Commercial Loans Blog

Timid Bankers Get Slaughtered in Commercial Real Estate Finance

Posted by George Blackburne on Mon, May 27, 2013

If you're a senior executive wth a bank, this article is pretty important to you.  I've been making commercial real estate loans for 33 years now, and I have a surprising observation:

Commercial bankers often get slaughtered in commercial lending because they are so timid.  By the time most commercial bankers work up the courage to enter a lending market, all of the really safe, high-yielding loans are already gone - leaving only the risky deals and the bank's eventual ruin and destruction.

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Let's start in residential lending first, even though this article mainly has to do with commercial mortgage lending.  When Nixon took the U.S. off the gold standard in 1971, he opened the floodgates of inflation.  Homes that the Greatest Generation bought for $15,000 in the 1960's began to appreciate to $40,000 or more.

Smart, entrepreneurial private lenders in California started to make 10% second mortgages (at a time when second mortgages were rare and were considered ridiculously speculative).  These early entrants made a killing.

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By the time commercial bankers finally started making residential second mortgages in earnest, many of the safest deals were gone.  Commercial bankers were left in a bidding war a decade later over the tiny handful of borrowers who had not already tapped the equity in their homes.  By then, real estate appreciation had greatly slowed.  Then, in 1986, a major tax overhaul sent real estate into a seven year tailspin.  California commercial bankers, for example, got slaughtered in residential second mortgages when California real estate tumbled by 40% in 1990 and 1991.

Now let's scroll forward to 1986, the year when Regulation Q was repealed.  Regulation Q was a law that limited the interest rate that banks and thrifts (savings and loan associations) could pay on deposits.  Suddenly commercial bankers could pay whatever they wanted to attract deposits.  It was an era when many wealthy developers bought savings and loans associations (S&L's).

At first these clever developer-banker-entrepreneuers make a killing investing in syndicates to make large commercial loans.  After all, they could charge almost any interest rate they wanted.  Who else - other than a syndicate of S&L's - could fund a $40 million construction loan?  And these early entrants made a killing.

But then mainstream commercial bankers (more precisely S&L executives) got in the act.  They too started investing in syndicates to make huge commercial construction loans.  Eventually the world was full of vacant, glass-and-brass office towers (called "see-through buildings"), and the S&L Crisis was upon us.  Hundreds of S&L's were eventually closed.

Scroll forward to the late 1990's.  Congress has created the tax entity, the REMIC, the Real Estate Mortgage Investment Conduit. Early conduit lenders made an absolute killing.  They made a bunch of superb quality, low-LTV commercial mortgages.  They pooled these super-safe commercial loans and then sold them off to Wall Street investment bankers at immense profits.  The bonds backed by these older, high-rate, low-LTV commercial loans surprisingly held their value, even during the bottom of the Great Recession.

But then dozens of large commercial banks got in the conduit loan business.  Competition got so fierce that interest rates plunged, loan-to-value ratios skyrocketed, and when the Great Recession hit, those commercial bankers stuck with commercial mortgage conduit loans in their portfolios got slaughtered. 

Helloooo?  Anyone spot a trend here?  Most commercial bankers are so timid that by the time they enter a lending field, all of the really safe, profitable loans are gone!  Almost inevitably these late-comers get slaughtered.

Right now the commercial real estate lending market is ripe to be picked.  A commercial bank could come into the market, make some super-safe and dreamy commercial loans, and charge an interest rate that is 1.5% higher than the market, say, 6%.  The smart bank would also insert a large prepayment penalty or a lockout clause.  (If your bank wants to see many such super-safe, dreamy commercial loans, be sure to join C-Loans!)

In a year or two, however, most commercial banks will come herding back into the commercial lending market.  The really cherry deals will already be gone, and the herd will get into a price war over average-quality and below-average-quality commercial loans.  I wouldn't fall off my chair in surprise if the herd ended up bidding interest rates on commercial loans back down to just 3.875% (when they could be getting away with 6% today).

I don't know why I am wasting my time today.  Commercial bankers will probably always be timid and foolish.  They equate "herd movement" with prudence and safety.  They couldn't be more wrong.  (Sons, always remember the slow reaction speed of commercial bankers.  When commercial bankers finally adopt a lending product, its time to get Blackburne & Sons out of that market.) 

