Self Storage University Podcast: Episode 75

How To Avoid Term Default

“Term default” is what happens when your loan comes due and you are unable to find a replacement borrowing option. It was a common problem in the Great Recession in 2008, and that was mostly because borrowers used poor judgement and little caution in their approach to loan renewals and it caught up with them. In this Self-Storage University podcast we’re going to review the loan process and how to best attack a pending loan renewal.

Episode 75: How To Avoid Term Default Transcript

Have you ever heard the term "term default"? What a term default is, is when you have a loan on a self storage facility and the loan comes due in the form of a balloon, and you can't get a replacement loan. So, you lose the property, not because it wasn't performing, you've made every payment, not because it's not the right occupancy, it's fully occupied, but you simply failed in getting the replacement loan in time. This is Frank Rolfe, the Self-Storage University Podcast. We're gonna be talking about term defaults and some creative tips to not let that happen to you. Now, I saw a lot of term defaults back in the period of about 2007, 2008, in the Great Recession. And what had happened is people had been too fat and happy for too long that they didn't really take their business seriously. They would play everything very fast and loose, they just thought, "Oh yeah, it's no big deal. My loan's coming up, I bet I can just get it renewed, I won't even worry about it, until just maybe a few days before." And then what happened, of course, was when they went to their bank a few days before, they came to find out that the bank didn't want to renew the loan, for whatever reason. Didn't wanna make any more storage loans, or they were trying to get the loan portfolio shrunk at the bank, whatever the case may be.

So, what happens? Well, when you can't replace the loan effectively, you are gonna lose the property unless you have at the last minute some Hail Mary pass in the end zone to save the day. And in many cases, the problem is not really with the self storage facility, it was the borrower, they didn't use good common sense. So, that being the case, what do you need to know about how to guard against having a term default? Well, the first thing is, make sure you got a notice somewhere, really big, that you see every day that tells you when your note is coming up for renewal. Some people after they get the loan, they just tell themselves, "Well, don't have to deal with this again for five years or seven years," and they just forget the date. The bank doesn't send you any advanced warning, the bank assumes you're smart enough to remember when the loan comes up. So, they don't start sending you letters a year out saying, "Hey, don't forget your loan's coming up." So, step number one is post in a private place somewhere the day any of your loans come due, so you don't forget about it.

Number two, after you get your loan, don't forget your banker. Some people after they get their loan, what happens? Well, they just stick the banker's name and phone number in a drawer and they never call the banker again ever, until the loan is coming up nearly to renewal. And the problem is people in banks change, people retire, people change jobs. What's gonna happen if the bank officer that you just assume will be there to help you is no longer employed by the bank? And you don't know about that because you were never staying in touch with them. Or maybe the problem is that there's been a change over in the leadership at the bank, and since you've just never talked to that loan officer, you never knew, and maybe you have not even been providing the bank with the different things they want over time, 'cause things changed.

And your loan officer never reached out to you, or maybe they did, but you didn't know why they were calling, so you never called 'em back. So, rule number two, stay in close, close contact with your banker at all times. I don't mean calling them every day. But I would definitely wanna be talking to them at least every six months, if not more frequently, maybe even quarterly. If you're in the same town, maybe you take them out to lunch quarterly, or maybe out to lunch every six months, or at least out to lunch every year, that way you can keep tabs on what's going on with the bank and keep that relationship going with that banker, as far as what will happen when that loan comes up.

Now, let's think for a minute of how much advance time you need to get a replacement loan. So, first, you're gonna have to have the time period you need to ascertain whether that bank is going to renew your loan or not. They're not gonna tell you on the spot, it's not gonna be, "Yeah," you call them up, "Hey, well, you wanna renew my loan?" "Well, let me think about it overnight." No, I would give your bank 30 days to decide whether they want to renew your loan or not, so there's 30 days. And then let's say the answer is no, well, then I have to build a loan package for another bank and I have to find... Make a list of other banks so I can hit up with the loan package. And I need to get that loan package out to them and call them up and see if any of them wanna make the loan, and how much time does that require? I think fairly, you wanna give yourself at least 60 days on that to build a package, make the list, talk to the banks, start getting decisions back for them. So, now how far are we in? 

Well, now we're already in three months. And then once you get the bank that says, "Yeah, okay, I think we'll wanna do the loan," you still have a whole bunch of more issues. You have to probably go before a loan committee, get third party reports and then all the legal documentation needed to get the loan closed. How long can that take? Well, that can take at least another two to three months. Now, we're six months in to get that loan and let's give ourselves another month of fluff where it's seven months. So, what does it mean? Well, if your loan is coming up on X day, you better go and start that process about seven months ahead. And if you wanna go a little further, hey, there's no problem, let's start a year ahead. That's realistically the kind of time frame that you will need. It drives me nuts when people tell me, "Yeah, my loan's coming due soon, so I'm gonna go to the bank." "When is it coming due?" "Oh, in a month." There's no way that should have ever happened. You should always give yourself at least six, seven months to as much as a year, to get that loan replaced.

Now, is there any downside to being that prepared, working on things that far ahead? Let's think about it for a minute. Most loans out there have the ability to be prepaid. So, right off the bat, if you found a bank, if you start a year ahead and the bank says, "Yeah, I wanna do it, we can do it, but we're gonna get all closed up, nine months ahead of renewal," there's probably not going to cause a problem, you probably do not have any penalties for a pay-off that is that close to the expiration. In fact, a lot of loans are so desirous that you find a replacement, they actually make even the ones that have some kind of prepayment penalty, the prepayment penalty dissipates as long as it's within the final year. Even conduit loans which have defeasance costs, which is a giant penalty for prepayment, it pretty much evaporates as you approach the end of the loan. Because they want you, they encourage you to get the replacement. So no, you really don't have a penalty for starting away early. If you go out and find that bank and get that deal done and it's months and months ahead of the end of your expiration, then so be it, that's probably gonna work out just fine.

And also, don't forget, if you fail in your mission to get a replacement loan, let's say the problem is not your park or your properties but it's you, then you still have time to sell it. So, you can still, in your failure to get your self storage loan, you still have time if you start a year ahead or seven months ahead to quickly list it with a broker and get the thing sold. Just 'cause you can't get the loan replaced doesn't mean you lose everything. It only means you lose everything if you can't get it replaced and can't get the bank paid off in the form of a sale before it comes up. So you wanna have that option as well, that's why you wanna start really early on. Now, in many banks, if you go to them and keep them attuned to what you are doing, in the event you cannot get a replacement loan, they may give you more time. There's an old saying in the banking business in those situations called extend and pretend, maybe they tack another six months or a year onto the low as long as you keep making your payments 'cause they understand you're trying really hard to get a replacement loan. Maybe we're in a time of major recession or depression and the banking industry is very unstable, they appreciate that. No one likes to have a failed load.

No banker wants to have a loan that is at that moment in default, so they'll work with you. But they can only work with you if you stay in the game and keep them completely in the loop. And again, that's why it's so very important you maintain the relationship with your bank, such that they know that you're a good borrower, you're a friend, and you're someone they can trust that works hard to try to get that loan replaced. This is Frank Rolfe with the Self-Storage University Podcast, I hope you enjoyed this. Talk to you again soon.