Commercial Loans Blog

Commercial Loans and Negative Interest Rates

Posted by George Blackburne on Thu, Jan 29, 2015

Negative_Interest_RatesSomething extraordinary happened this month.  Interest rates turned negative in Germany, Switzerland, and Japan. In fact, the headline of a recent article in The Telegraph, a British newspaper, read, “Europe's Bond Yields Fall to Their Lowest Level Since the Black Death.”

Suppose you’re the trustee of the endowment fund for a large German university or the trustee of the pension plan for a large German corporation.  Your trust documents require you to keep 15% of your corpus invested in German federal treasury bonds – known as bunds. Since the German national government is almost running a budget surplus, there are a limited number of these bunds.  Other trustees want them for their own funds and plans, so you are forced into a bidding war for them. When the bidding settles, you realize that you have actually paid a huge premium for these bunds. Your yield over the next five years is a negative 0.007% annually. Basically you’re paying the German government to store your money for 5 years.

Italian, Spanish and Portuguese yields have also seen spectacular drops over the past several weeks.  The French state can borrow for five years at an annual rate of 0.13% (much less than 1%), and Ireland can do so at 0.32%.

One reason for these spectacularly low rates is that the European Central Bank (ECB) has just embarked upon its own quantitative easing campaign, in order the head off deflation and to jumpstart the slowing European economy. The ECB will soon be buying massive amounts of European government bonds.

 

Real

 

The issue is caused by far more than just a shortage of European government bonds. There is a currency exchange rate issue as well.  The Swiss Central Bank recently removed its peg to the Euro, resulting in a stunning, one-day, 25%+ leap in value for the Swiss franc.  As a result, large Swiss banks, like UBS and Credit Suisse, can now pay a negative 0.75% on deposits, loan it out to hedge funds at 0.50% annually, and still earn a handsome 1.25% spread on their money.

Why would any investor pay a private bank 0.75% annually to store his money? It’s the exchange rate! Sure, you might lose almost 1% on the interest rate, but if the Euro falls another 3% versus the Swiss franc, you are still miles ahead when you convert your Swiss franc deposits back into Euros.

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A banker buddy of mine recently shared this true story on Facebook:  My wife needs a little cheering up, so I would like to share one of our first and funniest memories. After a few months of dating, Amy was kind enough to accompany me to one of my annual poison ivy ER visits. Yep, I needed a shot. Without hesitation, I dropped my pants AND underwear. With my naked butt in the air, I heard the nurse surprisingly say, "Sir, the needle actually goes in your arm."

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Is the ECB making the right decision at this point to embark on another round of quantitative easing?  While I absolutely saluted Ben Benanke’s Quantitative Easing to save the U.S. economy, I wonder if the ECB is not now confusing bad deflation and good deflation.

There are actually two kinds of deflation – bad deflation and good deflation. Bad deflation is typically accompanied by fear and panic.  It is time of money destruction, as debtors go bankrupt and banks stop lending. Often the underlying basis of that fear and panic is the excessive debt accumulation and the poor investments made with the proceeds of that debt in prior years.  Economists from the Austrian School of Economics call investments that fail to pay off malinvestments. A good example of excessive debt and malinvestments were the home purchases made by unqualified subprime borrowers in the decade leading up to 2008.

But deflation is not always bad.  Did you know that during the period between the end of the Civil War and the start of World War I the U.S. economy enjoyed slow deflation and steadily falling prices? This and other periods of slow deflation were the result of scientific discoveries, improvements in production methods, and increased competition.  For example, oil prices today are declining because of advances in oil extraction technology, such as horizontal drilling and fracking.  U.S. producers are now competing with Russia and Saudi Arabia, resulting in falling prices.

One could therefore argue that the ECB may be overreacting to a modest amount of good deflation; but there is no question but that the ECB is indeed acting.  With European investors now desperate for yield, our mortgage bonds and commercial real estate look very, very attractive.  You can therefore expect mortgage rates to stay low for a number of years, and you can expect cap rates on commercial properties to continue to fall.

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“Keynes did not teach us how to perform the ‘miracle of turning a stone into bread’ but the not-at-all miraculous procedure of eating the seed corn.” – Ludwig von Mises, Austrian economist

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I had a very interesting conversation with a CMBS lender this morning.  He said the conduit loan business was fabulous.

Conduits are now regularly making 75% loan-to-value loans on multifamily, office, and retail centers.  This translates to debt yield ratios of 8.0% to 8.5%.  Conduits are also making 70% loans on hospitality properties, which translates to debt yields of 10%.

These leverage levels are much higher than I had expected to hear.  No wonder he is just killing it in conduit loan originations.

