Commercial Loans Blog

Commercial Financing, Cap Rates, and Valuations

Posted by George Blackburne on Sat, Nov 22, 2014

Cap_rate_2Today I am going to share with you an easy way to quickly estimate the value of a commercial property.  It's going to involve a tiny bit of math, but please don't freak out or tune out.  You remember how to divide, right?  Fourth grade math?  You can handle it.  And being able to quickly value commercial property is essential to both commercial brokerage and commercial mortgage banking.

In my prior blog articles about commercial financing, I described a Cap Rate as the return on your money that you would enjoy if you bought a commercial property for all cash.  In other words, what "interest rate" would you earn on your money if you bought an office building or strip center for all cash; i.e., you whipped out hundreds of thousands of dollars from your hidden stash under the floorboards, and you eschewed using any mortgage.  By the way, eschew is just a fancy verb that means to "deliberately avoid using or abstain from."

The formula to compute a Cap Rate is Net Operating Income / Purchase Price = Cap Rate.  If you do the caculation shown in the image above, you actually get 0.0711.  You have to multiply the answer by 100% to get a Cap Rate properly expressed as a percentage.

The following funny pic is a tiny bit naughty.  Read on at your own risk.  :-)

Swiffer

That's enough of a review of Cap Rates.  Remember, the object of todays' training article is to teach you how to quickly value commercial property.

Let's suppose that you are thinking about buying or financing a commercial property, and you want to know what the property is probably worth.   You ask the selling commercial broker for a marketing flier, which usually contains a Pro Forma Operating Statement and the property's net operating income (NOI).

You next make some calls to some local commercial brokers (commercial realtors), and you ask them, "I have a 25-year-old office building in the Kings Town district of Valencia.  What's your best guess at a reasonable cap rate?"  The commercial broker might come back and say, "Depending on the strength of the tenants and the length of the leases, you're probably looking at a cap rate of between 7.25% and 7.75%."  For a quick, desktop valuation, you decide to use a cap rate of 7.5%.

So you now know the property's net operating income (NOI) and the cap rate at which similar buildings are selling.  You can now roughly value the building.  The formula is shown below:

Cap_rate

Let's use a NOI on the building we want to value of $237,000 (remember, we got this off the marketng flier) and a 7.5% suitable cap rate (this is the cap rate that the local commercial brokers told us to use).  Plugging and chugging, we have:

$237,000 / 7.5% = $3,160,000

So this commercial building is worth around $3.16 million.

Okay, let's do one more example.  The commercial mortgage borrower submits a commercial financing package that contains a Pro Forma Operating Statement.  You pluck off a NOI  of $657,000.  Local commercial brokers suggest a cap rate of 6.75%.  Now we plug and chug:

$657,000 / 6.75% = $9,733,000

Remember, we started off today to learn a quick and easy way to value commercial buildings.  This was it.

Nemo

A lof of commercial mortgage brokers starved during the Great Recession because banks were making very few commercial loans.  Today the commercial mortgage market is on fire because of seven years' worth of pent-up demand.  It's a very good time to get in the commercial mortgage brokerage business.

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My hard money commercial mortgage company, Blackburne & Sons, was one of the few commercial hard money shops to survive the Great Recession.  You know how we did it?  Loan servicing fees!  I earn $60,000 per month (not per year but rather per month) for collecting the payments on fewer than 250 commercial loans.  Imagine earning $60,000 every month, even if you failed to close a single new loan.  The money in commercial mortgage banking is in loan servicing fees!

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Topics: Cap Rates

Veteran Commercial Lender (Not Me!) Shares Some Wisdom

Posted by George Blackburne on Sun, Nov 9, 2014

Apartment_RenovationThis morning I received a commercial loan solicitation flier (email) from an old friend of mine.  My buddy, Paul, also owns a hard money commercial loan company, and I have realized that he is one of the wisest guru's in the commercial loan business.

This flier contained so much wisdom about investing in commercial real estate and about commercial mortgage underwriting that I am sharing it with you almost in its entirety.  It is definitely worth a read.

