Commercial Loans Blog

Underwriting Special Use Commercial Loans

Posted by George Blackburne on Wed, Feb 19, 2014

Special Use PropertyA Special Use Property (aka: Single-Purpose Property) is a property whose design, construction, and use precludes uses other than that for which it was built.

When underwriting commercial loans on these types of properties, it is most important to understand there is never a defined list of Special Use Properties.  Instead the underwriter must be able to recognize the characteristics of the property, which make it Special Use.

For example:

  • The property is not easily converted, in terms of costs, to another use.
  • The zoning restricts the use.
  • The property and repayment could be affected by trends, operation, equipment or cash flow.
Some examples of Special Use Properties:
  • Residential Care Facilities
  • Gas Stations
  • Movie Theaters
  • Wineries
  • Self-Storage Facilities
  • Car Wash
  • Restaurants
  • Cold Storage
  • Gentlemen's Clubs
There are many risks involved which you need to understand before moving forward with a loan on these types of properties. Some risks include a limited market for resale, specialized building or equipment which limits use, and certain uses become obsolete over time, as with trends. In many cases, Special Use Properties may be worthless if they are not being operated.

Once you recognize that the property is Special Use, approach the valuation carefully.  You need to find an expert in the area for that type of property with proven competency. Know what kind of value you are looking for - Real Estate Only or Going-Concern Value.  Will the FF&E’s have any value?  You may need to research conversion costs.

It's important to know the operator of the property.  Who is the key person?  What is their experience?  What education or specialization is necessary?

What is the history of the company?  Have they always been in that location?  Is there a history? Is it a good story or well-grounded?

Sometimes its important to know the supplies used, the raw materials, and the suppliers.

Anticipate disasters, such as a ski resort with a no-snow year, a vineyard with a drought, or E-Coli at a restaurant.  Look at the company's track record.  Do they have the cash reserves to survive?

What is your exit strategy?  Have this in place.   Your exit strategy should be different from your borrower's exit strategy.  Is long term funding needed for the deal to work?  Can it be short term?

To mitigate risk follow the Big 5:

  1. Reduce the LTV
  2. Take additional security
  3. Obtain solid guarantees
  4. Include good operating covenants
  5. Don’t make the loan 

Here are some other important considerations:

  1. Who will come to OUR rescue?
  2. Is there a dumber lender?
  3. Will the guarantors really make a difference?

When making a commercial loan on a Special Use Property, you should include loan covenants, such as operating ratios, “no dark” provisions, periodic inspections and reports.  For example, if you have a storage facility request, you may want to obtain bi-annual reports of tenant names and information.  On properties with septic tanks and wells, require periodic inspections.

And last, but arguably most important, what is the mortgage history of the borrower?  Were his last two loans private money loans?  Did he take cash out each time?  What was his payment history?  You have to look at it as the borrower is not operating well if he needs to keep getting private loans.  Why?  Is he not making money?  Is he not good with his finances?

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Topics: Special Use Property Loans

Preferred Equity Can Save Investors and Commercial Loan Brokers

Posted by George Blackburne on Wed, Feb 12, 2014

Preferred equityIf you have a balloon payment coming due on your commercial property, or if you are trying to buy an investment property, and you don't have a whopping 42% of the purchase price to put down in cash, this article is super-important to you.

Preferred equity is a wonderful form of commercial real estate capital that can save your bacon, whether you're a commercial loan broker or a commercial real estate investor.  Some examples will hammer home this critical concept.

Let's suppose that you're a commercial real estate investor.  You make your living buying and leasing out office buildings and shopping centers.  In 2004, you paid $2.6 million for a strip center in Los Angeles.  You put down $650,000 (25%) and took out a $1,950,000 new first mortgage from Ruby Bank.  This new commercial first mortgage had a 10-year term.