If you enjoyed today's article, I sure would appreciate a few Twitter re-Tweets, Facebook Shares, Google+ atta-boys, and Linked-In Shares.  Thanks, guys.  :-)

Please be on the look-out for any bankers making commercial loans.  I'll trade you 2,000 of mine for one of yours.

 

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Topics: Negative interest rates

Issues with Making Commercial Loans on Mobile Home Parks

Posted by George Blackburne on Fri, Jan 23, 2015

Trailer_parkBlackburne & Sons, my private money commercial mortgage company, makes a lot of loans on small mobile home parks filled with older single wide trailers.  Often these small coaches are not owned by the residents.  Instead, these coaches are owned by the the park, and the park rents them out like apartment units.

While they are decent collateral, there are some tricky legal issues associated with making loans on older trailer parks.  Today you going to learn a lot about making mobile home park loans, perfecting liens, and bankruptcy law.

Okay, if you are going to make a loan on an apartment building, you simply record a Mortgage and Assignment of Rents against the property, and - voila - you're done.  The same is true with a mobile home park, right?  Maybe ... but maybe not.

Real property is land and that which is affixed to the land. Any property that is not real property is personal property - such as cars, boats, TV sets, stamp collections, and intangible rights, like the right of a famous football player to his own image. For example, you need to pay Peyton Manning if you want to use his likeness in a magazine advertisement.  Years ago such personal property was known as chattel, and a Security Agreement secured by personal property was called a chattel mortgage.

You perfect (accent on the -fect) a lien against real property by recording a mortgage in the County Recorder's office.  You usually perfect a lien on personal property by obtaining a Security Agreement against the collateral and filing a UCC-1 Financing Statement, usually with Secretary of State's office where the debtor either resides or was incorporated.  I didn't know this last part until I looked it up this morning on Wikipedia.  I always thought you filed it in the state where the property was located.  It might depend on the state.

UCC-1

 

I'll tell you a scary story.  Years ago I made a hard money loan on a small motel in the boonies.  I recorded my mortgage with the County Recorder, and I filed my UCC-1 Financing Statement with the California Secretary of State's office on the motel's beds, furniture, icemakers, washing machines, dryers, etc.  These items of personal property in a motel are known as the funiture, fixtures, and equipment or FF&E's.

The borrower defaulted, and then he declared Chapter 7.  When I got the notice of the bankruptcy filing, I opened the file and looked for the Security Agreement.  OMGoodness!  There wasn't one!  I had put the world and the bankruptcy trustee on notice that I had a lien on the FF&E's, but I had failed to actually obtain a Security Agreement, where the borrower agrees that I get to foreclose on the FF&E's if he fails to pay his loan.  Fortunately the bankrutpcy trustee didn't catch it.  Who would be dumb enough to file a UCC-1 but not obtain a Security Agreement? Uh ... me?  Fortunately the loan paid off in full, and all ended well; but this explains why I had a heart attack at age 50.  Ha-ha!

Anyway, back to mobile home parks with rental coaches.  Are single wide trailers real property or personal property?  Unless they are permanently affixed to a concrete foundation, like modular housing, trailers are personal property!  After all, you can haul a trailer away in an afternoon.

Therefore, you cannot secure your commercial loan on rental coaches with simply a mortgage.  You need to secure your loan like it was personal property; i.e., you need to obtain a Security Agreement and you need to file some sort of financing statement to put the world on notice that you have a lien against the coaches.

So do you file a UCC-1 Financing Statement to secure a chattel mortgage (personal property loan) against a trailer?  No.  Trailers are considered motor vehicles, and they are titled and licensed just like cars and trucks.  Each state department of motor vehicles uses its own motor vehicle lien form, but they are all very similar to the one shown below.

Trailer_Title     

Each trailer is a different motor vehicle, so this form must be filed for each coach.  And don't forget that you still need a blanket Security Agreement (Chattel Mortgage), describing each of the coaches and their VIN numbers, signed by the borrower.  If you fail to get one, you'll be just as foolish as me years ago, when I filed the UCC-1 but failed to get a Security Agreement on that motel.  The Security Agreement grants the lender a security interest in the coaches.  The state DMV form merely puts the world on notice that you have a lien and determines who has the first chattel mortgage and who has the second chattel mortgage.  The first guy to file his state DMV form wins that race.

 

Coke

 

"Gee, George, why couldn't you just obtain a blanket Security Agreement on all of the coaches."

