# Commercial Loans Blog

For decades I taught live classes in commercial mortgage brokerage   I am much too old now to stand and teach a nine-hour class.  They were sooo exhausting.

The single most important lesson in all of commercial real estate finance (“CREF”) is the Debt Service Coverage Ratio.  I would therefore spend an hour-and-a-half teaching the use of this ratio.

Then I would always pick some unsuspecting victim out of the crowd.  I would ask her, “Now what’s the name of this ratio that we have been talking about?”  The poor victim would reply something like, “The Debt Ratio?” “How about you, sir?”  He would stammer and stutter, and then he would reply meekly, “The Service Ratio?”  The audience would laugh, but they would all be secretly thinking, “I’m sure glad that he didn’t ask me.”

I would then ask them to say out loud, “Debt Service Coverage Ratio.”  Three times.  Out loud.  Like kindergarten.  Ha-ha!  In fairness, the name of this financial ratio doesn’t just trip off of the tongue.  How are we going to remember the name of this weird-sounding ratio?

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Q:  Do you know why you never see elephants hiding up in trees?
A:  Because they’re really good at it.

Q:  How does the elephant get out of the tree?
A:  He climbs out onto a leaf and waits until Autumn.

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HOW C-LOANS WORKS IN PLAIN ENGLISH

We are talking about a loan, and obviously “debt” is another name for a loan.  But what does it mean to service the debt?  Think of a server at a restaurant.  He provides service to, and attend to, the diners.  He makes them happy and satisfied.  And how to do we make a lender happy and satisfied?  We make the payments on his loan!  So debt service means the annual payments on the loan.

By the way, all debt service coverage calculations are, by custom, performed on an ANNUAL basis.  Darn!  You could squeak out a slightly larger loan if you could do the calculations on a monthly basis. Nice try.

Now back to the Debt Service Coverage Ratio.  Three times. Out loud.  Debt Service Coverage Ratio.  Debt Service Coverage Ratio.  Debt Service Coverage Ratio.

Okay, we've mastered Debt Service.  Now let’s tackle the word, “coverage”.

I rode horses for four years as part of the famous Culver Black Horse Troop - 100 all black horses.  I rode in President Nixon's second Inaugural Parade.  My son, George IV, rode in W's first Inaugural Parade.  Tom rode in W's second Inaugural Parade.  My daughter, Jordan, just rode in Trump's Inaugural Parade, as part of the Equestriennes, the girls counterpart to the Black Horse Troop.

I urge you to take a moment to look at some quick images of the Black Horse Troop and Culver Military Academy.  The academy is an incredible military high school, and it is why the Blackburne’s moved to Indiana, even though the company is still located in Sacramento.

Because I rode horses, when I think of “coverage", I think of a stallion covering a mare.  Do I mean...?  Yup.  Doing the wild thing.  It’s not a bad metaphor.  Normally the stallion is about 25% larger than the mare.  Commercial lenders want the Net Operating Income from the property to be at least 25% larger than the Debt Service.

Okay, and without talking about horses doing the wild thing again, the Debt Service Coverage Ratio (“DSCR”) is defined as:

DSCR = NOI / Debt Service x 100%

NOI stands for the property’s Net Operating Income, and the Debt Service stands for the annual principal and interest payments on the proposed loan, excluding taxes and insurance.  Residential lenders use PITI, principal, interest, taxes, and insurance.  In commercial real estate finance ("CREF"), we do NOT include taxes and insurance in the Debt Service because we have already deducted them from the Effective Gross Income when we computed the property's Net Operating Income.  We just include the annual principal and interest in the Debt Service.

The Net Operating Income is the bottom line number of the Pro Forma Operating Statement that you will prepare for your lender.

Commercial lenders today require that this ratio exceed 1.25.  On hotels and other business properties (any business where the owner has to be there everyday), commercial lenders require that the Debt Service Coverage Ratio exceed 1.45.

Interest rates have been going up.  The best rate offered by banks has increased from just 3.875% three years ago to 5.75% to 6.25% today. The Debt Service Coverage Ratio is once again important in sizing commercial loans.

