Commercial Loans and Fun Blog

By the end of this training article, you will know what banks are quoting on commercial loans on office buildings, retail buildings, shopping centers, and industrial buildings; i.e., what commercial banks are quoting on permanent loans.

You will know these commercial loan rates exactly, and you will know these commercial loan rates without the need to call anyone.  As a silly character in the 1950's-era sitcom, Dobie Gillis, used to say, "Good stuff, Maynard."

But first I have a reminder:  Commercial banks across the country quote almost the exact same commercial loan, whether the bank is located in Bangor, Maine or in San Diego, California.  (Please read that last sentence again and embrace it!)

That loan will be the current commercial loan rate for banks, fixed for the first five years, readjusted once at the beginning of year six to 2.75% to 3.50% over five-year Treasuries, 1 point, 25-years amortized, ten years due, and a declining prepayment penalty, commonly 5-4-3-2-1-open- 5-4-3-2-1.  Open means no prepayment penalty.  If the property is older than 40 years, most banks will cut the amortization down to 20 years.

Okay, so what is the current commercial loan rate?  You compute it first looking up 5-year Treasuries.  Just go to Google and type, "5-year Treasuries."  Presto-chango!  You have your answer.  As of December 27, 2018, five-year (constant maturity) Treasuries are 2.60%.

And now for the magician's trick.  Drum roll please, Maestro.  Just add 2.75% to 3.50% to five-year Treasuries to get your answer:   And of December 27, 2018, banks across the country are quoting 5.35% to 6.10% for commercial permanent loans.

So when do you get 5.35% and when do you get 6.10%?  Its depends on the beauty of the property, the location of the property, the loan-to-value ratio, the liquidity of the borrower (banks love-love-love liquidity), and the net worth and credit of the borrower.

Basically, Ginger gets 5.35%.  Mary Ann gets 6.10%.  It's really this simple.

What about apartments?  Typically apartment loans, which are always the most coveted kind of income property loan, are 20 to 30 basis points cheaper.  You will recall that a basis point is just 1/100th of one percent.  Twenty-five basis points is one-quarter of one percent.  Therefore, apartment loans are around one-quarter of one percent cheaper than commercial loans.

I had to look it up too.  Euripides wrote scores of tragedies in the days of ancient Athens.

Whenever a commercial mortgage lender offers you or your client an adjustable mortgage loan (AML), it is very important that you compute the implied rate before accepting the loan.  The implied rate is the sum of some index plus the spread.

According to Investopedia, "an index is an indicator or measure of something, and in finance, it typically refers to a statistical measure of change in a securities market. In the case of financial markets, stock and bond market indices consist of a hypothetical portfolio of securities representing a particular market or a segment of it."

In commercial real estate finance ("CREF"), commercial lenders tie their commercial loans to a number of number of different indexes.  The most popular indexes for adjustable rate commercial loans are the prime rate and LIBOR.  

LIBOR stands for the London Inter-Bank Offer Rate, and it is benchmark rate that represents the interest rate at which banks offer to lend funds to one another in the international interbank market for short-term loans.  LIBOR is an average value of the interest-rate which is calculated from estimates submitted by the leading global banks on a daily basis.

Example:

HSBC, a huge British Bank, just had a terrific week making new commercial loans, but it is low on cash at the moment.  Regulators require European banks to maintain a certain amount of liquidity (cash on hand), so HSBC borrows fifty million Euros from Credit Suisse, a huge Swiss banks, for 24 hours at some daily interest rate.  It's a good deal for both banks because Credit Suisse had just gotten a ton of pay-offs in its loan portfolio, and it had far more liquidity that it needed.

Regulators in London, the financial capital of Europe, get reports from hundreds of European banks about what they are paying for overnight funds, and they use these reports to produce an average rate for overnight funds called LIBOR.

Swap spreads is another popular index in commercial real estate finance.  Swap spreads is the difference between the swap rate (a fixed interest rate) and a corresponding government bond yield with the same maturity (Treasury securities in the case of the United States). ... The swap rate therefore is simply the yield on an equal-maturity Treasury plus the swap spread.

Are your eyes glazing over?  Let's give you a layman's translation.  Think of swap spreads as a measure of how likely it is that interest rates are going up.  For example, with the stock market in a bear market and with Wall Street worrying about a recession, it is less likely that the Fed will be raising rates dramatically.  Therefore swap spreads probably declined in the past three weeks.

Conduits - banks or commercial mortgage companies originating commercial loans destined for securitization - will usually price their commercial loans according to some spread over swap spreads.

