The vast majority of all large commercial real estate loans today are made to single asset, bankruptcy remote entities. This article will explain why.
About 30 years ago a lowlife scumbag was climbing on the roof of a retail building in New York City, looking for a way to break in and steal some of the inventory. The roof was old, and this poor-poor lowlife scumbag fell through the roof and was severely injured. This lowlife scumbag then had the audacity to sue the property owner for $6 million for negligently having an older roof and not warning him of the danger of collapse. The brain dead jury found for the the lowlife scumbag!
The property was not sufficiently insured for this kind of personal injury, and the older couple who owned the building held title in their personal names. The lowlife scumbag was therefore able to seize the life's savings of this honest, hard-working, older couple.
After this astounding case, most commercial real estate investors transferred title to their properties into some sort of entity that had a corporate shield, initially a Subchapter-S corporation and later, after the limited liability company was adopted by the states in 1978, an LLC.
However, it wasn't enough to have title vested in an entity with a corporate shield, as the following imaginary story will explain.
Peter Printer owned the world's largest illustrated Bible printing business in the world. His Bibles contained scores of full color illustrations, far more pictures than his nearest competitor. Customers loved his Bibles, especially parents who read the Bible to their young children at night. For thirty years Peter Printer made a wonderful income, and he invested his millions into a series of office buildings in Los Angeles. He held title to both his successful printing business and his latest office building (he sold his smaller buildings and traded up) in the name Peter Printer Enterprises, LLC.
In 2017 Amazon came out with the Kindle VII, which allowed book printers to embed numerous short videos right into their e-books. Clever Printing, LLC was the first Bible printer to embed short videos, scenes culled from scores of old Biblical movies, into their Bibles. Their new Bibles were a smash hit, and Peter Printer's Bible sales plummeted. Suffering from immense losses, Peter was even forced to use the rents from his investment property, the big office building, to prop up his Bible printing business. He stopped making payments on his $8 million first mortgage from Statewide Regional Bank.
When Statewide Regional Bank stopped receiving payments, it filed foreclosure. Ten days before the foreclosure sale, Peter Printer Enterprises, LLC filed a Chapter 11 (Reorganization) Bankruptcy. For sixty days, Statewide Regional Bank was not allowed by the automatic stay of bankruptcy to do anything; but when the sixty days had run, the bank immediately filed a motion for relief of stay or, in the alternative, for the immediate appointment of a receiver to collect the $75,000 in rent generated by the beautiful, big office building.
To the bank's absolute horror, Peter's bankruptcy attorney was able to convince the bankruptcy court that the $75,000 per month in rent generated by the big office building was absolutely essential to Peter's plan of reorganization. The company needed that $75,000 per month to pay the salaries of the printing company's employees while the company developed its own video-embedded Bible.
For three years the bankruptcy court forbade the bank from foreclosing, during which time the leases of 70% of the tenants came up for renewal. With no money to pay for repairs and upgrades to the office suites and no money to pay for leasing commissions, a Biblical Exodus of tenants ensued. By the time the bank was finally granted relief from the stay, the building was severely rundown and almost empty. The bank had originally made an $8 million loan. It lost all of its interest income and limped home with just $5.25 million of its original principal.
Are you learning anything today? This is how I teach commercial real estate finance. I try to use lots and lots of "real-life" stories. In the 200-year history of the industry, this year is the single best year to becomes a commercial mortgage broker. More commercial loans are ballooning this year than any year in history.
What mistake did Statewide Regional Bank make? They made a large commercial loan to an entity that that owned more than one asset. They got caught up in the bankruptcy troubles of Peter's printing business. The bank did not make a loan to a single asset, bankruptcy remote entity. Had Peter, as a condition of the loan, transferred title to the large office building into a stand-alone LLC with no other assets, the troubles of Peter's printing business would not have delayed the bank's foreclosure. The bank would not have taken a financial bath.
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