Sizing a commercial loan means to compute the maximum loan amount that a lender will make on a particular commercial property.  It will usually be the smallest loan amount generated by the Loan-to-Value Ratio, the Debt Service Coverage Ratio, and for Conduits (CMBS lenders), the Debt Yield Ratio

Topics: debt service coverage ratio

Today's article is more about economics than commercial loans; but first I have to post an important message, just for commercial loan brokers.  If you do not work in the commercial real estate finance ("CREF") industry, you should simply skip to the section below entitled, Trauma From the Great Recession.

IMPORTANT MESSAGE FOR COMMERCIAL LOAN BROKERS

For the past year, in order to add more bankers to CommercialMortgage.com, C-Loans, Inc. has been trading our wonderful training courses about the commercial loan business to commercial loan brokers in exchange for the contact information of bankers making commercial real estate loans.

The swaps have proven wildly successful, and we have now added around 4,000 commercial real estate lenders to CommercialMortgage.com.  If you are not using this free commercial mortgage portal several times per week, you are really missing the boat.

We now have enough commercial lenders on CommercialMortgage.com, so these swap offers ends on August 31, 2018, just one week away.   If you have a passion to learn commercial real estate finance, but you can't afford to pay hundreds of dollars for this invaluable training, this really is your last chance to get these courses for nothing out of pocket.  Here are the trades:

1. You can trade one commercial real estate loan officer working at a bank or a credit union for a free copy of my commercial mortgage marketing course, a free copy of my fabulous Income Property Underwriting Manual, a copy of my battle-tested commercial mortgage broker fee agreement, or a copy of a Regional Blackburne List with 750 commercial lenders.

2. You can also trade ten commercial real estate loan officers for a free copy of my famous 9-hour course, How to Broker Commercial Loans.  Please click here for details.

3. You can trade ten commercial real estate loan officers working at a bank or credit union for  a free copy of my super-important course, How To Find Your Own Private Mortgage Investors,.  It's all about the loan servicing income, folks!  Please click here for details.

4. Lastly, you can trade ten commercial real estate loan officers working at a bank or credit union for my very best course, the Practice of Commercial Mortgage Brokerage, which has over 60 important and practical lessons.  Please click here for details.

Remember, these trade offers will be withdrawn after August 31st.  However, the following incredible offer to commercial loan brokers will remain:

ENTER A COMMERCIAL LOAN INTO C-LOANS.COM
GET YOUR CHOICE OF TWO OF OUR TRAINING PROGRAMS

If you enter a bona fide commercial loan into C-Loans.com, using the six-step process, and submit that deal to six of our commercial lenders, we'll give you a choice of any TWO of the following prizes:

C-Loans Explained in Plain English

1.  Powerpoint presentation to our Commercial Mortgage Marketing Course.

2.  Income Property Underwriting Manual

3.  Commercial Loan Broker Fee Agreement

4.  Regional Blackburne List of 750 commercial lenders.

When you have submitted your commercial loan to six of our commercial lenders, please contact Tom Blackburne at 574-210-6686 and tell him which two gifts you want.  Borrowers and commercial brokers, feel free to take advantage of this offer as well.

Now finally we can get to today's economic observations.

TRAUMA FROM THE GREAT RECESSION

My father and mother both lived through the Great Depression.  My father was at West Point during the worst of the Great Depression, and he was an Army officer in Hawaii during the rest of the slump.  On an officer’s salary, my father lived like a king.

Interesting Note:  In 1939, my father was an Army Captain in charge of the shore defenses on the island of O’ahu.  His artillerymen were armed with French 75 mm howitzers, which were strategically emplaced all along the shoreline.  The French 75’s were excellent artillery pieces, except my father’s guns had no ammunition!  He kept complaining to his General, until he was finally ordered to shut the heck up. My father also told me of a time when he was looking down a sextant to site one of his howitzers, when he spotted a Japanese “fisherman” plotting my father’s gun with his own sextant. Yikes!