It's now the year 2014.  Your $1,950,000 first mortgage is ballooning, and you realize that you have a problem.  During the trough of the Great Recession, your $2.6 million strip center had fallen in value to just $2 million.  Fortunately, with the recovery, your strip center is now worth $2.5 million; but that's not enough.

The problem is that few commercial banks will make commercial real estate loans in excess of 58% to 63% loan-to-value today.  Even if you could convince a bank to make you a loan of $1,575,000 (63% of $2.5 million), the proceeds of the loan won't be enough to pay off your $1,950,000 existing first mortgage.  Yikes!

Even forgetting about points and closing costs, you will be short a whopping $375,000.  The bank will expect you to bring the shortfall to the closing; but you don't have $375,000 in cash!  You barely survived the Great Recession without losing any property.  To make matters worse, you personally guaranteed the loan from Ruby Bank.  You're in deep trouble.  Your dog could leave you, and your wife could bite you.

You sit down with your banker, and you ask him, "What if I could find a hard money lender to make a $375,000 second mortgage?"  The banker replies, "Commercial banks won't allow second mortgages behind their commercial first mortgages these days.  They don't want the propety overburdened with debt.  The danger is that if the owner's cash flow gets tight, he might be tempted to use the money earmarked for repairs and maintenance to make the payments on the second mortgage.  The property will fall into disrepair, the tenants will move out, and the bank will end up foreclosing on a run-down, vacant strip center with a leaking roof and mold all over it."

"What am I going to do?" you ask the banker.  The banker replies, "You need to find a partner to contribute $375,000 in cash to the deal, in return for a partial ownership of the building."  So you go to your brother-in-law, begging for cash, only to find out that he is as impoverished as you are.

Fortunately you find Blackburne & Sons, the only realty capital provider in the country making small preferred equity investments (its easier to think of them as preferred equity loans), from $100,000 to $600,000.  Most preferred equity providers won't even look at deals smaller than $3 million.

Blackburne & Sons agrees to invest $300,000 in preferred equity into your property, bringing the preferred equity capital stack (the sum of the first mortgage plus the preferred equity) up to 75% of value.  This means that you, the owner, still have to bring to the closing table $75,000 in cash, but this smaller amount is far more manageable.  It sure beats defaulting on your balloon payment and getting sued for the deficiency.

Here's another example of how preferred equity can save your bacon:

You're a commercial loan broker.  You have a wealthy commecial real estate investor who wants to buy an office building in Pleasanton, California for $3 million.  Your customer is insisting on a new permanent loan of 75% loan-to-value, but of the 13 banks that you have approached, none of them would lend more than 63% of the purchase price.  Your buyer refuses to put down more than $750,000, but the bank won't lend more than $1,890,000.  You are short $360,000, but the bank won't even allow the seller to carry back a second mortgage.  You're at loggerheads.

A $360,000 preferred equity investment from Blackburne & Sons can save this deal, along with your $22,750 commission (1 point).

Why would the bank allow a $360,000 preferred equity investment, but not a $360,000 second mortgage from the seller?  Preferred equity is NOT a loan.  If the buyer doesn't have the cash flow to make the preferred equity yield payments, he doesn't have to make them.  They simply accrue and defer.  The buyer doesn't have to neglect the needed repairs on the property in order to make the payments.  This is the critical distinction between a second mortgage loan and a preferred equity investment.

Preferred equity is not cheap.  It will cost the borrower between 16% and 22% annually, plus an 8 point investment banking fee to raise the capital.  The investment term is five years.  If the buyer does not pay us off at that time, the property will be sold to pay off the preferred equity investment.  Any remaining profit goes to the buyer.

Why is preferred equity so expensive?  Preferred equity competes against private money first mortgage investments, which can yield up to 12% to 14%.  Clearly a $300,000 preferred equity investment behind a $2.5 million first mortgage from the bank is far-far more risky than a $300,000 hard money first mortgage investment.  Suppose the tenants move out?  The monthly payments on the underlying first mortgage from the bank could be $14,000 per month.  Imagine making $14,000 monthly payments, month after month, as you deperately try to find new tenants.