That would actually work, as long as the borrower didn't file bankruptcy.  When the borrower signs the Security Agreement, he grants to the lender the right to seize and sell the chattel in order to repay the debt. As long as no other lender or bankruptcy trustee had a claim to the property, the lender would be golden.

But what if the borrower declares Chapter 11 Bankruptcy?  In that case, the lender is still fine, even if the lender failed to file the state chattel lien forms with the DMV.  Remember, the purpose of a Chapter 11 Bankruptcy is to give the debtor time to reorganize his finances and pay off his debts.  The lender's lien is still valid, even without filing the state DMV form.  It's only the priority of his lien - whether he has a first chattel mortgage or a second chattel mortgage - that is vulnerable.

But where the lender gets totally toasted is when the debtor files a Chapter 7 Bankruptcy.  In a Chapter 7, all of the debtors assets become the property of the bankruptcy estate.  The instant the debtor files a Chapter 7 Bankruptcy, the bankruptcy trustee instantly has a blanket lien against every asset owned by the debtor.  If the lender hasn't perfected his lien on the coaches with the state DMV, he is truly, utterly, and completely toast.  Now the bankruptcy trustee holds the first chattel mortgage position, and the mobile home trailer lender is in a second chattel mortgage position.  In real life, this means the trailer lender will collect, at most, a few pennies on the dollar.

Morale of the story:  When making loans on older trailer parks, be "absolutely positively" sure you perfect your chattel mortgage on each of the rental coaches!

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We're working on a trailer park loan right now, and the rental coaches already have a personal property loan on them.  It's not a mortgage, but rather just a business loan against the titles of all of the coaches owned by the park (16 out of the total of 20 coaches located in the park).

We called the state DMV office, and they told us to collect all 16 of the original coach titles and send them to the state DMV office, along with 16 completed Manual Title Applications (each asking the State of Kansas to add Blackburne & Sons to the new title as lien holder) and 16 filing fee checks for $11.50 each.

The existing lien holder on the 16 coach titles will send 16 similar Manual Title Application forms to the title company, along with a Demand for Payoff, sixteen checks for $10 each made payable to the State of Kansas, and instructions to the title company to send the forms and the money on to the State of Kansas, as soon as they send him his payoff check. 

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Important Weasel Words:  The guy writing this article is an idiot.  Do not rely on anything I've written.  Instead, be sure to consult an attorney.

If you learned something today, would you kindly share this article using the Twitter, Facebook, Google+, or LinkedIn buttons above?  It means a lot to me.  Thanks!  :-)

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Commercial mortgage brokerage is going to be a hot-hot field for the next few years because banks made very few commercial loans over the past seven years.  Finally really learn this profession.

 

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Topics: Mobile home park loans

Structuring Commercial Renovation Loans

Posted by George Blackburne on Tue, Jan 13, 2015

office_constructionOkay, so your client buys a vacant office building from a bank that took the property back in foreclosure.  In other words, the vacant office building was an REO of the bank, which stands for "real estate owned".  If you look at a financial statement of a bank, you will often see a line item entitled, "Real Estate Owned".  The term sounds fancy, but an REO is nothing more than a foreclosed property still owned by the bank.  In order to discourage banks from becoming major property owners, federal regulators financially punish banks for keeping REO's on their books for too long.  This punishment is why banks are always so anxious to clear REO's off their books.

Anyway, now your client needs money to renovate this vacant office building.  He will also need money to make his monthly mortgage payments on the property as he tries to lease it out.  Your client will also need money to finish the tenant improvements and to pay for the leasing commissions. The key thing to remember about commercial renovation deals is that the property is usually not generating any rental income, so the property alone cannot initially afford to make regular montly payments.  We therefore need to build in a reserve for the interest payments on the mortgage during the period that the property is being renovated and leased out.

Commercial loans to make major renovations to income property should therefore be structured just like a commercial construction loan.  You will recall that commercial construction loans are structured with an initial interest-only period, during which time the building is built and leased out.  During this interest-only period, the borrower is only required to pay interest based on the amount of his construction loan that he has actually drawn down.  An example will make this clearer.

Suppose the bank loans the borrower $2 million to build a spec office building, in other words, an office building built on speculation without any pre-leases.  In month one the borrower draws down $75,000 to pay his demolition subcontractor to remove an old building and to pay his grading subcontractor to level and compact the ground.  Therefore, at the end of month one, the borrower only has to pay for one month's interest on $75,000.  During month two the borrower draws down another $100,000 on his construction loan to pay the concrete guy for pouring the foundation.  Therefore, at the end of month two, the borrower has to pay for one month's interest on $175,000.  And so on.

 

Pubic_Hare

 

This is how construction loans are structured.  At the end of the construction loan term, the entire loan either balloons or rolls into some sort of takeout loan.