Here is the lesson from this article:  There has been no commercial construction since 2008.  The economy is recovering.  Many commercial buildings were so neglected during the Great Recession that they need to be bulldozed.  The prognosis for commercial real estate values is superb.  Just look at what has already happened to residential real estate.

Will commercial bankers have the wisdom to be early entrants back into the commercial mortgage market?  Will they have the wisdom to make 6% loans (with a lock-out clause) in a 4.5% commercial mortgage loan market?  I seriously doubt it.  Most commercial bankers will be too timid about commercial lending to re-enter the market before the best part of the recovery has long passed.

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Topics: timid commercial bankers

How Bankruptcy Affects Commercial Loans - Scary Stuff

Posted by George Blackburne on Wed, May 22, 2013

Let's suppose you FINALLY (Helloooo?  Is there intelligent life out there?) came to your senses and recognized that the real money in commercial real estate finance is in loan servicing fees.  Therefore you became a commercial hard money broker.

A commercial mortgage borrower comes to you and asks you to help refinance his ballooning commercial loan.  Of course, he comes to you just ten days before the scheduled foreclosure sale, and the speculators who bought the commercial mortgage note from the bank really want to foreclose on and own the commercial property.

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You scramble as fast as you can, but it becomes clear that you won't be able to close his new commercial loan in time.  Therefore you send the borrower to a local bankruptcy attorney, who puts the LLC that owns the commercial property into a Chapter 11 (Reorganization) Bankruptcy.  For the next 60 days the note holder's foreclosure is automatically stayed.

In the meantime, your commercial mortgage refinance is now ready to close.  You obtain a letter from the Chapter 11 bankruptcy trustee saying that its okay to pay off the ballooning loan.  The borrower signs your commercial loan documents, the title company blesses the transaction*, and you close.

Two months later the borrower stops paying.  You file foreclosure ... only to get the worst news of your life.  Your mortgage is invalid!  Because the borrower had declared Chapter 11 Bankruptcy (the bankruptcy where the borrower asks for more time to reorganize his finances), title to the subject property was no longer vested in the LLC that used to own the property.  Instead, title is vested in the name of the bankruptcy estate.

Only the bankruptcy court judge can grant permission (in the form of a formal order) to the borrower to sign for a new commercial loan.  While it is the job of the Chapter 11 Trustee to marshal the assets of the bankruptcy estate, the Trustee himself cannot grant your borrower authority to sign for a new loan.

So where does that leave you?  Totally screwed.  You have an unenforceable promissory note (but no mortgage) against a borrower in bankruptcy.  As the old joke goes, "The doctor says you're gonna die."

* What about the title company?  Can you make a claim on the title insurance?  No!  Title insurance does not protect you against fraud or the execution of the loan documents by the wrong party.  That's YOUR job as the lender to make sure the right party is signing on behalf of the property owner.  The title company will usually make a good faith effort to help you verify that, but their title insurance policy specifically precludes coverage in the event that the wrong party signs on behalf of the property owner.


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Topics: bankruptcy and commercial loans

Commercial Mortgage Activity Seems To Be Picking Up

Posted by George Blackburne on Sat, May 18, 2013

As the owner of C-Loans.com, the largest of the commercial mortgage portals, I sit in a somewhat unique location to observe the commercial real estate loan market.  From my point of view, commercial mortgage activity seems to be picking up nicely.

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  1. At Blackburne & Sons, the private money commercial mortgage company, we maintain a board listing all of the loans we have in process.  That board seems fuller right now than at any time in the past six years.
  2. A large number of participating banks reported that they had commercial mortgage loans in process for C-Loans this month.
  3. Our "big hitters" (former lead buyers who earned their listings on C-Loans by closing at least five loans for us) are reporting a nice number of closed deals for the month.

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It makes sense.  The housing market has been roaring back over the past year.  My oldest son, George IV, is trying to buy his first home in Sacramento; but speculators, paying all cash, are paying 120% of asking price for homes under $200,000.  He just can't move fast enough.

It therefore makes sense that banks are becoming more confident about making commercial real estate loans.  If residential property is enjoying a bull market, its not hard to see the commercial property market rebounding from its 40% drubbing.  My hard money mortgage company lost a $1 million commercial loan to a credit union last month.  The credit union made the loan at 4.5%, with no appraisal and no toxic report.