But there is good news.  Blackburne & Sons can be bought out at any time for what is "owed"; i.e., its original investment, any advances, interest on the advances, plus a 17% per annum preferred equity yield on the original investment.  If our deal were a loan, you would say that our loan had no prepayment penalty.

An example will make this more clear.  Let's suppose that Robert Buyer teams up with Blackburne & Sons to buy for $1 million a small row retail building in downtown Palo Alto, California.  Mr. Buyer puts up $250,000 and Blackburne & Sons puts up $120,000 in a preferred equity position.  The bank makes a new commercial loan of $630,000.  The agreed-upon preferred equity return is 17%.

Just weeks after we buy the property, Apple Computer decides to buy this entire block in Palo Alto as part of their campus.  Apple agrees to pay a ridiculous sum, a whopping $2 million.  The all-cash deal closes just 10 days later.  The equity holders get to split a cool $1 million profit.  But who gets what?

The profit distribution plan of an equity venture is called a waterfall.  In this case, the first equity investor to be repaid its $120,000 principal investment is Blackburne & Sons.  Is there any more left over?  Yup, there's TONS of money left over.  Okay, so Robert Buyer gets back his $250,000 principal investment.  Is there any money left over?  Yes.

Therefore, Blackburne & Sons earns its preferred return of 17% annually (prorated for 37 days), so we earn a whopping $397.  The balance of the $1 million profit ($999,603) goes to Robert Buyer!

Preferred equity capital is expensive.  Therefore the wise borrower will repay Blackburne & Sons at the fastest possible pace.

Are you a commercial mortgage banker?  If so, you would be wise to heed my words here.  This is a brand new program, and no one in the marketplace knows about it.  Using our preferred equity, you can give your buyers and borrowers more leverage that any other mortgage banker in the country.  This gives you a HUGE marketing advantage.  In commercial real estate finance, the commercial mortgage banker who wins the deal and earns the fee is often NOT the guy with the lowest rate, but rather the guy who offers his borrowers the most dollars.

So be smart here.  Promote the heck out of this program!

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Topics: preferred equity examples

10 Smart Commercial Loan Tips

Posted by George Blackburne on Sun, Feb 9, 2014

Smart IdeaCommercial loans are still quite hard to close these days.  Here are ten practical tips that will help you qualify for a commercial loan:

  1. Instead of calling random commercial mortgage companies for your commercial real estate loan, focus your phone calls on commercial banks.  Commercial banks make the most number of commercial loans these days.  You can also save yourself countless phone calls by simply using C-Loans.com.
     
  2. Don't forget about credit unions.  Credit unions, who historically never made commercial loans, have come out of nowhere to seize 5% of the commercial real estate lending market over the past two years.
     
  3. Use local lenders.  Many commercial mortgage borrowers are under the mistaken belief that some mystical nationwide commercial lender offers lower rates than a local bank.  This is simply untrue.  You'll get your best commercial mortgage deal from a commercial lender located close to the subject property.
     
  4. You can find all of the banks and credit unions located close to your commercial property by merely plotting your property on maps.google.com.  In the left column you'll see a photo.  Click the hyperplink underneath the photo that says, "Search Nearby."  Simply enter "banks" and hit return.
     
  5. If you are trying to buy a commercial property, and you don't qualify for an SBA loan, you are about to discover that you have a problem.  Most commercial banks will not make conventional (non-SBA) commercial mortgage loans in excess of 58% to 63% loan-to-value these days.  This means that you have to put 37% to 42% down.  Yikes!  Who has that kind of money?
     
  6. You can solve this problem by using preferred equity investments from Blackburne & Sons.
     
  7. What if you have a $2 million balloon payment coming due on your commercial property, but the bank will only lend you $1.6 million?  A $400,000 preferred equity loan from Blackburne & Sons might save your property.  (Technically our $400,000 is not a loan but rather an equity investment; but its easier to think of it as a tiny mezzanine loan.)
     