But it was my mother who was the most traumatized by the Great Depression.  Her father worked in a factory, until he was laid off in 1930. My mother then had to quit high school, at the age of fourteen, and go to work in a factory in order to feed the family.

Money was incredibly tight for my mother’s family, and those years traumatized her.  Even though my father worked as an aerospace engineer for Lockheed for most of my childhood, earning a fine wage, my mother could never get over the trauma of the Great Depression.

The minister's little six-year-old girl had been so naughty during the week that her mother decided to give her the worst kind of punishment.  She told her she couldn't go to the Sunday School Picnic on Saturday. When the day came, her mother felt she had been too harsh and changed her mind.  When she told the little girl she could go to the picnic, the child's reaction was one of gloom and unhappiness.  "What's the matter?  I thought you'd be glad to go to the picnic." her mother said. "It's too late!" the little girl said. "I've already prayed for rain."

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My mother therefore scrimped and saved her entire lifetime.  “Turn out the lights!” she would admonish us, “You are wasting money.” Toothpaste?  We were taught to squeeze that roll incredibly tight, so as not to waste a single brushing’s worth of toothpaste.  We were also hoarders.  Anything that could possibly be re-used was saved.

My mother was not alone in her trauma.  Most working people who lived through the Great Depression were deeply affected.  Thrift became a very admired trait.  Savings and loan associations were even called “thrifts” because S&L’s, back in the day, were able to pay 0.25% higher interest than banks.

__________________________

My wife accused me of being immature.  I told her to get out of my fort.  Ha-ha!

My wonderful parents took me to Disneyland when I was six-years-old.  To this day, almost sixty years later, I still remember the ‘coonskin cap and flintlock pistol that they bought me.  I still remember the butterflies of excitement I felt defending the fort on Frontierland Island against the attacking ‘Injuns.  And those dark, creepy Tom Sawyer tunnels… oh, my goodness, I was in heaven!

Okay, let’s finally get to it.  About five months ago, I predicted raging inflation this summer, caused by workers demanding higher pay.  I was wrong.

It’s true that the inflation rate has been increasing all year, and the figure for July was a strong 2.95%.  Net income, after taxes, has been increasing at the encouraging rate of over 3%.  It is also true that productivity has been increasing at the rate of 1.3% annually in recent months, the first increase in a number of years.  The reason why productivity is important to the inflation story is that increases in productivity often lead to higher wages.

But we have NOT seen the type of raging inflation figures that I was expecting.  Why not?  The unemployment rate is back down to 3.9% this week.  American companies are making money, and they can surely afford to pay higher salaries.  Why aren’t American workers demanding higher pay?

I submit that it is because American workers remain traumatized from the Great Recession.  If 2009 marked the beginning of the recovery – certainly that’s true with the stock market – American workers have had nine years to recover from the economic fright of their lives.  That should be long enough to “get over it”, right? (In the 1987 movie, Moonstruck, Nicholas Cage declares his love to Cher, who proceeds to slap him mightily – bam! - and replies, “Get over it!”)

But apparently not. It looks like Americans workers remain too traumatized by the Great Recession to risk their jobs by demanding higher wages.   Who’d have thunk it?

Topics: Great Recession Trauma

This practical marketing tip can be used by widget manufacturers, commercial mortgage brokers looking for commercial loans, and commercial brokers trying to sell a commercial property.  I've written around 300 blog articles, mostly about the commercial loan business.  This article may be my second most important article ever.

Whenever you market to a select group of recipients again and again, you should share a little bit of your life with them in each of your marketing pieces.   I am talking about price sheets (if you are a supplier or a manufacturer), newsletters (if you are a commercial loan broker), rate sheets (if you are a residential mortgage broker), or sales brochures (if you are a commercial broker).

By sharing your life, I mean just a one or two-paragraph story of something funny, entertaining, interesting, or heart-warming that recently happened in your personal life.  Here's an example:

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On a Personal Note...

