Commercial Loans Blog

Life Insurance Company Correspondents

Posted by George Blackburne on Fri, Nov 27, 2015

life_insurance_company_loans.jpgLife insurance companies offer by far the lowest interest rates on large commercial permanent loans. You will recall that a permanent loan is just a garden variety first mortgage on a commercial property, with a term of at least 5 years and with at least some amortization, typically 25 years.

Interest rates on commercial real estate loans from life insurance companies are typically 25 to 37.5 basis points lower than those offered by conduits, and they are often only 25 basis points higher than the prime residential mortgage rate.  In other words, if an A-quality borrower can obtain a conforming, 30-year, fixed rate loan of 3.5% on his home today, a life company might make a 10-year, fixed rate, commercial permanent loan at around 3.75%.

 

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In most cases, a borrower will NOT be able to obtain a new permanent loan from a life insurance company by applying directly to the life insurance company.

When you are the prettiest girl at the dance, lots and lots of guys want to ask you to dance. Screening twenty loan requests per day takes a lot of time. In addition, it doesn't make sense for most life insurance companies to open regional offices throughout the country, especially when the typical life company makes fewer than 30 loans per year.  Please note, however, that when a life insurance does make a new commercial permanent loan, it is usually a very large loan.

Therefore most life companies employ correspondents. A correspondent is a commercial mortgage company that has the exclusive right to make commercial loans in a given region for a particular life company. The correspondent does all of the site inspections for prospective loans in that region for that life company.

The correspondent then services the loan (collects the payments and handles any foreclosures) for that life company.  The amount of the loan servicing fee is tiny - typically just 12.5 basis points per year - but life insurance company loans are typically huge.  For example, 12.5 basis points on a $20 million loan is a healthy $25,000 per year.

 

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As I mentioned in another recent blog article about life insurance companies, most borrowers and brokers could live three life times and never have a commercial loan attractive enough for a life insurance company.  Life insurance companies are looking for the following types of commercial loans:

  1. The commercial loan must be secured by one of the four major food groups - which is just commercial mortgage lingo for (1) Multifamily; (2) Office; (3) Retail; or (4) Industrial.

  2. The property should be either brand new or in pristine condition.

  3. The property needs to be located in a primary location.  A primary location is one of the very best locations in a gateway city in terms of traffic count, accessibility, and affluence of the neighborhood.  In other words, a lot of Lexus'es, Mercedes, and BMW's need to be driving by.  You will rarely find a life company lending in a city of less than 400,000 residents.

  4. The loan amount must usually exceed $5 million.  You will occassionally see life companies making commercial real estate loans as small as $3 million, but these small deals are usually made on properties leased on a triple net basis to some incredibly strong tenant, like Walgreens, CVS, Rite Aid, or some other national credit tenant.  A national credit tenant is a company rated BBB or better by Standard & Poor's.

  5. Life company loans rarely exceed 55% to 58% loan-to-value.  They are designed for deals where the buyer is exchanging into the property with an enormous down payment.

 

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Remember, if you were to call a life insurance company directly, the company receptionist will usually ask you for the location of the property and then refer you to the appropriate correspondent. Don't get a broken nose over this.  This is just how life companies originate their commercial loans.  They almost always use exclusive correspondents.

You can apply to a dozen different life company correspondents using C-Loans.com.

 

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Debt Yield Ratio in Commercial Real Estate Finance

Posted by George Blackburne on Thu, Nov 26, 2015

When it comes to a commercial mortgage loan, the most important issue to most borrowers is not, "What is the interest rate?".  Most banks and conduits offer interest rates that are within 0.25% of each other.  Instead, commercial mortgage borrowers are most concerned about, "How large of a commercial loan can I get?"

In the past, the size of your new commercial loan was limited by either the Loan-To-Value Ratio or the Debt Service Coverage Ratio.  For example, the lender might say, "We will lend up to 75% loan-to-value, but the loan must also satisfy a 1.25 debt service coverage ratio.

 

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In the past, it was the debt service coverage ratio that was the true limiting ratio.  For example, a lender might say, "I see that you are buying this commercial property for $10 million.  In terms of loan-to-value ratio, you could qualify for a loan of $7.5 million.  However, in order to satisfy the 1.25 debt service coverage requirement, the largest loan we can make you is $7.1 million (71% LTV)."