  8. If you are in the commercial loan business, make sure you are building your list of referral contacts every day.  I am a huge fan of list advertising.  The cold weather has greatly slowed commercial loan demand this winter, but my own commercial mortgage company, Blackburne & Sons, was able to respond by doubling the number of email newsletters and fax newsletters that we send out every day.  I am pleased to report that we did this, and my loan officers are once again deliciously buried with commercial loans.
     
  9. Don't give up on your commercial mortgage newsletters too soon.  Your first five newsletters may not generate a single lead, but if you send out a fun, folksy, unprofessional commercial loan newsletter every 10 to 21 days religiously, your sixth newsletter will be a hit.  I  promise you!  Why?  It takes a while for The Newsletter Effect to kick in, but once it does, it is a powerful force.  This is what happened to my own son, Tom.  "Dad, these stupid newsletters aren't working.  No one is calling."  Then his sixth newsletter hit.  Bam!  His phone have been ringing like crazy ever since.  I've got to tell you, it felt good to be vindicated in front of my own son.  Need more help with your commercial mortgage marketing?
     
  10. You could easily be closing three times more commercial loans than you are today, but you keep making 67 different mistakes.  I recently finished my training masterpiece, my Commercial Mortgage Broker Practice Course.  The course contains 67 different, very practical lessons on commercial mortgage brokerage, including the very first thing to say to a commercial lender when you call him to run a deal by him and including the single most important lesson in all of commercial real estate finance.  It's a five-hour audio course, designed to be listened to in your car on long drives.  Ideally you should listen to it at least five times, but if you listen to it just three times, I promise you will triple your income as a commercial mortgage broker.  "But George, I'm as poor as a church mouse right now.  I can't afford $199."  No problemo.  Simply submit two commercial loans using C-Loans.com and earn $100 Blackburne Bucks for each submission.  Then you can buy this amazing course without it costing you one penny out of pocket.  Folks, it will change your life!

Commercial Mortgage Brokers Tired of Being Poor?

Topics: 10 Commercial Loan Tips

Save Your Commercial Loans Using Preferred Equity

Posted by George Blackburne on Tue, Feb 4, 2014

Capital StackIf you are a conventional buyer of commercial real estate, or if you are a commercial broker, this article is VERY important to you.  The reason is because you are about to discover a BIG problem with your next commercial real estate loan.

It is very hard these days for a buyer or a commercial broker to put together a conventional purchase of an investment property, like an office building or a shopping center.  Banks today will only make commercial mortgage loans up to around 58% to 63% loan-to-value.  This means the buyer of a commercial property - assuming he can't get an SBA loan - has to put 37% to 42% down in cash.  Who has that kind of money?

The good news is that Blackburne & Sons has a wonderful new commercial loan product - more precisely a preferred equity investment - that will solve this problem for you.

Why are the banks so conservative when underwriting commercial real estate loans today?  Many commercial banks lost a ton of money in commercial real estate loans during the Great Recession.  These banks watched in horror as commercial real estate fell in value by 45%.  In addition, the portfolios of many commercial banks are too heavily invested in commercial loans today.  Why?  They can't get these legacy loans (loans written before the Great Recession) off the books.  Although the vast majority of these legacy loans are current, a great many of them are past maturity, and they exceed 85% loan-to-value, based on today's lower values.  Yikes!

To make matter worse, not only will few banks make commercial loans that exceed 58% to 63% loan-to-value, these banks will NOT allow junior financing (a second mortgage).  In other words, the seller cannot carry back a second mortgage.  The banks don't want to see these commercial properties over-burdened with debt.

"Okay, George, you promised me the cure for this problem.  Let's hear it."

Blackburne & Sons will add its dough to the buyer's downpayment to come up with the 37% to 42% required by the bank.  Typically the buyer will come up with the first 20% to 25%, and we'll come up with the rest.  In return, Blackburne & Sons will take a preferred equity investment in the property.

