Commercial Loans Blog

Commercial Loans, Higher Rents, and the Return of Commercial Investors

Posted by George Blackburne on Fri, May 30, 2014

Office for leaseThe year was 2010.  Real estate had collapsed due to the Great Recession.  Commercial real estate had fallen by 45%.  Residential real estate had fallen almost as far.  Professor Robert Shiller of Yale was warning of further declines in real estate, as the tens of thousands of foreclosures-in-process (the homes in the so-called shadow inventory) were released onto the market.  And then ...

Nothin'.  The washout never happened.  Enormous opportunity funds, like Blackstone, had figured out that they could buy these foreclosures for all cash and rent them out for a 7% to 9% cash-on-cash return.  That was a huge return, considering that Treasuries were paying only 2%.

Stories began to circulate of hedge fund executives driving by hundreds of foreclosed homes in a single week ... and then making aggressive offers on them all.  Suddenly young couples could no longer find entry level houses to buy.  Home values stopped declining, stabilized, and then started to march back upwards.

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A little old man shuffled slowly into the "Orange Dipper", an ice cream parlor in Naples, Florida, and pulled himself slowly, painfully, up onto a stool.  After catching his breath, he ordered a banana split.  The waitress asked kindly, "Crushed nuts?"  "No," he replied, "hemorrhoids."

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When commercial real estate plunged by 45% during the Great Recession, most commercial lenders got crushed.  They took enormous losses.  As a result, for the past five years, the only types of commercial real estate loans sought by the banks were either SBA loans and USDA loans, which were mostly guaranteed by the government.  The key issue to grasp here is that most of the properties receiving commercial loans for the past five years were owner-user buildings.  This is about to change.

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A daddy teased his little daughter by suggesting she liked a certain boy in her kindergarten class.  The little girl was quite indignant. "No, daddy, I don't like him!" she stated. "He's only interested in one thing."  Shocked, the daddy cautiously asked what that one thing might be.  "Power Rangers, of course," said the toddler.

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Commercial real estate rents are about to start increasing.  The U.S. economy is building up tremendous strength due our plummeting reliance on imported oil, the thousands of new jobs being created in the oil fields, dirt cheap natural gas to power our power plants, our enormous cost advantage in heavy manufacturing (in heavy manufacturing energy is by far the largest line item expense), an improving housing market, the use of robots to replace cheap labor in Asia, and the growing trend of on-shoring, which allows a manufacturer greater quality control and flexibility.

Folks, I was right about the Great Recession, and I am right about this.  Our economy is already the King Kong of the world, and we will continue to pull even further ahead.  The next few decades will be the Golden Age for the United States.  Here in the Midwest, where I personally live, the wealthiest men in town are all in manufacturing.  At my country club, every manufacturer is telling me the same thing - business is booming!

With commercial real estate falling by 45%, there has been very little new commercial real estate construction for six years.  In the meantime, a certain number of older buildings have become economically obsolete and have been either demolished or abandoned.  Now overlay an expanding economy, and you can see how competition to rent existing commercial buildings will almost certainly lead to higher commercial rents this year.

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A pirate walks into a bar wearing a paper towel on his head.  He sits down at the bar and orders some dirty rum.  The bartender asks, "Why are you wearing a paper towel?"  "Arrr..." says the pirate. "I've got a bounty on me head!

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Do you know what you haven't seen for six years?  Investors buying commercial buildings for income.  This is the point of today's article.  This year will mark the return of income property investors and the commercial-investment loan.  Wealthy investors will be snatching up good rental properties, like multi-tenant office buildings, strip centers, and industrial buildings.

"Gee, George, how can you be so sure?"  With rents increasing, investors will be able to buy good rental buildings at attractive 6% to 7% cap rates, with the excellent prospect of earning 8% to 10% as the economy heats up and the demand for commercial space increases.