Now let's compute the implied rate of a real-life commercial loan:

Example:

Blackburne & Sons Realty Capital Corporation is a commercial hard money lender based out of Sacramento, California.  In response to pressure from Wall Street non-prime lenders, Blackburne & Sons recently came out with a much more competitive rate for "B" quality commercial loans.

Here is out new best rate:

7.9% fixed for two years, then 5-year Treasuries (index) plus 7.03% (spread), readjusted semi-annually, 3 points + $950, 30-years amortized, due in 15 years (note the sweet 15-year term), no prepayment penalty.

At the beginning of this training article, you will recall that I urged you to always compute the implied rate, the sum of the index plus the spread.  If we add the value of 5-year Treasuries (2.87%) to the spread (7.03%), we arrive at an implied rate of 9.9%.  In other words, if interest rates remain unchanged for the next two years, the interest rate of our loan increases to 9.9%.

I have no lessons about commercial loans today.  Instead, let's just have some fun on this relaxing Boxing Day.

On Netflix, Ellen Degeneres has a stand-up comedy special called, Relatable.  It's only 1:15 minutes long, and it's quite enjoyable.  The gag is whether or not Ellen is still relatable after she has gotten so rich.  Did you know that Ellen is 60-years-old?  Hard to believe.

Also on Netflix is a new TV series called, Bodyguard, starting Richard Madden, the actor who played Robb Stark in Game of Thrones.  I found the show to be riveting because it shows how easily we could lose our democracy to the security services, like Homeland Security and the CIA.  Great show!

My son, Tom, lost Pepper, one of his beloved chickens, to a hawk yesterday.  He and Alex, his new bride, are devastated.  Tom's golden retriever chased the hawk away several times in the days leading up to the fatal attack, and Tom didn't know how to deal with it.  You can't shoot a .22 or a shotgun in a residential subdivision.  In its fifth attempt over three days, the hawk killed and ate poor Pepper.

I'm giving Tom today my pellet pistol to protect his last two remaining chickens.  Two of his four chickens have already been taken by raptors.  Can you imagine living life in constant fear of a drone overhead?

I once hit a much-smaller woodpecker, who was drilling hole after hole in our siding, from about 40 feet away using that pellet pistol.  My own pretty wife was watching, and she confessed that she was impressed.  The pellet didn't kill the bird, but I am sure that it stung like crazy.  He never came back.

Raptors in our Indianapolis neighborhood are becoming a problem.  I told you guys about that Maltese puppy that was recently taken by a huge owl from a fenced-in backyard just two months ago.  A neighbor on a nearby hillside saw the entire attack.  Swoop.  Apparently the wings of owls allow them to fly soundlessly.

Coyotes are also becoming a problem.  They are taking many of the cats around the Geist Reservoir, including a bunch of attacks just twenty houses away from us.  Two months ago, a pack of coyotes attacked and mortally-wounded a beautiful golden retriever.   He bled to death in the veterinary hospital.  We have a dog door, so our three dogs and four cats can come and go at will in our fenced in backyard.  Our cats can easily slip between the metal bars of our black fence.  Can a coyote?

In truth, coyotes have learned how to jump over wooden fences.  They jump to the top of the fence and then jump down.  My wife was telling me about a new invention for wooden fence tops.  You can't use glass in my cases because of homeowner's association rules, rambunctious teenagers, and lawsuits; so some man who had lost a beloved pet to coyotes invented rollers for the top of the fence.  If a coyotes tries to jump to the top of the fence from the outside, he immediately rolls off backwards. 

So I told you that we have a dog door for our animals to go out, but wild animals can come in using that door.  We first realized that we had a problem when we discovered that local raccoons were carefully washing their paws in our water bowl before dining on our dog food.  "For these gifts we are about to receive..."  Then the HUGE neighborhood tom cat got trapped by our dogs in our house.  That darned cat was so big and fierce that he had absolutely no fear of me.  I found myself backing up.  Buck-buck-buck.  Haha!

The solution was elegant.  Each of our animals now wears a battery-powered, computerized disk around his neck.  All he has to do is approach our fancy new dog door, and then the dog door automatically slides open.

One last point about marketing for commercial loans.  You don't always have to be serious and professional when soliciting commercial loans.  Everyone loves to have some fun.

Perhaps you sold a small commercial building, and you carried back a commercial loan; or perhaps you bought a run-down house, renovated it, and sold the house to a couple who had lost their home during the Great Recession.  Their poor credit is why you had to carry back a first mortgage or a contract of sale.

These private first mortgages and contracts of sale can be a wonderful source of wealth and cash flow.  Let's suppose you own a first mortgage note or a contract of sale.  How much is your note or contract of sale worth?