Cisca (my darling bride of 35 years), our granddaughter, and I were on the way to the Indianapolis State Fair last weekend.  The turnoff into the parking lot of the Fair was right off a bustling boulevard.  Forty cars were stopped in line to make a right-hand turn.  We were the second to the last car in line.

Bam!  The car behind us smashed into the rear of our car, causing us to be heaved into our seatbelts.  Then, out of the corner of my eye, I saw a Jeep flying over the top of our car, like it was in slow motion.  This Jeep must have been twelve feet in the air.  The trajectory was such that my beautiful wife was about to crushed into mincemeat... Thankfully the Jeep continued its flight and landed on its side, just three feet to the left of my beloved wife.

Have you told your wife, husband, or children recently just how much you love them?  Bam - and they could be gone.  (This actually happened two years ago.  Thank God no one was seriously hurt, including the airborne astronaut.)

Let's suppose that you sell solvents, and every week you send a price sheet by email to your list of 127 local purchasing agents.  Three competing companies send a similar price sheet to the same purchasing agents.  Your owner would be immensely wise to include a personal paragraph at the top of each price sheet.  Suddenly ADR Solvents becomes... Adam Richter, his lovely wife Mary, and cute, little Adam Richter, Jr. (age six), who just got his first hit in a Little League game and who grinned with the greatest of joy when he looked over and saw his father, Big Adam, doing dog-flips in the stands.

What purchasing agent wouldn't be touched by such a story?  When the buyer looks at the competing price sheets, and he sees that all four solvent companies are offering about the same prices, which solvent company do you think is going to get the order?

"But George, that is so unprofessional!"

Nonsense.  I sell 7% to 12% first mortgage investments for a living to a very distinguished group of accredited investors - doctors, attorneys, CPA's, and the owners of large and successful businesses.  We service over \$55 million in first mortgage loans and properties for these well-heeled investors.

Nevertheless, I try to share a little bit about my personal life with them in every newsletter.  If anyone was going to be put off by my "unprofessional behavior", it would be these wealthy, conservative folks.  Let me assure you, the overwhelming majority of my investors seem to really enjoy my little stories.  They are why many of them invest with us.

This practice - becoming a pen-pal with your customers - will separate you from the crowd.  Those of you who a residential mortgage brokers, you simply MUST start doing this.  You sell a fungible product - a conforming loan from Fannie Mae or Freddie Mac - so the only reason why a residential sales broker is going to choose you is because he likes, trusts, and respects you as a person.

By the way, a fungible product is one that is perfectly interchangeable with another.  For example, a bushel of corn sold on the Chicago Board of Trade is fungible with any another bushel sold on the Exchange.  In plainer words, "There ain't nothing special about it."  So back to residential loan agents, they all their loans to the same buyer, Fannie Mae or Freddie Mac.   You therefore need to develop a more personal relationship with your residential sales brokers.  Don't just send rate sheets.  Include a personal paragraph!!!

This leads me to a very important lesson.  I call it the Newsletter Effect.  If you send a fun, folksy, and personal newsletter every three weeks to the same recipient for nine months, he will swear that he has known you forever. You laugh, but when I used to go to trade shows (I sent a lot of faxes back in the day), mortgage brokers would approach me and tell me that they had been receiving my funny faxes for years.  When I would later check my data base, I would find that they had only been on my fax list for nine months.

If you write to someone every three weeks for nine months, he will consider you to be extremely trustworthy.  After all, it does takes a certain amount of character to religiously send out a newsletter every three weeks.  Or perhaps you are considered extremely trustworthy because you have not been arrested in the "years and years" that he has known you.

If you are a consistent pen-pal, you will discover that your reader considers you a personal friend and the back-up godparent to his kids.  And that's a very good thing.  We are NOT trying to manipulate people here.  We love our friends, and we are darned grateful and humble to to have them.  We are just trying to become even richer in friendships.

