Commercial Loans Blog

Commercial Loans and Rent Roll Fraud

Posted by George Blackburne on Wed, Jul 11, 2018

Winning-1When I grow up, I want to be Robert Ringer.  Mr. Ringer was the  best-selling author of several business books.  I last saw Robert Ringer in Playboy magazine, where he was sitting in a hot tub at a party at the Playboy Mansion with two gorgeous, topless Bunnies.  It was lucky that I just happened to notice the picture because normally I only look at Playboy for the articles.  Ha-ha!

Every business person - especially investors - should read Robert Ringer's first #1 best-selling business book, Winning Through Intimidation.  If President Trump ever died and made me King, I would require that every commercial-mortgage-broker trainee read Ringer's book first, even before he started learning anything about underwriting commercial loans.


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The book teaches you that the world is full of snakes.  In fact, Mr. Ringer once wrote that there are only three types of people in business:  (1) The type who will screw you; (2) The type who tell you in advance that they are going to screw you and then who will screw you; and (3) The type who will swear to high heaven that they are not going to screw you and then who will screw you.

So why am I confessing my sins (Playboy and lust) today?  The answer is that Robert Ringer happened to be a hard money broker who specialized in making commercial loans on apartments!  His book was read by hundreds of thousands of lawyers, accountants, salesmen, and widget manufacturers, and it became a #1 business bestseller.  The really awesome twist is that all of his examples of people in business doing dastardly acts were from his real-life experiences in the hard money commercial loan business.  Talk about relevant, huh?


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One of the dastardly acts that Ringer wrote about was Rent Roll Fraud.  You will recall that a Rent Roll is a long list, by unit number or letter, of all of the units in an apartment building, as well as the configuration (bedrooms and baths), the tenant's name, and the rent currently being paid by the tenant.  Sometimes a Rent Roll will even include the square footage of the unit.

Rent Roll Fraud occurs when the owner of an apartment building applies for a commercial loan or lists his apartment building for sale.  Either the owner or his broker submits to the commercial lender a Rent Roll with dummy numbers.  Even a small increase in the Rent Roll can make a big difference in the valuation of the apartment building or the size of the commercial loan for which the borrower qualifies.


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Robert Ringer learned about Rent Roll Fraud from painful experience.  Dastardly borrowers?  You betcha.  He learned to knock on a few doors and to audit the Rent Roll.  "Hello, Mr. Smith.  My name is Robert Ringer, and I am doing an appraisal of the property.  Would you mind please telling me what you pay in rent?  Just $1,200 per month?  The Rent Roll says $2,000.  Hmmm."  "Mrs. Rodriquez, how many bedrooms and baths do you have?  Just two bedrooms and two baths?  That's strange.  The Rent Roll says you should have three bedrooms and two baths.  Hmmm."  [To himself:  "This entire Rent Roll may be fraudulent.  I better audit a half-dozen more units to confirm my suspicions."]

The reason why I am writing to you today about Rent Roll Fraud is because I got a call today from a reporter from the Wall Street Journal.  He is writing a piece about a big criminal case involving mortgage fraud in the upstate New York area.  According to the indictment, tens of millions of dollars in commercial loans on multifamily projects were fraudulently obtained, in part using fraudulent Rent Rolls.  These defendants allegedly went as far as placing doormats and shoes in front of vacant units.  They are also accused of placing radios in empty units and leaving the radios on in order to create the illusion of occupancy.  Yikes!


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The Wall Street Journal's reporter found me while researching Estoppel Agreements in connection with commercial leases.  He found my blog article on estoppels.  Pop quiz.  What is an Estoppel Agreement or Estoppel Certificate (same thing)?  An Estoppel Certificate from a tenant is a statement admitting the rent, the maturity date of the lease, the size of the unit, the fact that the tenant has NOT prepaid his rent, and that the owner has performed all of his obligations in connection with the lease.  

When a tenant has a signed an Estoppel Certificate, he is estopped (fancy word for stopped) from later claiming, after a lender has foreclosed on his commercial loan, that the rent is $2,000 per month less than that listed on the Schedule of Leases.  A Schedule of Leases is the commercial-industrial equivalent of a Rent Roll.  A Schedule of Leases lists the units by address, the square footage, the name of the tenant, the monthly rent, and who (landlord or tenant) pays which expenses.