Unfortunately, there is now a third sheriff in town, and this new ratio is limiting commercial loan sizes even more.  This new underwriting ratio in commercial real estate finance is called the Debt Yield Ratio, and this ratio is limiting large commercial loans to just 58% to 63% loan-to-value.

The Debt Yield Ratio is defined as the Net Operating Income (NOI) divided by the first mortgage debt (loan) amount, times 100%.  For example, let's say that a commercial property has a NOI of $437,000 per year, and some conduit lender has been asked to make a new first mortgage loan in the amount of $6,000,000.  Four-hundred thirty-seven thousand dollars divided by $6,000,000 is .073.  Multiplied by 100% produces a Debt Yield Ratio of 7.3%.  What this means is that the conduit lender would enjoy a 7.3% cash-on-cash return on its money if it foreclosed on the commercial property on Day One.

Please notice that this new Debt Yield Ratio  does not even look at the cap rate used to value the property.  It does not consider the interest rate on the commercial lender's loan, nor does it factor in the amortization of the lender's loan; e.g., 20 years versus 25 years.  The only factor that the Debt Yield Ratio considers is how large of a loan the commercial lender is advancing compared to the property's NOI.  This is intentional.  Commercial lenders and CMBS investors want to make sure that low interest rates, low caps rates, and high leverage never again push real estate valuations to sky-high levels.

So what is an acceptable Debt Yield Ratio?  For many years the answer was 10.0%.  This was the lowest number that most conduit lenders were using to determine the maximum size of their advances.  In our example above, the subject commercial property generated a NOI of $437,000.  Four-hundred thirty-seven dollars divided by 0.10 (10% expressed as a decimal) would suggest a maximum loan amount of $4,370,000.

Typically a Debt Yield Ratio of 10% produces a loan-to-value ratio between 58% to 63%, about the maximum level of leverage that the current CMBS B-piece buyers would allow.

That being said, the market is ravenous for commercial mortgage backed securities.  Competition for product, coupled the market's voracious for appetite for commercial mortgage-backed bonds, is putting downward pressure on the Debt Yield Ratio.  If the loan is large and the commercial property unusually desirable, conduits are making commercial loans today with Debt Yield Ratio's as low as 9.0%.  Average deals, however, are still limited to a minimum Debt Yield Ratio of 10.0%

It is the money center banks and investment banks originating fixed-rate, conduit-style commercial loans that are using the new Debt Yield Ratio.  Commercial banks, lending for their own portfolio, and most other commercial lenders have NOT adopted the Debt Yield Ratio.  The banks need to actually close loans.

You will notice in my definition of the Debt Yield Ratio that I used as the "debt" only the amount of the first mortgage debt.  The reason why I threw in the word "first mortgage" is because more and more new conduit deals involve a mezzanine loan at the time of origination.  The existence of a sizable mezzanine loan behind the first mortgage does NOT affect the size of the conduit's new first mortgage, at least as far as this ratio is concerned.

Will conduit's ever accept a Debt Yield ratio of less than 10.0%?  Yes, if the property is very attractive, and it is located in a primary market, like Washington, DC; New York; Boston; or Los Angeles - an area where cap rates are exceedingly low (4.5% to 5%) - a conduit lender might consider a Debt Yield as low as 9.0%.

Debt yields are also coming down.  The CMBS market is ravenous for commercial mortgage loans, so debt yield ratios of 9% are becoming commonplace.  I predict that within 18 months the minimum-acceptable Debt Yield Ratio will finally stabilze at around 8.0%.  (George's note:  I recently - 11/25/15 - updated this popular blog article, and so far 9.0% is still as low as conduits will accept.  Time will tell whether Debt Yield Ratios ever get as low as 8.0%.)

Why did the conduit industry start to use the Debt Yield Ratio?  For over 50 years commercial real estate lenders determined the maximum size of their commercial mortgage loans using the Debt Service Coverage Ratio.  For example, a commercial lender might insist that the Net Operating Income (NOI) of the property be at least 125% of the proposed annual debt service (loan payments).

