Commercial Loans Blog

Industrial Real Estate is the Hottest Commercial Property Type

Posted by George Blackburne on Mon, Oct 26, 2015

Industrial_BuildingIn late 2014 I wrote a blog article suggesting that industrial real estate was heating up, and I gave my reasons.  Apartments have enjoyed sensational appreciation for the past several years, but an investor looking to invest in commercial real estate in 2015 doesn't want last year's winner.  He wants to invest in that type of commercial real estate which is going to perform the best in the next 12 months.

This week I flew to Las Vegas for the California Mortgage Association's semi-annual training session for hard money mortgage companies.  The conference had a number of speakers, but by far the most entertaining and informative speaker was Luis A. Belmonte, the gentleman who gave the economic outlook for the upcoming year.  Mr. Belmonte is a former partner in Lincoln Properties and formerly the Executive Vice President of AMB Institutional Realty Advisors, the asset manager for 15,000,000 square feet of industrial property throughout the United States.




Mr. Belmonte made some very interesting points.  First of all, he remains bullish on multifamily due to the fact that leading edge of the children of the Echo Boom generation - the grandsons and granddaughters of the Baby Boomers - have reached the age of sixteen.  Soon these 80 million Americans will be forming new households, and they will need apartments.

Office space, in his opinion, is still greatly overbuilt.  The office space vacancy rate in most cities remains in the mid-teens.  Rents are going nowhere.  Retail space - he wouldn't touch it with a ten foot pole. is eating retail's lunch.




But then he got to industrial space.  "Industrial space is the best type of commercial real estate in which to be invested today."  He gave a number of reasons:

  1. There has been almost no new construction of industrial space for eight years.

  2. Absorption of industrial space is outpacing new construction in almost every major city.

  3. Wages in China have increased dramatically in recent years.  It's not that much cheaper to manufacture goods in China anymore.  [George's note:  The Boston Consulting Group maintains a cost index for the various counties, and China is only 4.5% cheaper than the U.S. right now, mainly because our natural gas / energy costs are tiny compared to the rest of the world.]

  4. But then he gave a reason that rocked my world.  "For every two square feet of retail space that the internet makes unnecessary, the U.S. needs one square foot of warehouse space" (for internet retailers to store their products).

End of article.

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Topics: Industrial Realty is Hot

Joint Ventures - A Primer

Posted by George Blackburne on Sat, Oct 17, 2015

Condos_under_constructionA joint venture is a sort of a "partnership" between a developer and one or more passive investors to build a commercial property.  The developer brings to the partnership the project; his expertise, as described in detail in his CV or curriculum vitae; and some prepaid expenses, such as architectural fees, engineering fees, and his down payment on the land.  The investor brings to the "partnership" the majority of the equity required by the construction lender.  I've used the term "partnership" throughout this article, but these business entities are almost always set up as limited liability companies ("LLC's").

Almost all commercial construction loans are made by banks.  Banks today are not going to take all of the risk of a construction project by loaning to the developer 100% of the total cost of the project.  Usually the bank will only cover part of the total cost of construction, and the developer will have to cover the rest.  How much of the total cost of the project that the bank will cover is determined by their loan-to-cost ratio.


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Doug Developer wants to build six town homes.  The total cost of the project - including land costs, hard costs, soft costs, and the contingency reserve - is $2,500,000.  This is a relatively small project, so his construction loan request will be small.  He therefore wisely applies to a small bank located close to the subject property.  (George's note:  Doug did two smart things here.  First he matched the size of the loan to the size of the bank to which he applied.  Secondly, he applied to a bank with a branch located just down the street.  Construction lenders greatly prefer local projects.)

Nearby Neighborhood Bank NT&SA has a bank policy that it will only make commercial construction loans today up to 70% loan-to-cost.  Remember, the total cost of the project is $2.5 million.  Seventy percent of $2.5 million is $1,750,000.  This is the largest construction loan that Nearby Neighborhood Bank will make.  Doug Developer will be expected to come up with the remaining $750,000.

Doug paid $500,000 for the land, and he put down $125,000.  The seller carried back a short term first mortgage of $375,000.  Doug also paid $65,000 for all of the architectural plans and another $22,000 for the engineering work.  He therefore has $212,000 in equity into the project.  He is short $538,000.  

$750,000 required equity - $212,000 in developer contributions = $538,000 shortfall

Where is Doug going to come up with the missing $538,000 in cash?