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Here's a story that will raise the hair on the back of your neck.  Blackburne & Sons, my private money commercial mortgage company, foreclosed on a row commercial building in the foothills of California.  After we had taken possession of the property, we notified the tenant to send all future rent payments to us.  At that point, the tenant notified us that he didn't have to make any more rent payments.  In exchange for an 80% discount from the guy losing the property in foreclosure (I am shocked, shocked I tell you, that there exists snakes in business), the tenant had prepaid his rent for the next five years!  Can you now see why Estoppel Certificates demand that the tenant disclose any prepaid rent?  In this case, the tenant had made this rent prepayment after we had recorded our loan, so his claim to prepaid rent was cut off by our foreclosure.  Phew!


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Here's another issue in connection with Estoppel Agreements.  A lender makes a commercial loan on an office building, and after the lender forecloses, the tenant tells him that he doesn't owe any rent until the landlord builds out the tenant improvements that the former owner had promised.  These tenant improvements could cost 18 months worth of rent.  This is why an Estoppel Certificate asks the tenant to admit that the landlord has performed all of his conditions precedent (the landlord has already completed everything that the landlord has promised to do prior) to payment by the tenant.


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Its pretty obvious why commercial lenders, before making a commercial loan on a multifamily property, can't get an estoppel certificate from every apartment tenant.  The paperwork would be impossibly enormous, and 90% of the tenants would have no clue as to how to fill out the Estoppel Certificate.  Therefore commercial lenders have to rely on the appraiser to do an audit of some of the apartment units on the Rent Roll.

To my own staff, let's please try to ask our multifamily appraisers in writing to audit 5% to 10% of the units on the Rent Roll before completing the appraisal.  Thanks!


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Topics: Rent Roll Fraud

Commercial Loans and Reserves For Vacancy and Collection Loss

Posted by George Blackburne on Sun, Jul 8, 2018

VacancyNationwide the vacancy rate for office space is 16.7%, plus or minus fifty basis points.  Remember, a basis point or bip is 1/100th of one percent.  Therefore fifty bps. (called 50 bips) is equal to one-half of one percent.

You are applying for a commercial loan, so you begin preparing a Pro Forma Operating Statement - an operating budget for the next twelve months.  Your property is an average office building in the downtown area of an average U.S. city.  Do you use as your Reserve for Vacancy and Collection Loss the national or city-wide average of 16.7%?  Or do you use 5%?  This is the subject of today's commercial real estate finance (CREF) training lesson.


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A good argument can be made that office building investors in the U.S. are lousy capitalists.  How could they allow 16.7% of their space to sit vacant?  Capitalism says that they should lower their rent in order to attract enough tenants to fill their buildings.  It makes good sense to lower their rent from $25 per square foot to $22 per square foot if they can fill the whopping 16.7% vacancy.

Let's do the math.  C'mon, guys, this is fifth grade math.  Stay awake.  Let's assume that the office building has 100,000 net leasable square feet.  If 83.3% of the space is leased at $25 per square foot, the office building generates $2,082,500 in gross rent.  If all 100,000 sf was leased at $22 per square foot, the office building would generate $2,200,000 in gross rent.  The owner picks up extra $117,500 by lowering his rent!


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This brings up an important training point.  Above I talked about rents of $25 or $22 per square foot.  It is the customary in commercial real estate to talk about rental rates in annual terms.  Therefore $25 per square foot works out to $2.08 per square foot per month.  If you are renting 2,000 square feet for your property management company, you would be paying $4,160 per month in rent (2,000 sf. times $2.08 per square foot per month).

So why aren't office building owners better capitalists?  For one reason, the higher the occupancy rate, the higher the operating expenses, such as common area heating, cooling, electricity, and wear and tear on the common areas.


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There is another reason why office building owners don't lower their asking rents in order to fill their building.  Suppose you own a mortgage company in the building, and you sign a lease at $25 per square foot.  Then the owner starts advertising identical space for just $22 per square foot.  Are you going to be a happy camper?  Is your higher rental rate going to eat at you like an ulcer?  And what is going to happen when your lease comes up for renewal?

But the most important reason why office building owners won't reduce their rents enough is that the lower asking rents will lower the value of their office buildings.

[Commercial mortgage brokers:  You are making exactly 63 bonehead mistakes running your commercial mortgage brokerage.  Bonehead mistakes.  Sixty-three of  them.  I can fix you.]