So today's lesson is to include a personal paragraph or two in every one of your marketing pieces.  Those of you who are commercial loan brokers and commercial brokers (experts who sell commercial real estate), you have probably been added to our funny newsletter lists.  You may recall that you have been assigned to a particular loan officer at Blackburne & Sons (my commercial hard money shop), and that this loan officer always includes a personal paragraph in his newsletter.    My loan officers kick and scream a little when I make them write their little stories, but I have read some very funny and incredibly heart-warming stories from them.

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If you are a regular reader, you know that you can trade one commercial real estate loan officer working at a bank or a credit union for a free copy of my commercial mortgage marketing course, a free copy of my fabulous Income Property Underwriting Manual, a copy of my battle-tested commercial mortgage broker fee agreement, or a copy of a Regional Blackburne List with 750 commercial lenders.

You can also trade ten commercial real estate loan officers for a free copy of my famous 9-hour course, How to Broker Commercial Loans, a free copy of my super-important course, How To Find Your Own Private Mortgage Investors, or my very best course, the Practice of Commercial Mortgage Brokerage, which has over 60 important and practical lessons.

That's the good news.

The bad news is that so many brokers have taken advantage of this offer that our latest commercial mortgage portal, CommercialMortgage.com is now packed with over 3,000 commercial lenders.  We really don't need any more.  We have dozens of banks and credit unions for every state (although Alaska is admittedly a little light).

My offer to make any of these trades ends on August 31st.  Any list submitted after August 31st will be ignored.  Fair warning.

BUT THE FOLLOWING OFFER REMAINS:

If you enter a bona fide commercial loan into C-Loans.com, using the six-step process, and submit that deal to six of our commercial lenders, we'll give you a choice of any TWO of the following prizes:

1.  Powerpoint presentation to our Commercial Mortgage Marketing Course.

2.  Income Property Underwriting Manual

3.  Commercial Loan Broker Fee Agreement

4.  Regional Blackburne List of 750 commercial lenders.

When you have submitted your commercial loan to six of our commercial lenders, please contact Tom Blackburne at 574-210-6686 and tell him which two gifts you want.  Borrowers and commercial brokers, feel free to take advantage of this offer as well.

Topics: Personal Paragraphs

Heavens, salaried commercial loan officers working for banks sure can be lazy.  This is especially true for salaried guys over the age of 50, and loan officers over 50 constitute over 70% of all bank commercial real estate loan officers.

These sleepy, old, privileged white guys all have their stable of repeat customers.  They are mainly on salary (zzz), and they are going to close enough commercial real estate loans to meet their quota and earn their bonus.  Why close even one more commercial loan?  They might have to exert themselves.  Arghhh.

Oh my goodness, you submit a super-cherry commercial loan application to an old banker.  All he has to do is click on the attached PDF.  You have spoon-fed the guy.  The PDF contains some great color pictures.  You have prepared a Pro Forma Income and Expense Statement.  You have computed the the Loan-to-Value Ratio, and it is less than 70%.  You have computed the Debt Service Coverage Ratio using the proper loan constant, and it exceeds 1.25.  The borrower has good credit, and its clear that his Net-Worth-To-Loan-Size Ratio exceeds 1.0.  It's a slum-dunk deal.

But the lazy bum won't even click on your PDF.  You call him four days later - you have foolishly been waiting patiently by the phone - and you ask him what he thought about the deal.  He replies, "I was just about to open it.  I'll do it right now."

This reminds me of an old joke.  A man finds in his old raincoat pocket a shoe repair ticket (receipt) from ten years ago.  He had dropped off a pair of expensive dress shoes to be reheeled.  "I wonder if that old shoe repair shop is till open?"  He goes into the shop, and the old cobbler is still there. The old man takes the ticket to the back, comes back, and says, "They will be ready by Thursday."  Ha-ha!

The lesson:  You must always call your commercial lender about three hours after emailing your commercial loan to him "to confirm receipt of the package."  You're not really calling to confirm receipt of the package.  You're calling him to boot him in the tush to read the package!