Doug approaches Dr. Dan Deeppockets, a retired neurosurgeon, and invited Dr. Dan to enter into a joint venture with him.  Doug Developer and Dr. Dan negotiate the following deal:

Dr. Dan will contribute the needed $538,000 in additional equity.  If the project is successful and the condo's are sold off, Dr. Dan first gets his $538,000 investment back.  Then, if there is any money left over, Doug Developer gets back his $212,000 cash contribution.  If there any money left over, Dr. Dan gets a preferred return (before Doug Developer) of 15%.  If there is still any money left over, Doug Developer earns a 15% return on his $212,000 cash contribution to the project.  Any money left over?  Dr. Dan and Doug developer agree to split any remaining profit 50-50.  This repayment schedule is known as a waterfall.

End of example.




Who can qualify for a joint venture?  In order to qualify for a joint venture, a developer needs one heck of a curriculum vitae (construction experience resume).  After all, the developer is saying, "With my brains and your money, we are going to make a fortune together."  I don't know about you, but if I were the guy putting up the dough, that developer's brain would have to be pretty darned impressive.

In real life, almost no one ever qualifies for an institutional joint venture - a JV with some huge fund.  If you are an average commercial mortgage broker, I strongly urge you never to work on a joint venture.  You'll never get paid.  Personally I have come to the conclusion that the only developers who can convince a life insurance company, a REIT, or some wealth fund to JV with them are developers who are rich enough to build the project for cash using their own dough.  You and I, as commercial mortgage brokers, will never get to represent one of these guys.  Helloooo?  You will never get paid.  The guys we as brokers get are the developers who spend their last dimes on the architectural and engineering fees.

But what about private joint ventures - joint ventures with wealthy private investors?  Many years ago, scores of broker-dealers raised money for development deals.  Then the rolling commercial real estate depression hit in the early 1990's, and all of these broker-dealers were sued into oblivion.  For 25 years developers found it extremely difficult to raise equity dollars from private investors.

Then something changed.  During the Great Recession, President Obama signed the JOBS Act, which now allows real estate developers and entrepreneurs to publicly advertise to accredited investors for investments, just like hedge funds have been allowed to do for decades.  This is huge.  

Thirty years ago the syndication business was enormous, far larger than the hard money business nationwide.  The syndication industry is not back yet, but I predict that it will return over the next five to seven years.  My own hard money commercial mortgage company, Blackburne & Sons, is looking at a relatively tiny ($1.8 million) joint venture in California.  In fact, we just issued a  Letter of Interest.  Risky-risky-risky, but I remain very bullish (after 20 years of being a perma-bear) on the future of the U.S. economy.


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Hypothecations - What They Are and How to Apply

Posted by George Blackburne on Mon, Oct 12, 2015

hypothecationA hypothecation is defined, at least in the context of commercial real estate finance, as a loan secured, not by a piece of commercial real estate, but rather by a mortgage note owned by the borrower, which is itself secured by a piece of commercial real estate.  In short, its a loan to a guy who owns a mortgage note.  He pledges his mortgage note receivable for a smaller loan.

It is normally far-far better for a note holder to hypothecate his mortgage note rather than to sell it at a huge discount.  Normally when an investor sells a mortgage note, he is forced to take an enormous haircut (loss).  If he simply borrows against his mortgage note receivable (hypothecates it), he can pay back the hypothecation loan and regain title to the full value of his mortgage note.  An example will make this much more clear.




Once upon a time Billy Whiteshoes (he wears plaid pants and a matching white belt) owned an 80-unit apartment building in Naples, Florida free and clear.  He was 68-years-old, and it was finally time for his bride of 55 years and him to retire.  He sold his apartment building for $4.2 million and carried back, for tax reasons, a $3,700,000 first mortgage at 6% interest for 20 years, a wonderful return considering that banks are only paying 0.50% for deposits right now.


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Sadly his beloved bride is snatched by an alligator while feeding the ducks in a pond near their Florida retirement community.  Billy Whiteshoes is devastated and realizes that life is short.  He resolves to live his last remaining years with gusto.  That's when he meets Lola La Boom-Boom, a 42-year-old retired stripper, working as a bartender in a nearby watering hole.  It's love at first sight (of Billy's assets).  Lola convinces Billy to take her on an expensive cruise and to buy her an enormous diamond engagement ring ($120,000).

Needing $150,000 in cash for the rock and the cruise, Billy contacts a mortgage note broker, who offers him just $2,250,000 for his $3.7 million first mortgage note.  "This is a 20-year mortgage, Billy, and while 6% may sound like a great yield today, in five years it may be well below market.  Then my investors will be stuck with a below-market yield for 15 more years.  In any case, we buy our mortgage notes discounted to yield at least 13%."  Outraged, Billy calls a half-dozen more mortgage note brokers, but the offers he receives are all about the same.