Hopefully this is the start of a commercial loans frenzy, where several hundred new banks will enter the commercial mortgage market and start to make a serious volume of deals.  There is six years of fruit that has ripened in the commercial real estate market.  A bank would be smart to try to book some commercial real estate loans right now at 5.5%, before competition forces them to drop their commercial loan rates down to 3.75%.

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Topics: commercial mortgage market

Marketing Your Commercial Mortgage Website

Posted by George Blackburne on Fri, May 17, 2013

c loans yelp listing resized 600One of the best ways to market for commercial loans is to have a website designed to capture leads.  Most commercial mortgage borrowers will find your website using one of the search engines, like Google, Bing, or Yahoo.  Today I am going to teach you a free technique on how to use review sites to increase your ranking on the search engines.

A review site is a website where the social community online ranks the service that you provide.  For ease of understanding, think of Angie's List as an example of a review site.  There are quite a few review sites, but two of the most highly-respected review sites are Yelp and Google's competitor to Yelp, Google Places.

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Here is how these review sites work...

Suppose I am visiting Kansas City for the first time, and I am in the mood for sushi.  I would go to Yelp and type in, "Find a sushi restaurant near Kansas City, MO."  A number of sushi restaurants would appear, along with a rating system (think of stars) showing what reviewers thought of the restaurant.  As the owner of a commercial mortgage business, you can list your business on Yelp and Google Places for free.

There are three advantages to listing your commercial mortgage business on these review sites:

  1. Commercial mortgage borrowers may find you.  To those who regularly use Yelp and Google Places, these review sites are an excellent way for out-of-towners to find local businesses, without having to pay a $12 fee or so to Angie's List.
  2. Being listed on Yelp or Google Places gives you two, free incoming links to your website.  Google and the other search engines like it when lots of other websites link to your site.  The more incoming links you enjoy, the more credence they give to your site.
  3. Google and the other search engines give you special "bonus points" for being listed on Yelp and Google Places, apart from being just two more incoming links.  If you want your web site to be listed highly on the search engines, being listed on these two important review sites will definitely help.

Now I have a favor to ask...if you appreciate the little commercial mortgage finance tips that I share regularly with you, would you please go to Yelp.com and write a favorable review on C-Loans.com?  Thanks!!

 

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Topics: review sites

Commercial Loans and Promotable Preferred Equity

Posted by George Blackburne on Wed, May 15, 2013

An old buddy of mine, Dave Repka of Bison Financial Group, taught me an interesting, new term this week - promotable preferred equity.  To understand promotable preferred equity in commercial mortgage finance, one first has to understand preferred equity.

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To understand preferred equity, perhaps it is easiest to first understand preferred stock.  In the old days, before there were were organizations known as limited liability companies (LLC's), most businesses were owned as corporations.  How much of the corporation you owned was based on how many shares you owned.  Most shares were known as common stock.

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Remember, we're tyring to help you to understand the term preferred equity, and we said the best way to do this was to first help you understand the term preferred stock.   The best way to do this is to use an example.

So the year is 1972.  You own a small wood-products manufacturing corporation, and you come up with the brilliant, new idea to build houses in a factory.  This way you won't have to pay union carpenters outrageous wages to build the homes on site.  You just need $2 million to open your first home-building factory.

Therefore you go to your father-in-law and beg for money.  He offers to loan you the money, but you confess that you won't be able to make the monthly payments on a $2 million loan, at least for awhile.  You then suggest that you could give him half of the shares of your corporation.  He replies that he doesn't want to run a company.  He's retired.  He needs income the moment you can afford to make payments.

After negotiating for awhile, he agrees to buy $2 million worth of preferred stock in your corporation.  The thing about preferred stock that is better than debt is that you don't have to make monthly principal and interest payments.  After all, preferred stock is a form of equity.  Equity does not have required monthly payments.

And thank heavens for that!  For the first two years, your new-fangled product was slow to catch on.  You only sold a handful of manufactured homes.  Year three was different.  You sold a lot of homes and made a decent profit.  You decide to pay out $160,000 in dividends to the shareholders.

Your father-in-law owns 2 million shares of $1 face-value preferred stock with a yield of 7%.  The thing about preferred stock is that the preferred shareholders get paid first.  They are shown a preference, and common shareholders only get paid if the all of the preferred shareholders have first already been paid.