What does this mean for you?  More and more of the commercial loans that you'll be seeking this year will be for commercial-investment properties, as opposed to owner-user properties.  The bank may not give you a 75% LTV loan, even if your proposed commercial loan cash flows beautifully.  Banks are still nervous.

If you ever find yourself frustrated because the bank won't make you a large enough commercial loan, please remember our preferred equtiy.  We'll add our equity to your downpayment to create a downpayment large enough to satify the bank.

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Topics: Higher commercial rents

Commercial Loan Lessons #1 - Land Loans, Crashes, and Con Men

Posted by George Blackburne on Mon, May 19, 2014

Land LoansThe more expensive the commercial loan quote, the less likely it is to be either BS or some advance fee scheme.  Put another way, the higher the rate and points a lender quotes you, the more likely the commercial loan quote is to be real.

For example, a buddy of mine recently sent me an email saying that he had just funded a $1 million hard money land loan using a single, wealthy investor.  Apparently this investor used to be in the land banking business, and he only invests in land loans.  Here's the comment in his email that convinced me that this investor of his was real:  "This is expensive money - make no mistake about that.  The minimum IRR for him alone is 16-18% annually, before we get paid."

In contrast, an advance fee scammer would quote 5.5% and 2 points.  On a land loan?  Whenever you hear an unusually attractive quote like that, ask yourself, "Who is quoting 5.625% and forced this so-called lender (advance fee scammer?) to drop his rate to 5.5%?"

Lenders only drop their interest rate and points in response to competition.  If a "lender" has no apparent competition, and his rates are deliciously low, be on your guard.  He's out to con a big application fee out of you.  The interest rates here at Blackburne & Sons started out at 5,000% per day (hey, I'm a proud capitalist), until we were forced by competitors to drop our rates.  Now we're quoting just 8.9% to 11.9% annually.  Darned competitors!  :-)

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You know it's time to diet when you dance, and it makes the band skip.

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The new hot commercial lending product out there is a blanket commercial loan against a portfolio of 5 or more rental houses.  More and more lenders are entering this market.  Blackburne & Sons is doing a $1.25 million blanket loan on about 35 homes this month.

 

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I have owned my own hard money commercial mortgage company now almost 34 years.  During those years we have survived three horrible real estate recessions.  The guys that bought commercial real estate at the very bottom of the market made a fortune.  If only I knew when the bottom was the bottom.  I would have loaded up on commercial real estate.

Hey, wait a minute!  I actually DO know.  In all three real estate crashes over the past 34 years, commercial real estate fell by almost exactly 45%.  All three times a 45% decline was the nadir (bottom point) of the collapse.

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You know its time to diet when you are diagnosed with the flesh eating virus, and the doctor gives you 22 more years to live.

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"Gee, George, if commercial real estate fell by almost exactly 45% during the Great Recession, you ought to be loading up on commercial real estate!"

We are!  That's why Blackburne & Sons has just come out with its new preferred equity program.  We add our equity on to your buyer's 25% downpayment to create a cash downpayment large enough to satisfy the bank.  You really-really need to understand this concept of preferred equity.  It will save so many of your commercial real estate loans and property sales.  Preferred equity is NOT a loan.  It's equity!

 

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About two dozen mortgage brokers out there have had the common sense to trade one banker making for commercial loans for the 2,000+ bankers making commercial loans on The Blackburne List.  "Gee, one for two thousand ... is that a good deal?"  You better jump all over this offer before it goes away.  Or you can buy The Blackburne List for $39.95.

 

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While we are on the subject of real estate crashes, did you ever wonder how commercial real estate appraisers find market comparables when nothing is selling?  That is when commercial real estate lenders stop talking about fair market value, and all they want to talk about is cost.  What did you pay for the building originally?  Don't tell me what it once appraised for.  What did you actually pay for it?  Cost-cost-cost.  Marcia-Marcia-Marcia.  All commercial lenders want to talk about during real estate crashes is cost.