 

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Training reminder:  A permanent loan is just a first mortgage loan, with a term of at least five years and with some sort of amortization, usually based on a 25-year amortization.  In other words, every monthly payment includes at least some repayment of principal.

A two-year or five-year first mortgage loan with interest-only monthly payments is considered a mini-perm.  Most mini-perms have terms of just two or three years.

Interest-only loans with terms of less than two years are called bridge loans

A takeout loan is just a permanent loan used to pay off a construction loan.  Every takeout loan is a permanent loan, but not every permanent loan is a takeout loan.  Whaaat?  Think about it.  A permanent loan is only called a takeout loan if it is used to pay off an existing loan that was used to build the property.  What if the existing loan was used to simply buy an already completed building?  A permanent loan used to pay off another permanent loan is just another garden-variety permanent loan.  Got it? 

 

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Okay, let's try to remember where we were.  Our borrower owns a vacant office building, and he needs a loan to renovate it and lease it out.  We also said it wasn't generating any income right now.  The way to underwrite and finance such a project is to structure it as commercial construction loan.

From the proceeds of the loan, the borrower would obtain the following:

  1. Money to pay off the bridge loan used to acquire the REO
  2. Hard costs of renovation
  3. Interest reserve during the renovation and leasing period
  4. Tenant improvement costs
  5. Leasing commissions
  6. Soft costs of the renovation loan, including loan points, closing costs, building permits, architectural and engineering fees.
  7. Very large Contingency Reserve.  The typical renovation costs twice as much as projected!

 

Nose_Ring

 

"That all sounds great and everything, George, but clearly the renovation loan lender (construction lender) is not going to lend 100% of the renovator's costs.  The renovator is going to need some skin in the game, right?"

Exactly.  Here is how you tell if your borrower's renovation loan is likely to get funded.  First, you compute the Total Cost of the project by adding up all of the following costs:

Purchase price of the vacant office building
Original closing costs
Hard renovation costs
Tenant improvement costs (probably a reserve)*
Projected leasing commission*
Interest reserve for renovation and leasing period
Soft costs of the renovation loan
Contingency reserve

*Your leasing agent can help you with these numbers.

Your construction lender (renovation loan lender) will probably limit his loan to 75% to 80% of the total project cost.  This is known as the Loan-to-Cost Ratio.  Your renovator/borrower will have to be able provide cash or proof of prepayment of the rest.

The lender will also subject the deal to a Debt Service Coverage Ratio analysis based on the projected rents and expenses in the Pro Forma Operating Statement, but interest rates are so low today that almost all deals cash flow comfortably.

The Loan-to-Value Ratio must also not exceed 70% to 75%, based on finished and leased value of the property, known as the Stabilized Fair Market Value.  Most REO's, however, sell at such large discounts that the LTV is unlikely to be a problem.

If you want your construction loan (renovation loan) to fund, my advice is to concentrate on documenting the costs that your borrower has pre-paid.  Your deal will turn on whether he can show that he is contributing 20% to 25% of the total cost of the project.

The good news is that the economy is booming, companies are expanding, and banks make a ton of dough on construction loans.  Renovation loans, structured like construction loans, are also far less risky than ground-up construction loans for the bank because the walls and the roof on your property have probably already been errected.

To submit your renovation loan (or any commercial real estate loan) to our 750 hungry commercial lenders, simply click on the button below:

 

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C-Loans, Inc. is also now offering business loans not secured by real estate.  We closed an interesting $300,000 deal last week with a peer-to-peer lending platform, which is just a fancy way of saying a tiny syndicate of private investors.  Just like private investors invest in the hard money commercial loans originated by my hard money mortgage company, Blackburne & Sons, private investors are now making business loans directly to small businesses, in effect cutting out the bank.  We actually closed one such deal last week, and the wonderful thing is that business loans usually close in less than ten days!  

 

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Wow!  Last week I wrote a blog article about Deflation and Negative Interest Rates.  That article was re-Tweeted five times, shared on Facebook twice, and shared on Linked-In a whopping 29 times.  Thanks, guys.  That meant a lot ot me.

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Don't forget that I consult with commercial mortgage brokers.  Most consultations last just one hour, and they are usually scheduled at 1:30 p.m. Eastern Time on Mondays, Tuesdays, Thursdays, and Fridays.  Maybe I can help you to get back on track.

I did a one-hour consultation yesterday, and I came away knowing I really-really helped this new commercial mortgage broker.  He emailed me afterwards, "Thanks so much for making time to talk with me yesterday... You were very helpful and knowledgeable in answering my questions. You gave me added confidence to move forward in making brokering commercial mortgages a reality for me."