Billy is inflamed with desire for Lola, but he is not a complete idiot.  He keeps calling commercial mortgage brokers, until he reaches a subscriber to George's blog.  "You know, Billy," the wise commercial mortgage broker explains, "there is another way.  I can arrange for a $170,000 loan, secured by your first mortgage note receivable.  You don't have to sell the note at a discount.  You can just borrow against it.  This is a private money lender, so you are going to pay 12.9% and 4 points, plus my loan brokerage commission.  But when you pay off this hypothecation loan, you'll still own the entire $3.7 million first mortgage note.  Your cash flow from his mortgage note receivable is large, so I recommend that you triple up on your monthly payments.  Billy, you would be an idiot to sell your $3.7 million note for just $2.25 million!"

My private money commercial mortgage company, Blackburne & Sons, will hypothecate commercial first mortgage notes.


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How much can you borrow against a commercial first mortgage note?  For how much can you hypothecate it?  Most lenders (there are very few of us) who hypothecate commercial first mortgage notes will lend up to 80% of the discounted present value of the note.  Without trying to teach a whole college-level course in business finance, most hypothecation lenders will discount the monthly payments and the balloon payment back to present value.  Blackburne and Sons will use a discount rate of 13%, the yield required by our private investors.  Since we charge a 4-point loan origination fee on hypothecations, we would use as our value of the note 96% of its discounted present value.  Just like we are not going to lend 100% of the value of a property, we will lend up to 80% of the value of that note (to us).




So how do you package a hypothecation loan?  If you are a commercial mortgage broker, what documents do you ask for?  One of our newer loan officers recently ran across a hypothecation loan request, and our brilliant EVP, Angelica Gardner, sent this to him:

Good Morning, (New Loan Officer),

I received your voicemail message regarding a hypothecation loan. I figured it would be better to send you the details so you can review (the deal) first, then we can discuss details or questions.

First, the definition of a hypothecation: The established practice of a borrower pledging an asset as collateral for a loan, while retaining ownership of the assets and enjoying the benefits therefrom. With a hypothecation, the lender has the right to seize the asset if the borrower cannot service the loan as stipulated by the terms in the loan agreement.

Below is a list of the documents that I would want to see. It is unlikely that you will be able to gather all of the documents listed below, but try to get as many of them as possible.

  1. Color photos of the property.

  2. Copy of Promissory Note and Mortgage*

  3. Original title insurance policy (or fresh prelim)*

  4. Something showing the payment history*

  5. Closing statement from when note was created*

  6. Financial statement on the maker/borrower (when the note was created)

  7. Credit report on the maker/borrower (when the note was created)

  8. Two years’ tax returns on the maker/borrower (when the note was created)

  9. Appraisal - an old one is very helpful and a new one is blissful

  10. Rent roll and/or commercial leases (when the note was created)

  11. Current financial statement of the Maker (hypothecation borrower), current credit report on the Maker, last two years tax returns on the Maker, current Rent Roll, current commercial leases.

* Very, very important.

Find out early who has possession of the original Promissory Note and Mortgage. It is legally impossible to properly assign a note and mortgage to the assignee (buyer of, or lender against, the discounted commercial loan) without delivering the original promissory note.  In fact, if the assignee (buyer of, or lender against, a discounted commercial loan) fails to take physical delivery of the original promissory note, and if the assignor (the seller of, or borrower against, the discounted commercial loan) later files Chapter 7 bankruptcy, the promissory note becomes the asset of the bankruptcy estate!  (In real life) the intended assignee is completely wiped out.

Another important note: We will require that the underlying borrower makes his payments directly to us. We want to always make sure that the payment on our loan is covered by the payments from the underlying borrower. Please let me know if you have any questions.


Angelica D. Gardner
Executive Vice President

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Topics: Documenting Hypothecations

Types of Commercial Loans

Posted by George Blackburne on Thu, Oct 8, 2015

There are quite a few different types of commercial real estate loans.  Below is a partial list.  I predict that several of them will be unfamiliar to you:

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  1. Permanent LoansA permanent loan is a garden variety first mortgage on a commercial property.  To qualify as a permanent loan, the loan must have some amortization and a term of at least five years.