This brings up the concept of clearing the market.  For almost all goods (including stocks in a financial panic), there is some price at which an all-cash buyer can be found.  The process is also called liquidation.  The price just has to drop - drop - drop until the asset finally clears the market.  I was reminded today of a Warren Buffet quote:

Be fearful when others are greedy, and be greedy when others are fearful.

 Tornado

Topics: Commercial loan lessons #1

Commercial Loans on Restaurants

Posted by George Blackburne on Fri, May 16, 2014

CrisisIf a restaurateur owns a successful restaurant, it is often surprisingly easy for him to obtain a new commercial loan from his own, local commercial bank.  Bankers go out for lunch a lot, and they spend much of their time schmoozing with the wealthy elite of the community.  They know from mere observation which restaurants in town are packed and which ones are almost deserted.

Therefore, if a restaurateur has a thriving restaurant and a good financial statement, and if he maintains healthy cash balances on deposit with his bank, his banker will usually fall all over himself in an effort to supply any needed commercial loan.

But what about less-successful restaurants or restaurants wth unimpressive financial statements.  Can these borrowers still obtain a commercial loan?  It depends.

We all know from experience that restaurants suffer from a very high failure rate.  The common belief, however, that 90% of all restaurants fail in their first year is just a myth.  According to a 2005 research study by the Cornell Hotel and Restaurant Administration Quarterly, about 25% of restaurants fail in their first year.  Another 20% fail in the second year, and another 15% fail by the third year.  Therefore 60% of all new restaurants fail within the first three years.  Clearly restaurants are a very risky asset class upon which to make commercial loans.

But the Chinese character for crisis is the symbol for danger next to the symbol for opportunity.  For commercial loan brokers, there is money to be made helping restaurateurs find a commercial loan.

When might a restaurant commercial loan be do-able?  We start from the basic proposition that if the restaurant owner's business is thriving, if he has a good financial statement, and if he maintains substantial cash on deposit with the bank, he doesn't need the help of a commercial loan broker.  His own bank will do the deal.

Therefore, if you are looking at a commercial loan package on a restaurant, you can pretty much bet that the deal will be flawed.  The restaurant will either be losing money on paper, the restaurateur will have sloppy or poor credit, and/or he will not have a lot of liquidity.

Here are some times when a commercial loan on his restaurant might still be do-able:

  1. If the borrower has pristine credit and substantial cash deposits, but his income statement and tax returns show him making very little money, many private money commercial lenders, like Blackburne & Sons, will still make him a commercial loan.  The restaurant business is a cash business, and few veteran commercial loan underwriters would be terribly shocked to learn that every single cash sale is not making it into his bank account and/or on to his income statement.  He is also probably running a lot of household expenses through his business.  The guy clearly is making money.  He is just cheating on his tax returns.
     
  2. This reminds me of the old joke: The owner of a small deli was being questioned by an IRS agent about his tax return. He had reported a net profit of $80,000 for the year. "Why don't you people leave me alone?" the deli owner said. "I work like a dog. Everyone in my family helps out. The place is only closed three days a year. And you want to know how I made $80,000?" "It's not your income that bothers us," the agent said. "It's these deductions. You listed six trips to Bermuda for you and your wife." "Oh, that," the owner said smiling. "I forgot to tell you - we also deliver.”
     
  3. If the restaurant business has been in business for ten years or more, under the same owner, a commercial loan underwriter will probably be more inclined to approve the deal, even if the business is losing money on paper.  It's those dangerous first three years when the failure rate is so high - 60%.
     
  4. Can the building be used for anything else?  A Denny's-style restaurant building, with a corner location and a large parking lot, probably is best used as a restaurant.  In contrast, what if the propety is a garden-variety row commercial building.  A row commercial building is simply a big box in a downtown area, where the neighboring buildings touch it on the left and right sides.  It's basically like a townhouse, but its commercial space.  Today it might be occupied by a restaurant, but in the past it was an office supply store, and before that it was a dress store.  The key thing here is that the space is generic.  A private money commercial lender could lend aggressively on such a commercial building because the property has multiple uses.
     