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How could increasing an office building's gross income possibly decrease the property's value?  It has to do with the Pro Forma Operating Statement that will be prepared by the real estate broker representing the owner.  When the selling broker prepares his Pro Forma Operating Statement, he will employ a concept called stabilized rent.

In theory, stabilized rent should represent the rental rate that would allow the entire building to find tenants.  In real life, stabilized rent, as used by selling brokers, is the actual rent of any currently rented space, plus the possible rent that could be received if all of the vacant space was rented at the highest rental rate that the owner has ever received for any of his space.


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Stabilized rent is an important concept, so please let me go over it one more time.  The real estate broker or commercial mortgage broker is preparing a Pro Forma Operating Statement in preparation of either selling the property or refinancing it.  He has prepared a Schedule of Leases that shows the existing tenants.  But what does he do about the vacant units?

If he is one of my students, and he has read my blog article about getting the largest possible commercial loan (it received the most Linked-In likes I've received in two years), he uses the market rent of any vacant unit.  But what is the market rent of this vacant office space?  In truth, its $22 per square foot; but some idiot owner of a commercial mortgage company once paid $25 per square foot (sorry, but that was you).  So the real estate broker uses $25 per square foot for the vacant space.

[Mortgage brokers:  If you are not working every day towards building a loan servicing portfolio... get the hell out of the business!  The only way to survive the next regular real estate crash is to fall back on your loan servicing income.  The easiest way to build a servicing portfolio is to become as hard money lender.  I service a $55 million portfolio at 1.9% annually.  That's $87,000 every month, whether I close a new loan or not.]


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But what about commercial lenders?  What if you are applying for a commercial loan?  Are commercial lenders stupid enough to fall this stabilized rent concept.  Why yes... yes they are.  Ladies, please cover your ears.  Why do dogs lick themselves?  Because they can.  Translation:  In real life, almost all commercial lenders will allow you to get away with this stabilized rent nonsense.

So the question I posed at the beginning of this training article was this:  Should you use 16.7% as the Reserve for Vacancy and Collection Loss when you are preparing a pro forma operating statement on an average office building in an average big city?  No!  You should use stabilized rent and a 5% Reserve for Vacancy and Collection Loss.  Why?  Because you can.


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Topics: Commercial loan vacancy

Commercial Loans and Rate Locks

Posted by George Blackburne on Fri, Jul 6, 2018

market collapseInterest rates on commercial permanent loans have increased sharply since the end of the Great Recession in 2009.  At one point - about three years ago when the yields on ten-year bonds in Germany and Switzerland went negative - fixed interest rates on commercial loans to prime borrowers reached as low as 3.75%.  Today even very good borrowers are likely to pay 5.6% to 6.0% for the same commercial loan from a regional bank.  Small town banks are quoting rates as high as 6.25%.

We are clearly in an era of increasing interest rates.  It sure would be great if you could lock your rate when while your commercial loan is in process.


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Now if you are buying a house, its possible to get the lender to lock his interest rate for 30 days or so.  The reason why residential lenders can do this is that they buy huge fixed-rate forward-commitments from Fannie Mae or Freddie Mac.  The same is NOT true for commercial loans.  As a general rule, commercial real estate lenders do NOT lock their interest rates.

If you had a commercial loan in process with a bank, and the bond market suddenly collapsed; i.e., interest rate spiked sharply higher, the bank would not be legally obligated to fund your loan at the interest rate originally quoted.


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Big Pebble Bank is processing a $700,000 commercial loan on an office building on Main Street in Big Pebble, New Mexico.  The bank has quoted 5.75%, 1 point, twenty-five years amortized, ten years due, with a rate readjustment at the beginning of year 6, and a 3% prepayment penalty for the first 4.5 years.

Suddenly China, angry over the trade war, sells all of its $2T in Treasury bonds in a single day.  The bond market collapses, and interest rates spike sharply upwards.  (When interest rates spike upwards, the price of existing bonds crash.  This is why the first picture above shows a down arrow.)  By the way, a permanent loan is merely a garden-variety first mortgage on a standing commercial property with a term of at least five years and at least some amortization.  Twenty-five years is the most common amortization for bank commercial loans.