But then, in the mid-2000's, a problem started to develop.  Bonds investors were ravenous for commercial mortgage-backed securities, driving yields waaaaay down.  As a result, commercial property owners could regularly obtain long-term, fixed rate conduit loans in the range of 6% to 6.75%. 

At the same time, dozens of conduits were locked in a bitter battle to win more conduit loan business.  Each promised to advance more dollars than the other.  Loan-to-value ratio's crept up from 70% to 75% and then to 80% ... and then up to 82%!  Commercial property investors could achieve a historically huge amount of leverage, while locking in a long-term, fixed-rate loan at a very attractive rate.

Not surprisingly, the demand for standard commercial real estate (the four basic food groups - multifamily, office, retail, industrial) soared.  Cap rates plummeted, and prices bubbled-up to sky-high levels.

When the bubble popped, conduit lenders found that many of their loans were significantly upside down.  The borrowers owed far more than the properties were worth.  The lenders swore to never let this happen again.  The CMBS industry therefore adopted a new financial ratio - the Debt Yield Ratio - to determine the maximum size of their commercial real estate loans.

 

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Topics: Debt yield ratio

Commercial Loans From Life Insurance Companies

Posted by George Blackburne on Mon, Nov 9, 2015

Commercial loans from life insurance companies typically offer the lowest interest rates and the best terms in all of commercial real estate finance.  Most commercial real estate loans from life insurance companies have a fixed rate, and these wonderful loans typically have a term of either 5, 7, or 10 years.  The interest rate is usually 25 to 37.5 basis points cheaper than those from any CMBS lender (conduit) or major bank.

Pop Quiz:  What is a basis point?  Answer:  A basis point is 1/100th of 1%.  Therefore 25 basis points is one-quarter of one percent.

By the way, in the lingo of commercial real estate finance, a life insurance company is known as a life company.

 

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Life insurance companies insist on fixed rate loans because they need to know exactly what they will earn during the term of the investment.  They need these precise numbers because they need to be sure they can meet the death benefits promised in their life insurance policies, based on their actuarial projections.

Therefore most life company loans have a lock-out clause for the first half of the loan (the first five years of a ten-year loan).  A lock-out clause is defined as an absolute prohibition against prepayment.  Suppose you win the lottery.  You walk into the life insurance company's office, overturn a wheelbarrow containing $5.2 million in cash, and then proudly march out.  Three days later you get a certified check in the mail for $5.2 million (less this month's payment).  "Sorry, sir, but you are NOT allowed to pay this loan off early."

For the remaining half of the loan term almost all life company loans have a defeasance prepayment penalty.  A defeasance prepayment penalty is defined as one where the borrower is required to go out and buy a series of Treasury bills and bonds that will provide the lender with the exact same stream of incoming payments, plus any balloon payment.  There are defeasance companies which will buy and assemble these securities for you.  The thing to remember about defeasance prepayment penalties is that they are HUGE.  Think of the largest prepayment penalty that you have ever encountered and then multiply by twenty.  Ouch!!!

 

 

 

 

Life insurance companies are looking for the following types of commercial loans:

  1. The commercial loan must be secured by one of the four major food groups - which is just commercial mortgage lingo for (1) Multifamily; (2) Office; (3) Retail; or (4) Industrial.

  2. The property should be either brand new or in pristine condition.

  3. The property needs to be located in a primary location.  A primary location is one of the very best locations in a gateway city in terms of traffic count, accessibility, and affluence of the neighborhood.  You will rarely find a life company lending in a city of less than 200,000 residents.

  4. The loan amount must usually exceed $5 million.  You will occassionally see life companies making commercial real estate loans as small as $3 million, but these small deals are usually made on properties leased on a triple net basis to some incredibly strong tenant, like Walgreens, CVS, Rite Aid, or some other national credit tenant.  A national credit tenant is a company rated BBB or better by Standard & Poor's.

  5. Life company loans rarely exceed 55% to 58% loan-to-value.  They are designed for deals where the buyer is exchanging into the property with an enormous down payment.

 

 

"Gee, George, those are some pretty tough requirements to meet."