  5.  Be wary of restaurant buildings whese several prior restaurants have already failed.  Sometimes the location just sucks.  Maybe the building is on a busy one-way street.  Maybe there is a road divider (median), and there is no suicide lane for easy access to the restaurant building.  Maybe its almost impossible to find a  parking space.  Some restaurant buildings are so poorly located that any restaurant that tries to open there is doomed to failure.
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Do you have a client trying to buy a commercial-investment property with just a 25% downpayment?  Frustrated that the bank will only lend up to 58% of the purchase price, even though the deal cash flows perfectly at 75% LTV?  We'll add our equity to your buyer's downpayment to create a downpayment large enough to satisfy the bank.
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Topics: restaurant loans

Commercial Loans, Marketing Leverage, and Meeting Wealthy Investors

Posted by George Blackburne on Mon, May 12, 2014

LeverageThis article has some real gems for both commercial brokers (commercial realtors) and commercial loan brokers, so please read on.  Both kinds of professionals need to finish this article.

Historically, my hard money commercial loan company, Blackburne & Sons, has relied on commercial loan brokers to bring it most of its deals.  The advantage of advertising to mortgage brokers is marketing leverage. Commercial loan brokers, this section on marketing leverage is your gem.

Let me explain what I mean by marketing leverage.  Let’s assume that the average mortgage broker spends $400 per month advertising for real estate loans.  The mortgage broker might use a classified ad in the newspaper or an advertisement in the local PennySaver.  He might buy AdWords on Google.  He might call on realtors.  He might market for leads using direct mail.  Marketing for real estate loans using direct mail (snail mail) is very expensive and is essentially a complete bust if you are seeking commercial loans.  It does work, however, for home loans.  My point is that the typical mortgage broker spends at least $400 per month marketing for real estate loans.

If you can reach a mortgage broker, every ten days to two weeks, using a fun, entertaining, wacky, and intentionally unprofessional newsletter for, say, $1 per month - and if the mortgage broker himself is spending $400 per month marketing for real estate loans - you will have reached a huge market for your lousy $1 expenditure.  You will be able to compete for any deal that your mortgage broker finds that fits your niche.  You have leveraged that one marketing dollar by 400 times (his $400 expenditure).  I love marketing leverage.

But the commercial loan market is changing - evolving - become more efficient.  In the past, very few hard money lenders, like Blackburne & Sons, made commercial loans.  Since the real estate crash caused by the Great Recession, Federal regulators have made it extremely difficult for hard money lenders to make loans on owner-occupied homes.  Many hard money lenders therefore have fled residential lending, and they are now making commercial loans.

Hard money commercial loan companies, like ours, now have far more competition.  Mortgage brokers therefore have lots of choices, and one hard money commercial mortgage loan is often priced much like another.  Blackburne & Sons can no longer rely on being the only company willing to make a commercial loan.

Therefore Blackburne & Sons has little choice but to change the thrust of its commercial loan marketing.  Instead of being just a wholesale commercial loan company, we must also add a retail channel - where we solicit income property investors and commercial brokers (commercial realtors) directly.

Here is a vitally important concept that I really need to engrain in you: “An investor is an investor.”  The same guy who has a large stock portfolio may also own commercial real estate.  He might also invest in first trust deeds.  He just needs to be wealthy.

The way I raised my first private mortgage money thirty years ago was by advertising to my wealthy former commercial loan borrowers.  “George, you turned former commercial loan borrowers into trust deed investors?  You turned borrowers into lenders?”  Yup, and it makes perfect sense.  Who owns large office buildings?  Poor folks?  I think not.

Large office buildings and shopping centers are owned by wealthy investors.  An investor is an investor.  (Where have I heard that before?)  It made perfect sense that that the wealthy income property investors coming to us for bank-quality commercial real estate loans (we brokered commercial loans to banks back in the early days) would also have tons of dough in their profit-sharing plans and IRA’s to invest in our first trust deeds.