A preferred equity investment is NOT a second mortgage or even a mezzanine loan.  It's an equity investment.  The buyer of the property is not promising to pay any interest rate to the preferred equity investor, nor is he promising to even repay the preferred equity investor's original investment.  Repayment is dependent on the success of the real estate venture.

If the real estate venture is successful, however, the first equity investor to be repaid is the preferred equity investor.  He's special (said in the voice of the Church Lady from Saturday Night Live).  The original buyer of the property - who owns what is known as the common equity - only gets paid any profit after the preferred equity investor gets repaid his original investment, plus the agreed-upon preferred return.

An example will make this more clear.  Let's suppose that Robert Buyer teams up with Blackburne & Sons to buy for $1 million a small row retail building in downtown Palo Alto, California.  Mr. Buyer puts up $250,000 and Blackburne & Sons puts up $120,000 in a preferred equity position.  The bank makes a new commercial loan of $630,000.  The agreed-upon preferred equity return is 17%.

Just weeks after we buy the property, Apple Computer decides to buy this entire block in Palo Alto as part of their campus.  Apple agrees to pay a ridiculous sum, a whopping $2 million.  The all-cash deal closes just 30 days later.  The equity holders get to split a cool $1 million profit.  But who gets what?

The profit distribution plan of an equity venture is called a waterfall.  In this case, the first equity investor to be repaid its $120,000 principal investment is Blackburne & Sons.  Is there any more left over?  Yup, there's TONS of money left over.  Okay, so Robert Buyer gets back his $250,000 principal investment.  Is there any money left over?  Yes.

Therefore, Blackburne & Sons earns its preferred return of 17% annually (prorated for 37 days), so we earn a whopping $397.  The balance of the $1 million profit ($999,603) goes to Robert Buyer!

An important and very favorable point to notice here is that Blackburne & Sons can be bought out at any time for our original principal, plus its preferred return (17% annually in this example) since inception, compounded, with no prepayment penalty!

Let's look at another example.  Let's suppose we buy together a multi-tenant office building.  Unfortunately two of the seven tenants move out.  Therefore the property is not bringing in the kind of income that we projected.  Fortunately the property is making enough money to service the first mortgage, plus there is enough to pay the preferred equity investors a 5% return, but not the agreed 17% preferred return.

What happens?  Can Blackburne & Sons sue Robert Buyer?  No!  Remember, Mr. Buyer never promised Blackburne & Sons any sort of return, not even a return of its $120,000 principal investment.  All Blackburne & Sons can do legally is fire Mr. Buyer and bring in a more competent property manager.

What happens to the unpaid preferred return?  It accrues, defers, and compounds at 17%.  When the property sells, any profit will first be applied towards these arrearages.

"Okay, George, what you're describing is pretty garden-variety preferred equity.  What's so special about your program?"

The unique thing about Blackburne & Sons' Preferred Equity Program is that we will make TINY deals.  Most preferred equity providers have a $3 million minimum.  Blackburne & Sons will only make preferred equity investments of between $100,000 and $600,000.

"How much does your equity cost?"

Each deal is individually priced, so a lot depends on the deal.  Deals in California are much cheaper.  Attractive properties are cheaper.  In these equity investment deals, the CV (curriculum vitae or the business resume) of the buyer matters a lot.

That being said, most deals will cost between 16% and 22% annually and eight origination points.  Keep in mind that these preferred equity investments are tiny-tiny amounts, especially when compared to the bank's new first mortgage.  If he can borrow $630,000 at only 4.75% and $120,000 at 17%, the buyer's weighted average cost of funds is dirt cheap (6.71%).   Also remember that the buyer can buy out Blackburne & Sons at any time.

"How do we get started?

Just call your Blackburne & Sons loan officer or call Angela Vannucci, Vice President and Equity Division Manager, at 916-338-3232.

Learn More Details About Preferred Equity

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Topics: preferred equity