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Example Continued:

After China dumped its bonds, the current rate for commercial permanent loans from Big Pebble Bank increased to 7%.   Will Big Pebble Bank honor its original quote of 5.75%?  Probably not.  The jump in interest rates is just too big.  Rather than candidly saying, "Interest rates have jumped upwards, so we can no longer make your loan at 5.75%," they will probably find some goofy qualitative reason to turn the deal down, like the bricks on the building are red or the property is on the left-hand side of the street.  A quantitative reason might be that the deal no longer produced a 1.25 debt service coverage ratio at the higher 7% rate.

Now the example above was an extreme one.  What would happen if interest rates merely drifted 0.25% higher during the 65 days that it took Big Pebble Bank to process the commercial loan?  Will the bank likely honor its original quote?


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Probably.  While a term sheet is not legally binding on the bank, most banks will hold their quoted rate if the rate change is not terribly dramatic.  You will recall that a term sheet (or loan proposal or conditional commitment letter) is merely an expression of interest in making a commercial loan and a good faith estimate of the eventual terms.  A term sheet is not legally binding on the lender, but it does have some moral influence.

You will recall that a conduit is a commercial mortgage company that specializes in originating commercial loans destined for re-sale into the CMBS market.  CMBS stands for commercial mortgage-backed securities.  CMBS loans are large commercial loans, typically $5 million or more, secured by the Four Basic Food Groups - multifamily, office, retail, and industrial.


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Conduit lenders will NOT lock their interest rates.  Your rate will float with the credit markets while your huge commercial loan is in process.  That being said, most conduits will usually hold true to their margins or spreads.  Let me explain.

Conduit loans are priced at some margin or spread, say, 225 bps. (2.25%) over ten year Treasuries or ten-year swap spreads.  A basis point or bip is 1/100th of 1%.  Therefore 25 bps. is equal to one-quarter of 1%.  Fifty basis points is one-half of one percent.


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What is this ten-year swap spread thingee?  A swap occurs when a lender assumes the risk of rates going up by swapping his adjustable rate bond for a fixed rate bond.  Remember, if you own a fixed rate bond - say a ten-year Treasury bond at 2.5% - and interest rates increase so that new ten-year Treasuries start yielding 3.5%, then your 2.5% bond will fall painfully in value.  

Since the guy swapping his adjustable rate bond for a fixed rate bond is taking a risk, he will normally demand some sort of sweetener to do the deal.  That sweetener is known as a swap spread, and it it expressed as an interest rate.  Today, ten-year swap spreads and ten-year Treasury bonds (also known as the long bond), are about the same value.


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Conduits today are pricing their big commercial loans using the higher of either ten-year swap spreads or ten-year Treasuries.  For example, a conduit might issue a term sheet today for a $7.2 million ten-year permanent loan on a shopping center in Los Angeles.  They might price the commercial loan at 225 bps. over ten-year swap spreads.  The 225 basis points, in this example, is the conduit's margin.

Above we mentioned that conduits will NOT lock their interest rate during the 75-day processing period of one of these huge commercial loans.  Most conduits, however, WILL hold true to their proposed margin or spread under most circumstances.  It's kind of a moral thing.  Conduits are not legally obligated to lock in their margins; but unless there is absolute chaos in the market, they will usually not change it.


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Occasionally, however, the credit markets will plunge into chaos; and the appetite of bond buyers (pension trusts, insurance companies, family offices, etc.) to buy bonds backed by commercial mortgages will disappear.  For example, suppose English jets sought out and destroyed a Russian destroyer in retaliation for a second poisoning attack on English soil.

When this happens, conduits have little choice but to keep increasing their interest rates until CMBS bond buyers return to the market.  "Dude, we're sorry to do this, but with the chaos in the marketplace, we are going to have to re-price your loan."  In other words, the conduit will only make the big $7.2 million loan if the borrower agrees to an increase in the conduit's margin or spread to 325 bps.


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Guys, below you will see some trade offers, where I give you a chance to trade a commercial real estate loan officer worker for a BANK for either a free Regional copy of The Blackburne List, a free commercial mortgage marketing course, or a free copy of my famous fee agreement.  Heavens, guys, you know what a banker is, right?  A banker (NOT a mortgage banker!) works in a big building with a fifty-ton vault, several ATM machines, and FDIC insurance signs all over the walls and counters.  C'mon, guys.  This trade is based on the Honor System.  YOU are NOT a banker.  Please click to view my new Hall of Shame.