A seven percent yield on $2 million is $140,000.  Therefore you have to pay your father-in-law $140,000.  This only leaves $20,000 left of the $160,000 in profit to distribute to you and your wife.  Drat!  As Tommy Smothers (of the Smother's Brothers) once said, "Mother always loved you best."

The next year, however, your company does even better.  You have $400,000 in profit to distribute.  Your father-in-law only gets $140,000 because it was agreed when the shares were issued that the yield on these preferred shares was only 7%.  Once you pay your father-in-law his 7% interest, he is NOT entitled to anything else.  You are distributing $400,000 in profit.  Your father gets his $160,000, and you get the remaining $240,000!

This is how preferred stock works.  A yield is agreed upon, but the preferred shareholder only gets his yield if there are profits to distribute.  In addition, the preferred shareholder only gets a return up to the agreed yield.  If the profits of your corporation are $1 million the following year, your father-in-law still only gets his $160,000.

But almost no one uses corporations anymore.  Instead, most new companies formed in the last 18 years have been LLC's.  Instead of shareholders, LLC's have members.  Shares are called membership interests.  Members whose membership interests enjoy a preference are called preferred equity holders.  There are no required monthly payments on preferred equity, although in commercial mortgage finance, if the managing members miss an interest payment, the managers can be ousted by the preferred equity holders.

Now, with this refresher completed, I can finally explain the concept of promotable preferred equity.

In commercial real estate finance, its is customary to have two parties, the sponsor and the equity provider.  The sponsor is the guy who finds the deal and typically manages the commercial property.  The equity provider is the guy who puts up the majority of the dough, the downpayment to buy the property and the money to fix up and lease the property.

Now let's suppose Bob, a frequent sponsor of commercial real estate investments, finds a vacant car factory in South Carolina.  Bob has heard through the grapevine that Volkswagon is looking around the South for a new manufacturing plant.

Now Bob goes to the family office of one of Sam Walton's children and pitches the deal.  Together they will buy the industrial plant, they'll clean it up, and then lease it out.  The family office agrees to be the equity provider; i.e., the Walton Trust will put up most of the dough.

The total amount of the capital to buy the former auto plant and to fix it up is $100 million.  The Walton Trust will put up $90 million, and Bob will be required to put up $10 million.

Rents and profits from the venture might be distrubuted as follows:

  1. The Walton Family and Bob share proportionately (90/10) in the rents and profits until both of them enjoy a preferred return of 8%.
  2. Any additional return is shared 90/10 until both parties have received a 12% internal rate of return (IRR), plus the return of their original principal.
  3. After both parties have gotten their principal back, plus a 12% IRR, Bob gets promoted.
  4. Any additional return is distributed 80% to the Walton Trust and TWENTY PERCENT to Bob!  Note:  Bob got promoted from 10% to 20%.
  5. After both parties have received all of their dough back, plus a 20% IRR, Bob gets promoted again to 50%!   After the 20% IRR is reached, Bob gets FIFTY percent of any additional return.

A profit distribution plan where the formula changes as more profit targets are met is called a waterfall.

As my buddy, Dave Repka, puts it:  "Promotable preferred equity is how dudes (sponsors) get rich!"  Thanks for the education, Dave!


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Topics: promotable preferred equity

Commercial Mortgage Marketing Tip From George's Son, George IV

Posted by George Blackburne on Tue, May 7, 2013

I'm pretty thrilled right now because I am about to teach you a commercial mortgage marketing tip taught to me by my own son.  George IV, my oldest son, recently said something very wise:George Blackburne IV

"It's better to repeatedly touch ten referral sources than to speak with one-hundred referral sources just once."

 

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A touch could be a short visit, a lunch, a hearty handshake at a mixer or convention, an email, a phone call, or a letter.  By "repeatedly touch" I mean at least six, separate, independent touches.

What the younger George is saying is that many loan officers run around trying to make as many contacts as possible.  Many of these might be quality contacts - maybe even perfect referral sources - but they don't stick.  If you speak with someone just once or twice, after a short period of time they will usually forget you.

 

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It's much better to speak with fewer referral sources, but to speak with them or to touch them again and again.  I recommend that you touch a new referral source at least once every ten days for sixty days.  That's a quick six touches.  Six touches is the magic number.  After that you can go on the Jenny Craig maintenance program of just one touch every three weeks.