Just as I despair for old, white commercial real estate loan officers, I absolutely love-love-love Asian women commercial loan officers.  When you call her three hours later, she has already called the borrower, gotten the last of her required documents, and is ordering a BPO.  A BPO is a Broker's Professional Opinion, a quick estimate of value by a local real estate broker.  Human dynamos.

Okay, but 70% of the time we are going to have to deal with the lazy old guys.  This is reality.  How are you going to get this old-timer to look at your deal.  After almost 40 years in the industry, I have concluded that you can't submit your commercial loan as a PDF.  He simply won't open it.

You should therefore just initially submit your commercial loan as a simple  Executive Loan Summary, not as an attachment, but rather as the email itself.  Remember, the sleepy, old banker is not going to click on an attachment.  Here's a sample for you to copy:

ABC APARTMENTS
345 MAIN STREET
SACRAMENTO, CA

EXECUTIVE LOAN SUMMARY

TYPE OF LOAN REQUEST:  Permanent First Mortgage

AMOUNT OF LOAN REQUEST:  \$1,000,000

TYPE OF PROPERTY:  Apartment Building

NUMBER OF UNITS:  88

GROSS RENTABLE AREA:  34456 sf

NET RENTABLE AREA:  23340 sf

AGE:  8 years

PROPERTY DESCRIPTION

88-unit garden apartment project. The units consist of 78 one-bedroom units of 1,112 square feet each plus 10 studios of 836 square feet.  The property is in good condition, but the parking lot needs to be resurfaced.  The proceeds will be used to resurface the parking lot and install washers and dryers in each unit.

VALUE OF THE PROPERTY:  \$2,000,000

LOAN TO VALUE RATIO:  66.7%

DEBT SERVICE COVERAGE RATIO:  1.35 based on a 5.25, 30-year constant

INTEREST RATE DESIRED:  5.25%

LOAN FEE DESIRED:  1 point

AMORTIZATION SCHEDULE REQUESTED:  30 years

TERM DESIRED:  30 years

SPECIAL ISSUES

The borrower was forced to declare a Chapter 11 bankruptcy when he suddenly inherited in the property from his grandmother, only to find that she was just two weeks from a foreclosure sale. He liquidated some stocks and bonds, brought the loan current, and dismissed the bankruptcy, all within 30 days of inheriting the property. His personal credit has always been immaculate.

NAME OF BORROWER:  Steve & Marsha Smith

TYPE OF ENTITY:  Individuals

OCCUPATION:  Attorney

ANNUAL INCOME:  \$450,000

NET WORTH:  \$5,000,000 to \$10,000,000

CREDIT:  Very Good

CREDIT SCORE:  760

Bob the Loan Officer,

I have a complete package ready for you.  Just call me, Tom Blackburne, Blackburne & Sons Realty Capital Corporation, at 916-338-3232.

Now your commercial loan officer at the bank has no excuse for not looking at the deal.

IMPORTANT WARNING:

If you are a regular reader, you know that you can trade one commercial real estate loan officer working at a bank or a credit union for my commercial mortgage marketing course, my fabulous Income Property Underwriting Manual, a copy of my battle-tested commercial mortgage broker fee agreement, or a copy of a Regional Blackburne List with 750 commercial lenders.

You can also trade ten commercial real estate loan officers for a free copy of my famous 9-hour course, How to Broker Commercial Loans, a free copy of my super-important course, How To Find Your Own Private Mortgage Investors, or my very best course, the Practice of Commercial Mortgage Brokerage, which has over 60 important and practical lessons.  Please click here for details.

That's the good news.

The bad news is that so many brokers have taken advantage of this course  that CommercialMortgage.com is now packed with over 3,000 commercial lenders.  We don't need any more.  We have dozens of banks and credit unions for every state (although Alaska is admittedly a little light).

My offer to make this trade ends on August 31st.  Any list submitted after August 31st will be ignored.  Fair warning.

Guys, if you are a commercial mortgage broker, and you are not using CommercialMortgage.com several times per week, you are a stupido.  Geesch, it has over 3,000 different commercial lenders, and its free!

Topics: Packaging a commercial loan