This brings up the gem I promised for commercial brokers:  
Every commercial broker (commercial realtor) should also own a commercial mortgage company.  There is no better way to meet wealthy investors in the legitimate course of business than to own a commercial mortgage company.  (Please read that last sentence again.) Once you meet these wealthy income property investors through your commercial mortgage company, you can sell them commercial real estate.

My main point today is our loan officers at our commercial loan company need to start saving the contact information of every wealthy income property investors that they meed in the legitimate course of business.  The same is true of any commercial brokers (commercial realtors) they meet because these commercial brokers can introduce them to wealthy income property investors who need commercial loans.

The goal is this:  That each commercial loan officer will have so many contacts in the world of wealthy income property investors that his business will morph from being a guy who has to beat the bushes for commercial loans to a guy who works full-time just closing commercial loans for his network of commercial loan clients.  The commercial loan officer will stop being a wholesaler of commercial loans to becoming the guy with the real financial power - a commercial loan officer with hundreds of loyal commercial loan clients.
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If you are trying to finance the purchase of commercial real estate for an investor, you are about to run into a big issue:  Banks won't make conventional commercial loans higher than 58% to 63% LTV.  Our preferred equity solves this problem.
 
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Topics: Wealthy investors

Commercial Loans and Properties on a Hill

Posted by George Blackburne on Mon, May 5, 2014

Gauls Invade RomeIn the year 390 B.C. - two-hundred-ninety years before the birth of Julius Ceasar - Rome was just a small city-state.  We are not talking about the Roman Empire now.  The Golden Age of Rome would not happen for another 350 years.  We are talking about Rome when it could barely sprout whiskers.  

The Gauls (barbarians from modern-day France) had invaded Italy, and they were marching on Rome.  A formidable Roman Army marched out to meet them ... and the Romans got their butts kicked (Battle of Allia).  A handful of Roman survivors streamed back into the city, bringing the ill-tidings.  The population of Rome, already fearing the worst, was packed and ready to go.  Almost the entire population fled south, taking with them their valuables.

The Gauls poured in, raping and killing anyone they found still in the City.  A handful of survivors took refuge at the top of the Capitoline Hill of Rome, where they built barricades of wood, stone, carts, and anything else they could find.  For days the Gauls stormed that hill, only to be driven back, with heavy casualties, by the handful of survivors.

Then the Gauls settled in a for siege, where days passed without further fighting.  The Roman survivors were lulled into complacency.  In middle of the night the barbarians crept up a narrow, hidden path to the top of the hill, where they silently dispatched the guards.

SUDDENLY a gaggle of geese was disturbed, and they began to HONK and HONK loudly.  Awakened from their slumber, Roman soldiers, old men, and young boys rushed to the imperiled battlements.  Desperately fighting for their wives, mothers, and children, the valiant defenders drove the Gauls off the walls and back down the hill.

Several weeks later a Roman relief army broke the siege, and the near-starving Roman inhabitants were saved.  For the next 800 years, geese were considered sacred in Rome.  If you look carefully at the illustration, you'll see the sacred geese squawking up a storm.

"Wow, George, that was an exciting story, but what does it have to do with commercial real estate finance?"

For the reasons described here today, real estate on hills almost always sells at a large premium compared to real estate in the flatlands.  The good views available from real estate on a hill are an equally important reason, but there is always the thought in the minds of the wealthy, "The barbarians are coming.  Barricade the road!"

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Continue to be on the look-out for that old business card of that banker you picked up eight months ago.  You can trade it for a Directory of 2,000 Commercial Real Estate Lenders.

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Are you working on a purchase money commercial loan?  Are you frustrated because the bank will only lend your buyer 58% of the purchase price?  Remember, Blackburne & Sons will add its equity dollars (called preferred equity) to your buyer's 25% down payment to make your down payment large enough to satisfy the bank.