Most of us could live three lifetimes and never run across a commercial real estate deal suitable for a life company.

But don't panic.  If you use C-Loans.com to apply for a commercial real estate loan, you can apply to a dozen conduits and banks at the same time you apply to a half-dozen life insurance companies.  If the life companies all turn you down, the conduits will probably do your deal at just a slightly higher rate.

 

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Loans on Gentlemen's Clubs and Politically Incorrect Properties

Posted by George Blackburne on Sun, Nov 1, 2015

A bank is never going to finance a gentlemen's club, which is just a fancy term for a nudie bar.  Nor would a bank finance an adult bookstore or a lingerie and marital aid store.  Can you just visualize the headlines?  First Neighborhood Bank Forecloses on the Pink Feather Lounge!  Bank Vice President seen collecting the cover charge at the door.  This is NOT gonna happen.  Ha-ha!

The owners of such establishments, along with the owners of medicinal marijuana facilities, will usually be forced to borrow from private money (hard money) lending companies.

For those of you who think that I am some depraved sinner, it is important you appreciate that over the past 35 years, we have financed six churches.  Every one of these loans defaulted, and we took a huge loss on each one.  Actually that's incorrect.  We once made a $1.5 million loan on a free and clear church in a nice area of Texas.  When this loan defaulted as well, it turned out that the pastor had stolen the money to originally buy the church from his former church in Detroit.  Our private investors were in litigation for three years, but they eventually came out whole.  Needless to say, we are not a big fan of church loans.

At Blackburne & Sons, we actually prefer loans secured by gentlemen's clubs, adult bookstores, and other politically incorrect properties.  We have made twenty such loans over the years, and we have never taken a loss on one of them.  Usually they are cash cows.

 

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We are actively looking for new loans on politically-incorrect properties right now.  We just put a $1.1 million loan on a gentlemen's club in Detroit (scary area) out for sale to our private investors, and the entire loan sold out in a day and a half.  Our private investors understood the concept that boys will probably always enjoy looking at pretty girls.  They absolutely ate this loan up.

 

 

Now if you were reading carefully, you probably noticed something.  Blackburne & Sons does NOT use a mortgage fund to fund its deals.  Instead, we syndicate every loan.  On a $1.1 million loan, we might have as many as 30 different private investors, and the group of private investors in each deal will be different.

"But George, if you have to syndicate every loan, doesn't that mean you will take longer to fund a new loan than a competing hard money lender?"

Yes, it does.  It might take us a week longer to fund our loans because each participating private investor has to send in his check.  It can be a pain in the tail sometimes.

Blackburne & Sons actually has its own mortgage fund, but I absolutely hate the concept.  Huh?  Why?  Every ten to fifteen years commercial real estate is hit by a depression, where commercial real estate falls by 45%.  When commercial real estate values are crashing, every hard money mortgage fund in the country is absolutely swamped with withdrawals.  They are forced to stop making new loans because they have no liquidity.  Every penny of liquidity is spent returning money to panicky investors.  They are completely out of the market.

 

 

Sons, please remember this.  During commercial real estate depressions, real estate falls by almost exactly 45%.  Certainly it has every time in my lifetime.  (Confused?  I write this blog to teach my two sons everything I have learned in my 35 years in the business.  I have a bad heart, and I was in the cardiac intensive care unit of the hospital twice in the past two weeks.  These wonderful blog training articles cannot continue forever.  I'm just sayin'...)

Everyone, here is why this matters to you.  Here is why you want to be the best friend of my two sons.  Blackburne & Sons was the ONLY commercial hard money lender to be in the market to make new commercial loans every day of every year of the Great Recession.

We can always find first mortgage money from our filthy rich private investors - even when blood is running in the streets.  It's just a matter or price.  And if you can find commercial mortgage money during a horrible depression, you can charge a huge loan brokerage fee.

So if you are a surviving veteran of the commercial mortgage brokerage industry, you definitely want to develop a relationship with Alicia Gandy (our biggest producer who is affectionately known as the Loan Goddess), my son George IV, or my son Tom.

Why are relationships so important?  The most important lesson about commercial real estate finance that I ever taught my sons was that commercial lenders make loans for their friends.

 

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