 

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Topics: Commercial Renovation Loans

Commercial Loans, Deflation, and Negative Interest Rates

Posted by George Blackburne on Mon, Jan 5, 2015

Black_TuesdayAs I write this post, the Dow Jones Industrial Average is down 323 points on the day.  Oil has fallen to less than $50 a barrel.  The European Central Bank is considering a massive intervention in the European bond market - very much like our own Fed's Quantitative Easing - in order to prevent deflation.

Yields on five-year German Treasury bonds - known as Bunds - have just turned negative.  Hellooo?  I am talking about negative interest rates.  European investors are so frightened of deflation and so distrustful of European banks that they will now pay the German government to store their money for five years.

In other words, its like they are saying, "Hey, German government, here's 10 million Euros.  Don't worry about paying me any interest.  You just hold on to my money for five years, and then you only have to give me back 9.997 million Euros.  You can keep the .003 million Euros for your trouble."

No way!  Yes way.  German bonds are offering the lowest yields since the Black Death.  In fact, since the German government is now running a budget surplus, it isn't even issuing new Bunds.

Conspiracy

Here is why central banks and governments fear deflation:

  1. When prices (and interest rates) are falling, consumers put off their purchases.  Why buy (a car, a house, etc.) today when the price will only be cheaper tomorrow?  The toughest year I ever suffered in commercial real estate finance was in 1982, when the prime rate fell from 21.5% to 14%.  Interest rates were falling monthly.  Absolutely no one was borrowing.

  2. When consumers put off their purchases, companies fail, workers get laid off, demand falls, more companies fail, more workers are laid off, demand falls even more, and so on.

  3. Debt is much harder to repay when each dollar becomes more valuable.

  4. As debt defaults increase, banks get frightened and stop lending.  This only increases deflation.

  5. Left unchecked, deflation often leads to a full-scale economic depression.

Bus

Okay, George, I understand everything you wrote, except for the part that read, "banks ... stop lending.  This only increases deflation."

Okay, let me explain.  Most people think that the U.S. money supply increases when the Fed creates money out of thin air and uses it to buy bonds.  Well, that's true ... but its like saying, "If the Federal government tips a thimble full of water into the ocean, the sea level rises and drowns some unfortunate South Sea island."  Uh... not so much.

Where the money supply really increases is when the bank, which sold that bond, uses that dough - let's say $100 - to make a new loan.  This $100 loan eventually ends up in another bank, which sets aside $5 for reserves, and then lends out $95.  This $95 ends up in a new bank, which sets aside $4.75 (5%), and then lends out $90.25.  This $90.25 eventually ends up in a new bank, which sets aside 5% and lends out the balance.  And so on.

This huge increase in the money supply is called the multiplier effect.  If the reserve requirement is 5%, the multiplier effect is a whopping 20:1.  In other words, for every new dollar the Fed creates, the U.S. money supply increases by a whopping $20 - twenty to one.

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Now we get to the point of today's training article.  The multiplier effect only works if banks are confident enough to lend.  If banks are too frightened to lend - like they were in 2008 and 2009 - or if borrowers are too frightened to borrow - like what is still somewhat true today - then the multiplier effect is much, much smaller.

But what happens if banks are too frightened to lend at all?  What happens if the banks are so frightened that they take in payments and don't lend them back out.  Uh-oh.  The multiplier effect can work in reverse!  Then the world gets flattened.  I even wrote a book on the subject, right before the Great Recession.  It was entitled, The Reverse Multiplier Effect - When Crushing Deflation Destroys America.

Fortunately Ben Bernanke was absolutely brilliant during the Great Recession.  His unconventional monetary policies saved this country.  To give you an idea how bad this could have been, every time a bank takes in a $1 loan payment and fails to lend it back out, $20 gets sucked out of the U.S. money supply.  Remember, the multiplier effect also works in reverse.  Yikes!

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Should you be worried?  Naw.  The U.S. economy is cookin' with gas.  Banks are starting to lend again, and, more importantly, borrowers are confident enough to borrow again.  The U.S. money supply is finally growing on its own.  That's why the Fed was able to end quantitative easing.

In fact, I predict that the next 15 years will economically be the best years of your life.  The future is so bright, I gotta wear shades.

So why did I even write today's training article?  Now you at least understand why the Europeans are freaking out.  They're terrified of deflation.  Fortunately Ben Bernanke showed central banks worldwide how to prevent deflation taking hold.  They'll all do the same thing, and for awhile, all will be well.

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Topics: Economics