bank lending world is for storage, things could be far worse at some point in the future. We have no idea, but don't sign up a seller note that's one year or two years or three years. It's simply not enough time to maneuver. It can actually get you in even more trouble than it helps you because if that park is not truly financeable in its current state, all you're doing is, the seller letting you... Giving you enough rope to hang yourself. So you gotta have a lengthy period of time on the note. Number two, the interest rate needs to be somewhere between bank interest rates and current CD rates because the person carrying the paper is not a bank.
They don't have all the overhead and costs banks have. When banks are out there selling CDs at 4%, they have at least a point or two of that in cost and overhead in the bank. The seller doesn't have any, and the most they would be able to get if you paid them in cash and then they reinvested it was in what CDs are charging. So try and get a rate that's a little lower than the bank, but yet a little higher than the CD. Don't do a seller note where somebody is wanting an interest rate of 10% or 12%. That's ridiculous. That's almost like hard money levels. A true seller note has to be something that's at the worst case at current bank rates, but typically a little less. Also, a good seller note has to be non-recourse. We've never signed a recourse seller note. I've never seen a recourse seller note myself, but I do hear they do exist. Non-recourse means if you default on the loan, they can't come after you for the loss. So non-recourse is clearly the absolute best available means on a seller note, but I wouldn't wanna do a seller note that has recourse. I don't think a seller's even in a position to do recourse. I don't think they have the legal know-how to have your future, your fate at the hands of some crazy seller who's unable to even calculate what he's supposed to be going after you for in the form of a loss.
Also, a good seller note should never have more than about 20 to 30% down. And seller notes is where you have that one option, that amazing ability to do zero down or 5% down or 10% down. The things you hear in stories and you're very jealous, saying, how did the guy get that? Those are always seller notes. Regular lenders, unless it's a cash-out refi, they don't go with low percentages down like that. But I've also seen cases where the seller says, yeah, I'll carry the paper, but I want 50% down. Don't do that loan. There's no lender out there that charges 50% down, and since it's the amount you put down is what creates the leverage and the leverage is what creates the really high yields, you would be an idiot to do a deal with 50% down. You've gotta have a seller note that's typically, I would try and get 20% or lower, but at the most, 30% would be the absolute limit. Also, if you're gonna do a seller note, you gotta make sure you understand what happens in form of the cure period. The cure period is if you don't make the payment or they don't get the money, they have to notify you in writing before they call the note due in full.
Some states, and it's a shame they have this, but they do, under their state law, if the person doesn't receive the check, you're already in default. Even if you sent the check and it was lost by the US mail, which is not uncommon. So to defend yourself against that, you gotta have a cure period, which gives you the right to cure it. You get a letter saying, I didn't receive your payment, and if you don't pay me within X number of days, you'll be in default of the note, and therefore you can get it fixed. Without that, you could be in real trouble, even though you made the payment to the right address with the right amount, simply because some postal carrier dropped it on the ground and it fell in the gutter and it washed into the sewer and it comes out in an ocean somewhere, and you did everything right and still you're penalized with your note being called due in full. One other item on seller notes, you must understand the difference between a seller note and a wrap note. So what's a wrap note? A wrap note is where you get seller financing, but the seller's taking a second position and there's a first lien with a bank. Let's just look at that for a minute. Imagine a seller has a storage facility and they're gonna sell it to you for $800,000, and you're gonna put down only $100,000, and therefore there'll be $700,000 of note.
But there's a $400,000 note that's already on that property in a first lien, which the seller's been making monthly payments on, and he takes 300, the difference, on a second. That all sounds all kinds of fun and good, but it's very different than the seller notes that are common where the seller has the first lien position. Because if that bank later comes back and says, wait a minute, I never approved that sale, which many can under their loan agreement, they can call that loan due in full. Unless you have the 400,000 to pay it off and the seller has the 400,000 to pay it off, he's gonna lose the property and you're gonna lose your down payment. So make sure that on the seller note, it needs to be at closing at a title company, and the seller needs to be the sole first lien on that property. Because a wrap, if poorly constructed, can come back to really bite you. It could make you lose all of your money and the property all at once. The bottom line is seller notes are great. We love seller notes. You should as well love seller notes, but if you're gonna build them, you gotta build them right. You gotta build them on a good foundation, a foundation for success. This is Frank Rolfe, the Self Storage University podcast. Hope you enjoyed this. Talk to you again soon.