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HOW TO FALL IN LOVE WITH AND FUND
AN ABSOLUTELY IMPOSSIBLE APARTMENT PURCHASE DEAL

The scenario:

  • Purchase of 60 run-down, low-rent apartments in South Carolina
  • 70% vacant!
  • Major deferred maintenance!

We (Paul's company) closed the loan and funded 97% of the purchase price !!!!!

Why would we make a 97% loan on such difficult property?   Simple: We have incredible faith in the borrowers.   We identified one factor in particular that our “maverick” underwriting found compelling.

The borrowers aren’t extraordinarily wealthy, but they earned every dime themselves, and they have superb credit.   They also have an admirable “self-made” business and investment history.   They had previously bought low-rent apartments and personally, “hands-on”, did all the renovation and property management.  All their other income properties are now 100% occupied, and they pledged these properties as additional security for our 97% loan.

BUT HERE IS WHAT WE FOUND IRRESISTIBLY COMPELLING:  

They have a history of consistently pre-paying their mortgage loans.

In fact, they now own several properties free and clear, having paid down the purchase mortgages on an accelerated basis.  Instead of continually leveraging and over-leveraging and insanely taking on more debt, they took things slowly.

They did all their own work.  They paid down their mortgages aggressively and have no personal debt.   When I did our lender’s inspection of their current assets, I was impressed to find that all their tenants knew them on a first name basis – and smiled at them.  Our borrowers are young, hungry, possess great judgment . . . and energy.  What rare judgment, skill and self-discipline!

These are the kind of young (immigrant [are you listening, Washington?]) borrowers with whom you instinctively want to build a relationship.   I wouldn’t be surprised if we wind up “partnering” with them one of these days.

Bone

Do you now understand why I respect Paul so much?  (That's his picture above. Ha-ha!)  He has the flexibility to blanket additional collateral, even if it means making a loan of 97% loan-to-value on a horrible property.  He has the wisdom to appreciate the importance of the character of the sponsor (borrower/developer).  He spotted and admired the fact that these sponsors use debt cautiously and pay it off quickly.  He saw value in the work ethic and ambition of these young immigrant sponsors.  (Studies have repeatedly shown that, around seven years after a big wave of immigration, the U.S. economy soars.)

"Gee, George, I might have a deal for your friend Paul.  Where can I find him?"

Paul is one of the 750 commercial lenders listed on C-Loans.com.  When you enter your commercial loan into the C-Loans System, you will find Paul listed as one of the very first lenders on the Suggested Lender List.  He ranks near the very top of the Suggested Lender List because he has closed a TON of commercial loans for C-Loans.

Do you guys understand the Lender Diligence Score listed next to the name of each lender on C-Loans?  The hotter the commercial lender - the more deals he closes for C-Loans - the higher his score.  You definitely want to work with the loan officers near the top of the Suggested Lender List.  They are the guys and ladies who are actually closing loans.

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The real money in commercial mortgage banking is in loan servicing fees.  For example, I earn about $60,000 per month for collecting the payments on less than 250 commercial loans - even if I don't close a single new loan that month.  Become a hard money lender yourself.

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Commercial Loans on Industrial Real Estate Gone Wild

Posted by George Blackburne on Mon, Nov 3, 2014

Multi-tenant_industrialYou are about to learn that the future of American manufacturing is so bright that you better put on shades.

Beginning in 2007 millions of Americans started to default on their home loans.  Nine months to a year later these former homeowners were finally evicted from their homes, and they found themselves on the street in search of an apartment.  At the same time, commercial banks found themselves foreclosing on lots and lots of existing commercial properties.  Not surprisingly, new commercial construction came almost to a complete halt.

Training moment:  You will recall that a commercial bank is just a garden variety bank that accepts deposits and makes loans, as opposed to a merchant bank or an investment bank.

Therefore we had millions of extra tenants seeking apartments at the exact same time that new apartment construction hit a brick wall.  It was the perfect recipe for a squeeze.  Rents soared, and apartment owners and apartment lenders made a killing.