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A mortgage broker named Nathan traded me ten bankers two weeks ago for my popular nine-hour video training course, How To Broker Commercial Loans.   He was so pleased with the course that he came back today and traded me another ten bankers for my four-hour video training course, How To Find Your Own Private Mortgage Investors.


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Do you have a real estate related web site?  You can add a link to in minutes.  Our software automatically captures the URL from which our commercial mortgage borrowers come.  When a deal closes, we go back to the owner of the website and pay him a referral fee.  We once paid Alan Dunn of Spydercube a referral fee of $21,250 for merely putting a link to on his website.  He was even sleeping when the referral came over!  Can you imagine that call, "Alan, we've got some good news for you..."  If it were me, I could splash links all over my web pages, maybe three per page.  "Commercial Loans."  "Need a Commercial Loan?"  "Commercial Financing."  Just point these links to, and you're done.


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Topics: locking your rate

How To Get the Largest Possible Commercial Loan

Posted by George Blackburne on Mon, Jul 2, 2018

Interest RatesI often tell the following story to my commercial loan brokerage trainees.  Goliath Bank offers a $2 million commercial loan to the borrower at 5.75%, 1 point, 25 years amortized, ten years due, with a rate readjustment at the beginning of year 6.  The prepayment penalty is 3% in years one through five.  Caution:  While the above quote accurately reflects today's market for bank commercial loans, rates are definitely going up.


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A mortgage broker, competing against Goliath Bank, brings in a quote of $2,150,000 at 6.25% interest and two points.  The broker is making one point.

Guess which commercial loan quote the borrower will most likely chose?  Nine times out of ten, the borrower will choose the 6.25% offer, even with a one-point higher fee, because the broker is getting him more dollars.  With most commercial mortgage borrowers, it all about max cash.  They want as large of a commercial loan as possible, as long as the interest rate is not too much higher.


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So how did this experienced commercial mortgage broker get a larger loan for his borrower?  The key to getting the largest possible commercial loan is to pay attention to the TOP LINE of the Pro Forma Operating Statement.

When you look at a Pro Forma Operating Statement - a projected budget for the property for the next twelve months - the very top line is typically listed as the Gross Potential Income.  This line item represents the amount of rent that the property could generate if every single unit was rented.


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When submitting a Pro Forma Operating Statement to a commercial lender, many borrowers and commercial mortgage brokers repeatedly make the same mistakes:

(1)  They fail to show the market rent of any vacant units.  They will submit an apartment Rent Roll showing 58 units occupied, with the actual rent next to the number of the apartment; but they will leave the rent showing as zero for the two vacant units.  By the way, a Rent Roll is a list of the rentable units / spaces by number or letter, the name of the tenant, the size of the unit, and the current rent.


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(2)  If the borrower fails to show the market rent of vacant units, the lender will often just take the Total Rent from the bottom of the Rent Roll and multiply it by twelve in order to compute the Gross Potential Income.  If this happens, the borrower is screwed.  He might lose ten to fifteen percent off the size of the loan that the commercial lender might have offered.


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(3)  Another common mistake is to fail to show the onsite manger's unit at market rent.  Borrowers to often cut $500 to $1,000 off the manager's rent as compensation for his work.(4)  The reason why your Gross Potential Income line item must appear as large as possible, especially when applying for an apartment loan, is because many lenders will simply grab the Gross Potential Income and lop off 35% for Operating Expenses.  The lender will often totally disregard your projected expenses.


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(4)  Let's go back to the Onsite Property Manger.  If the borrower had wisely shown the manager's unit at market rent and had deducted $1,000 per month down below in the "Property Management - Onsite" line item, then the lender wouldn't even have deducted the $12,000 per year ($1,000 per month) from the Gross Potential Income.  He would simply have ignored this line item expense in favor of using a 35% Operating Expense Ratio.  Wow, huh?  This is huuuuge.


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(5)  When choosing the market rent of a vacant unit, be sure to use the highest rent that you have ever achieved for a unit of that size.  Let's suppose you have six identical units.  Five of the units are rented at $2,000 per month, and one is rented at $2,200 per month.  If a seventh unit is vacant, be sure to show the market rent as $2,200.


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If you want to obtain the largest possible commercial or apartment loan, pay particular attention to the top line of the Pro Forma Operating Statement - the Gross Potential Income.


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Topics: Maximizing Your Commercial Loan