  2. Bridge Loans - A bridge loan is a short-term, first mortgage loan on commercial property.  The term could be from 6 months to three years.  The interest rate on bridge loans is typically much higher than on permanent loans.

  3. Mini-Perms - A mini-perm is a first mortgage on a commercial property with a term of two to three years.  A mini-perm can either be an interest-only loan or amortized over 25 years.  Most mini-perms are made by banks, and they are used to give the property owner time to solve some problem, most often leasing out the property.  Many mini-perms are written by banks, in connection with their own construction loans, to serve as standby takeout loans, just in case the developer cannot qualify for a normal takeout loan, perhaps because the building is not yet sufficiently leased.  These are known as construction / mini-perm combo's.  The banks typically charge an extra point for the mini-perm commitment letter and another one point if the mini-perm actually funds.

  4. Commercial Construction Loans - A loan of one to two years used to build a commercial property.  The loan proceeds are controlled by the lender in order to make sure they are only used in the construction of the new building.

  5. Takeout Loans - A takeout loan is a garden variety permanent loan where the proceeds of the loan are used to pay off a construction loan.

  6. Forward Takeout Commitment - A forward takeout commitment is a letter from a bankable lender promising to deliver a takeout loan in the future.  Most, but not all, forward takeout commitments are issued by life insurance companies on large construction projects.  The letters usually cost between one and two points, plus many lenders often charge an additional fee of 1/2 point to one point if the loan actually funds.

  7. Standby Takeout Commitment - A standby takeout commitment is defined as a letter from a bankable lender promising to deliver an undesirable takeout loan in the future.  No one ever expects a standby loan to fund.  The reason why is because the actual loan terms of most standby takeout loans are pretty ghastly - a very high interest rate and an additional one to two points if the loan actually funds.  The purpose of a standby takeout commitment is merely to satisfy some construction lender that he has a guaranteed way to get paid off.  Standby takeout commitments cost two to three points, just for the letter.  The standby takeout commitment business is really out of favor right now because too many standby lenders over the years have used legal loopholes to weasel out of their commitments to pay off the construction lenders.

  8. Uncovered Construction Loan - An Open-Ended Construction Loan or an Uncovered Construction Loan is defined as one with no forward takeout commitment in place.  This has become quite common today as banks develop confidence in the constant availability of commercial takeout loans.

  9. Covered Construction Loan - A Close-Ended Construction Loan or a Covered Construction Loan is defined as one with a forward takeout commitment firmly in place.  For the past 20 years commercial mortgage money has been abundantly available.  As a result, most construction lenders are quite comfortable making Uncovered Construction Loans.  Those commercial construction lenders demanding a forward takeout commitment are finding that they are not closing many deals.

  10. Conduit Loans - A conduit loan is a large permanent loan on a fairly standard type of commercial property, which is written underwritten to secondary market guidelines and which has an enormous prepayment penalty.   Such loans enjoy very low interest rates.  Conduit loans are later assigned to pools and securitized to become commercial mortgage-backed securities.

  11. SBA Loans - Loans to users of commercial real estate which are written by private companies, such as banks and specialty finance companies, but which are largely guaranteed by the Small Business Administration.  SBA loan guarantees were created by Congress to encourage the formation and growth of small businesses.

  12. SBA 7(a) Loans - The SBA 7(a) program is a 25-year, fully-amortized, first mortgage loan program with a floating rate, tied to the Prime Rate.

  13. SBA 504 Loans  - The SBA 504 loan program starts with a conventional, fixed-rate, first mortgage and then adds a 20-year fully-amortized, SBA-guaranteed, second mortgage behind it.  It is the most common way to get a fixed rate SBA loan.

  14. SBA Construction Loans - Many SBA lenders will write conventional construction loans that convert automatically to 25-year SBA loans upon completion.

  15. USDA B&I Loans - The Department of Agriculture’s Business and Industry loan program is very similar to the SBA loan program, where a conventional lender makes the loan but the USDA guarantees most of it.  USDA Business and Industry loans were created to help create jobs in rural areas.

  16. Hypothecations - A hypothecation is actually a personal property loan secured by a note and mortgage owned by the borrower.  The borrower’s note and mortgage are often created when the borrower sells a piece of real estate and carries back the financing.  Later the borrower might need cash and pledges his mortgage receivable as collateral.  My own private money commercial mortgage company, Blackburne & Sons, will make these rare kind of commercial loans.

  17. Fix and Flip Loans - Fix and flip loans are renovation loans that are similar to construction loans.  Typically the loan is used to acquire property with enough additional proceeds to renovate the property for a quick sale.





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