By the way, by "referral sources", I mean bankers, commercial real estate brokers (known as "commercial brokers"), property managers, other mortgage brokers (on a name and number referral basis only), other lenders, residential real estate agents, lawyers, CPA's, accountants, and insurance agents.  Never advertise to the public!  It doesn't work.  For fifty more tips, see my wonderful, new course, Commercial Mortgage Marketing.

The reason this came up is because my loan officers enjoy (but don't appreciate!) a wonderful marketing software program that we use, Hubspot.com. Hubspot software allows us to set up six to eight automatic follow-up emails for new contacts.

For example, suppose Alicia Gandy, our star loan officer, speaks with a new mortgage broker about Blackburne & Sons' private money commercial lending program.  Now remember, this is the first time that this mortgage broker has ever heard of Blackburne & Sons.  All Alicia has to do is to type his name and email address into Hubspot.  Then she can move on to her next lead.  While Alicia is busy quoting other deals, this new mortgage broker will automatically receive six follow-up emails from her, reminding him about our commercial lending programs and teaching him exactly when it makes sense to bring us deals.

You would be amazed how wonderfully this automatic follow-up system works.  We even started using it last year with new private mortgage investors who want to invest in our hard money loans, and we have been raising money like crazy recently.  It's the repeat nature of these follow-up emails that really cements the relationship.

But let's face it.  If you're a small loan brokerage shop, you probably can't afford Hubspot's wonderful software; but you can afford a stamp, right?

This is what you want to do.  Start by finding an empty envelope box that your company's envelopes came in.  Now, suppose you meet a banker who handles the commercial loans for Nearby Corner Bank.  Every day this banker gets inquiries from potential commercial mortgage borrowers, and he probably turns down at least 70% of them.  You desperately want this bank's turndowns!

Now you met the guy today.  That's Touch #1.  The first thing you do when you get back to the office is to hand-address a company envelope to the banker.  Inside he'll find a short letter from you reminding him that you guys met today, thanking him for his time, and reminding him that you broker commercial loans.  He'll also find enclosed two of your business cards.  You send this thank you note out immediately.  This is Touch #2.

Then you address six to eight more envelopes to him.  In each of the envelopes you include a Rat Goodie.  A Rat Goodie is a reward you give him for opening your mail, sort of like the prize inside of Crackerjacks.  The Rat Goodie could be a photocopy of a clever cartoon that you've seen recently.  The Rat Goodie could be a cute, clean joke.  You'll find hundreds of clean jokes to choose from on the Past Newsletters link on C-Loans.com.  The Rat Goodie could be a movie review or a heart-warming boast about your 9-year-old son's hit in Little League.

Never send a letter or an email newsletter without a Rat Goodie.  We are conditioning this guy to open our envelopes and to read our emails, and the rats don't like it when they don't get their Rat Goodie.  Grrrrrr!  (Just kidding.)  And of course, be sure to enclose another one of your business cards.  "But George, he already has ten of them."  Answer:  He's probably thrown them way, given them out, and or lost them.

Now back to the envelope box.  You've just met the banker.  You've sent him a thank you note immediately.  You've printed out six to eight new envelopes.  You have stuffed each one with a different Rat Goodie.  You put a business card in each one.  Now, in the upper right-hand corner where the stamp will eventually go, write in pencil a date ten days out.  On envelope #2, write a date that is ten days later, and so on.

Now you will file these pre-addressed envelopes in your empty envelope box in chronological order.  Each day, from now on, when you come in the office in the morning, the first thing you will do, after turning on the coffee pot, is to pull out the day's pulls - envelopes marked with today's date.  After awhile, you'll have at least a half-dozen pulls every day.  You affix a stamp over the date, and you drop today's envelopes in the mail.  Voila!  You now have an immensely efficient commercial mortgage marketing system.

But now let's get back to today's lesson.  A marketing system where you follow up a small number of good contacts repeatedly is far-far more efficient than one where you meet hundreds of contacts just once.  It takes at least six touches to cement a relationship, and after that you still have to touch your contacts at least once every three weeks (what I call the Jenny Craig maintenance program).

Folks, this works beautifully, and you don't need a huge marketing budget.  You just need to be religious about repeatedly touching your referral sources.


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Topics: Repeated Touches