Today tens of thousands of new apartment units are under construction.  Always remember this economic principle:  Outrageous profit breeds competition.  Apartment owners have been making outrageous profits, so developers are going to keep building new apartments until there is a glut.  This is as predictable as the sun rising tomorrow.

But there is a new class of real estate that is about to have another day in the sun - industrial.  Why?  First of all, there has been essentially no new commercial construction (other than apartments) since 2007.  In the meantime the U.S. manufacturing sector has been gaining tremendous momentum.

Why is American manufacturing rebounding so strongly?  Here are just four reasons:  (1) Robotics and computers; (2) the trend towards in-sourcing; (3) the productivity of U.S. workers; and (4) low energy costs.

The use of modern robots and computers by American manufacturers has greatly reduced the need for labor.  Cheap but uneducated Chinese workers would find little to do in many modern American manufacturing plants.

You know all of the American manufacturers who moved their plants overseas?  We called the process out-sourcing.   Well, a lot of them now wish they hadn't.  Tens of thousands of formerly out-sourced manufacturing jobs are returning to the U.S. in a process called in-sourcing.

Huh?  What about cheap Chinese labor?  That all sounds great on paper, but having a supply chain that is 4,000 miles long makes it almost impossible to control quality.  Chinese quality is not as good as American quality.  In addition, a 4,000 mile long supply chain makes short production runs very difficult.  A plant in China is great for cranking out 100,000 identical products; but what if you only need 2,000?  And what if you want to make a design change once the run has started?  It's a nightmare.  And this doesn't even take into consideration that the Chinese are stealing American designs, and the Chinese government turns a blind eye.  Manufacturing in China?  Forget about it (said in a New Jersey accent)!

Cat_Lady_Organizer

Did you know that American workers - because they use robots, computers, and the latest in industrial equipment - are four times more productive than Chinese workers?  A Chinese worker might work for just 20% of the wage that an American might work, but if the American worker is four times more productive, the wage gap is far less pronounced.

Okay, hold onto your hat.  I am about to hit you with the pièce de résistance - energy costs.  You know all of those new oil wells that they are digging in the U.S. using horizontal drilling and fracking?  These new wells are throwing off enormous amounts of natural gas, almost as a by-product.  The U.S. is ballooning with cheap-cheap-cheap natural gas.

This natural gas is being used to power heavy U.S. manufacturing plants, like steel plants, auto plants, truck plants, tractor plants, aircraft plants, railroad car plants, etc.  Big stuff.  Heavy stuff.  And you know what is the single largest line item cost for most heavy manufacturers? 

You guessed it!  Energy costs.  How cheap is our natural gas?  Would you believe about one-fifth of the cost of Europe, Japan, or China?  The Boston Consulting Group did an important study last year in which they predicted that heavy manufacturers from all over the world will be economically forced to open new plants in America.  We are talking about millions and millions of new job migrating to America.

Study

Folks, this is truly the Golden Age of U.S. Manufacturing.  I live in a tiny town in the cornfields of Northern Indiana, and even here - in the former Rust Belt - a huge percentage of our residents work for small manufacturers who supply parts to the automakers in Detroit.  In other words, wherever you have some large industrial plants, lots and lots of small manufacturing suppliers sprout up around them.

The wise commercial real estate investor will therefore turn his attention to multi-tenant, multi-use industrial buildings, anywhere in a safe, large city in America.  I'm not a big fan of industrial buildings, custom built for some defunct owner-user, in the middle of Bum Flowers, Egypt.  You need to located in, or near, some very large city.  The more well-educated working people in the city, the better.  It is when 27-year-olds from different fields exchange, over lunch, their ideas, experiences, and tales of new products hitting the market that new industries are conceived and created.  (Please re-read that last sentence.)  Therefore you want to invest - or lend - in the largest and most educated cities possible.

The hot investment product for the next seven years (until developers over-build again) is industrial, specifically multi-tenant, multi-use industrial centers.

If you are trying to buy a multi-tenant, multi-use industrial center, Blackburne & Sons would be interested in helping you raise part of the downpayment.

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Topics: Industrial Realty is Hot