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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.
The first time I ever heard the phrase extend and pretend, it was 1987, 1988, Dallas, Texas. And what was happening was we were in the middle of the famous Texas savings and loan crash. There were problems everywhere, lots of loans in trouble, you couldn't give properties away. Every office building in downtown Dallas was under foreclosure at the same time. So what did lenders do in this kind of complete anarchy? Well, they came up with a concept called extend and pretend. And what they would do is if a loan was coming up, knowing you couldn't get it replaced because the Texas banking system was broken, they would instead extend the date in which the loan came to fruition, buying you time to later be able to go out and refinance it. So they would extend the due date and they would pretend it was all gonna work out in the end. And back during the savings and loan crash, that was a very effective tool. And a huge number of loans that would have ultimately ended up as bank-owned property, instead, under extend and pretend, they got a lifeline.
And ultimately banking stabilized in Texas and suddenly the values came back. And those people who used extend and pretend as a mechanism to be able to hold their property and continue to run it during the bad times, they came out looking very, very good. And since then we've seen extend and pretend used many other times. We saw it used during the dot-com bust, we saw it used during the Great Recession in 2007 and 2008. And right now there are a lot of loans out there on extend and pretend. There's almost $2 trillion right now of commercial real estate coming due, and a whole lot of that is self storage. But suddenly a lot of banks are ending the practice. This is Frank Rolfe with the Self Storage University podcast. We're gonna talk about why pretend and extend is coming to an end. So we all, I think, understand the basic idea of extend and pretend, which is you extend out the date in which the loan comes due and you hope for the best. I don't think that's rocket science. But one problem you have with this is for you to do that, people have to have the belief that things will get better, that the loan that they can't get renewed right now, they can in the future because they will be able to attain higher cash flow and EBITDA and make it all happen. But there are some shockwaves in American real estate that suddenly render many of your industry categories in trouble. And it's a trouble that's not gonna go away. In the office industry, obviously the advent of the internet, remote work, COVID has created a dire situation where there's just too much office square footage for the number of people who need an office.
And so a lot of banks are thinking, well, I don't think that that's gonna work. I don't think I should extend this loan because I don't think it's gonna get any better. The same is true of retail. Who doesn't go in their neighborhood shopping center and say, "Hmm, I thought there was a store there last time I was in here... Wait, I know there was a store in that spot of the mall." But yet all we're seeing is greater and greater vacancy. And when we see something go into the mall, what is it? Is it a blue-chip tenant? No, it's a pop-up shop. It's somebody who's never had a retail store paying a reduced rent, and that's not doing any good. And it's unlikely with the internet and the ability to buy things on Amazon that you're ever really gonna go to those brick-and-mortar stores. So once again, that seems pretty doomed. And then, of course, hotels are ruined because business travelers really don't exist much anymore. People today, if they're gonna have a meeting, they'll do it on Zoom or in some other fashion, but they're probably not gonna hold something at a big old hotel in a ballroom. That's just part of the old ways things happened.
But that's the office, the retail, and the hotel industry. What about self storage? Where is that at? Well, self storage has not been ruined by the internet. It's been hurt a little. You have things like pods and different things which are kind of hybrids of storage where they bring these things out to you and you load your stuff in it and then they store it, and it's not like your typical brick-and-mortar self storage unit. But by and large, self storage is pretty low-tech, right? You have to store your stuff. And if you're gonna store your stuff, then self storage, public storage, whatever is near to you geographically, that seems like a pretty good idea.
But what's happened with some of self storage right now is people have lost faith in it actually working out. So a lot of self storage units in the urban core of America, particularly multi-story stuff, climate-controlled stuff, it's unclear whether or not that stuff will, in fact, ever work, 'cause we're not really sure it was ever gonna work in the first place. A huge amount of storage was built not with the customer in mind, but with the storage owner in mind. And they elected multi-story things, and they elected climate control, and they elected having things stacked upon each other where you can't just pull up with your pickup truck, but you gotta put it on a dolly and wheel it, wheel it through a labyrinth of hallways to get to your storage unit. And I don't know if that's ever gonna return like it is. We're seeing reduced occupancy, reduced rent levels in those kinds of properties.
And as a result, what's happening is some of those loans, people are electing not to extend and pretend, but it's not the bank doing it, it's often the borrower. And that's one big reason you're seeing a huge issue with extend and pretend is that it's not the banks that have completely given up hope in many cases, it's the borrower. The borrowers are just saying, "I'm not gonna keep making payments for another 12 months or 24 months, because I think at the end of the movie, you're gonna take the property away from me anyway. It's got negative cash flow, it has capex needs, I don't wanna do it anymore." And that's the real trigger to why it's the end of extend and pretend. It's not really bank-driven, it's more borrower-driven.
So what does it all mean? Well, we have $2 trillion of commercial debt coming up: office, hotels, retail, self storage, apartments, you name it. And a good amount of that is not gonna clear the trees. And when that does happen, and it will be accelerated if, in fact, people don't do extend and pretend, then those properties will go into trouble, and that's gonna cause losses on the parts of the bank. And when banks have losses, what do they do? Every recession in real estate since the beginning of time, what happens is they go into protection mode, and it's called flight to quality.
So under flight to quality, what happens is banks that were making loans on lesser properties change their mind. In the self storage arena, what that will mean is people are gonna look at properties which have declining rents and have declining occupancy and say, "Nope, it's too risky for our bank. I only want stuff that has ascending NOI, ascending rent levels, ascending occupancy, or we're not gonna make the loan."
So what's the moral of all this? The moral is, going forward, on anything you're gonna get a loan on in self storage, do make sure it's a quality asset that banks will wanna make loans on. Because everything in self storage lending does, in fact, go in cycles. And right now we're entering a new phase and a new cycle. And people who stick with bread-and-butter storage needs, that can find facilities in areas that have growing population think suburbs, think exurbs, think super-commuter areas those are the ones that are gonna be the winners in the next cycle. This is Frank Rolfe with the Self Storage University podcast. I hope you enjoyed this. Talk to you again soon.
These are the ones that will prosper and be able to get the loans because the banks will have great confidence. The stuff which has proven to be weak, banks are gonna fail to want to extend or make new loans on those properties because they just simply don't trust them. Now, will it change over time? It always does. Things always run in cycles and there will, in fact, come a time where even marginal properties can once again have access to financing. But at this point in the cycle, if you're gonna buy a self storage property, make sure that it is quality, 'cause flight to quality is about to begin. This is Frank Rolfe with the Self Storage University podcast. Hope you enjoyed this. Talk to you again soon.