Learn More Details About Preferred Equity

Topics: Property on a hill

Commercial Loans That Cash Flow Too Well

Posted by George Blackburne on Thu, May 1, 2014

Bad CreditOne of our commercial loan officers said to me this week, "George, this commercial loan cash flows really-really well."  To which I replied, "I would much rather make a commercial loan that didn't cash flow worth a darn."  Why of EARTH would I say such a thing?

Poor folks with lousy credit pay far more for a 2-bedroom, 1 bath apartment than renters of nicer units with good credit.  The reason why is that in order for landlords to be willing to rent to folks with poor credit, they need to make a large premium in order to make up for the flakes who skip out in the middle of the night and the lowlifes who trash their property.

Its much the same way for rent-to-own funiture and appliance stores.  Used car dealerships, which sell most of their cars to buyers with poor credit, do the same thing.  They charge a huge premium for their cars.

Therefore any time you see a multifamily or commercial property that cash flows unusually well, be alert to the possibility that the property may be in a rough area and/or may have low-class, dangerous tenants.

Another way to look at the same issue is to look at the cap rate.  Remember, a cap rate is just the return on your money that you would enjoy if you bought a commercial property for all cash.

For example, if you paid $1 million for a property that generated $80,000 in net operating income, you purchased the property at an 8% cap rate ($80,000 NOI / $1,000,000 purchase price times 100%).

What would you say if I told you that in order to collect your 8% return, you would have to drive through the ghetto every month to collect your rent?  Would you still pay $1 million for the property, when you would literally be risking your life every time you drove to see your own property?  If you got a flat tire, you might never see your sweet wife and kids again.  I can see the headline now, "Landlord Beaten to Death With Lead Pipe.  Local Toughs Suspected."

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Okay, so clearly you wouldn't pay $1 million for just $80,000 coming out of the ghetto.  How about $900,000?  Naw.  How about $750,000?  Tempting ... but no.  How about $600,000?  Well, every person has his price.  You could hire an armed guard to accompany you every month when you went to inspect the property and collect your rent.

Okay, so if you buy the property for just $600,000 - what is your cap rate?  C' mon, guys, this is just 7th grade math.  Chug a Red Bull and stay awake here.

Cap Rate = (Net Operating Income / Purchase Price) x 100%

Cap Rate = $80,000 NOI / $600,000 Purchase Price - all times 100%

Cap Rate = .133 times 100%

Cap Rate = 13.3%

The good news for you is that your new commercial loan from the bank is going to cash flow very well.  If the bank is financing 70% of the purchase price ($600,000 times 70% LTV = $420,000), and the bank is offering 5.5% commercial loan, with a 20-year amortization and a 5 year term, your debt service coverage ratio would be a whopping 2.31.  Wow.  This commercial loan has to be really-really safe, right?

Well ... until the tenant moves out, the two pit bull terriers are no longer manning the barbed-wire fence, local druggies quickly strip the building of all of its copper wire, and then the local gangsters vandalize the building, just for fun.

Okay, now let's compare this industrial building in the ghetto to a nice apartment building within walking distance of Chinatown.  That same $80,000 in Net Operating Income, because the property is in a such a wonderful location, might sell for $2,286,000 (a 3.5% cap rate).  The building would only carry a $858,000 new loan, if the commercial lender insisted on a 1.25 debt service coverage ratio.  Holy smack, the property will only carry a new commercial loan of 37.5% LTV because the property is selling at such a low cap rate.

But let's forget about cash flow for the moment and assume that the lender made new commercial loans of 60% LTV, based on the purchase price, on both properties.  Then let's assume that the borrowers defaulted and the lender has to foreclose both commercial loans.

After the foreclosure auction, which property do you think would be in better condition, the property in the ghetto or the property in the far nicer neighborhood with better quality tenants?

This brings me to the point of this article.  Any time a commercial property cash flows extraordinarily well, be on guard.  Perhaps the property is being valued at a very high cap rate because it is located in a very dangerous and very yucky area.

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Topics: High cap rate property