First of all, is your contract of sale worth less than a regular first mortgage?  Naw.  The buyers of discounted notes are pretty sophisticated investors, and they are far more concerned about about the interest rate, the monthly payments, and the term of the note they are buying.  From a practical point of view, there is little difference between a mortgage and a contract of sale, assuming we are in a mortgage state.  (Trust deed foreclosures are much faster.)  

One of the first things that a note buyer is going to want to see is the closing statement.  What was the purchase price of the property?  How much did the buyer put down?  Obviously, the smaller the downpayment, the less the note is worth; however, if the note is several years old and the borrower has demonstrated a good payment history; i.e., the note is seasoned; the real estate recovery since the Great Recession may have created enough protective equity to satisfy the note buyer.

Now let's talk about how the terms of your note affect its value.  Obviously, the higher the interest rate on your note, the more valuable it is (within reason).  Would a note buyer actually pay a premium for a high-yield first mortgage note?  A premium is paid when a note or a bond has a higher-than-market interest rate, and the buyer pays more than the face value of the note or mortgage.  

Example:

Smart Sammy bought a foreclosure during the Great Recession, and he fixed up the home very nicely.  Bonnie Buyer and her husband, Dave, looked at the property, and Smart Sammy noticed that Bonnie, an attractive woman whom Dave obviously adored, was clearly in love with the property.  

Dave then confided to Sammy that he and Bonnie had lost their home in foreclosure during the Great Recession.  They therefore could not qualify for a conventional mortgage.  Would he, Sammy, carry back the first mortgage?

Now Sammy loved notes, and he would ordinarily carry them back at 11%; but Smart Sammy was convinced the pretty Bonnie desperately want this home, and Dave could never deny her.  "Yeah, I'll carry back a first mortgage for 85% of the purchase price, but because of the extra risk, I want a 14% interest rate."  The Buyers jumped at the offer.

Later Smart Sammy needed cash, and the ideal note to sell was his $100,000 first mortgage at 14%.  Indira Investor, a note buyer, showed herself too willing, so Smart Sammy said, "Gee, Mrs. Investor, I hate to part with it.  After all, its yielding a whopping 14%.  Where else can you earn 14%.  I'll tell you what.  I'll sell you this $100,000 note for $105,000 - a $5,000 premium - because the note rate is so much higher than the market."

Indira Investor thinks to herself, "Hmmm, I'll earn an extra $3,000 per year in interest, and in a little longer than a year-and-half I will have recouped my $5,000 premium.  After that, I'm golden."  "Okay, Sammy, I'll buy your $100,000 note for $105,000."

Six months later, a clever mortgage broker (named Sammy) took his former buyers to a subprime mortgage company and got them a new mortgage at 7.5%, making himself a cool $2,000 loan fee.

Indira Investor was horrified, but there was nothing she could do.  She had paid a $5,000 premium and only recouped an extra $1,500 in interest during the six months that she owned the note.  Arghhh!

Where did Indira Investor make her mistake?  She should not have paid a premium if the loan lacked a prepayment penalty!

Note:  One of the largest loans that C-Loans.com closed over the past two years was a USDA Business & Industries loan, kinda like an SBA loan but for lowly-populated areas.  The government recognized that it needed to bring jobs to the Boonies.

But the single most important reason of all to use C-Loans.com is when you are looking for an SBA lender.  Remember, a SBA lender must put at risk a ton of their own capital, even though most of the loan is guaranteed.  Different banks on different SBA loan requests see the risk differently.  Forty banks can turn down a particular SBA loan request - only to have the 41st bank approve the loan!  Got an SBA loan request?  Think of C-Loans.com first.

Blackburne & Sons will buy your discounted notes!

Contracts of sale come up modernly when fix-and-flippers sell their recently renovated houses to buyers who lost their prior home during the Great Recession.  These receivables are a terrific source of cash flow and wealth, and in my next blog article we are going to talk about how to value them, how to sell them, and how to borrow against them.

A contract of sale is simply a contract to transfer title to real estate or goods once the purchase price has been paid in full.  The key words here are, "... once the purchase price has been paid in full."  In other words, bare legal title to the renovated house remains in the name of the seller until the buyer pays him off.

When the buyer of a renovated home signs his contract of sale, he enjoys all of the other rights in the bundle of rights that is fee title.  Think of the bundle of rights as a quiver of arrows.  One arrow is the right to occupy the property.  Another arrow is the right to exclude other.  "Get the heck off my property!"  Another arrow is the right of quiet enjoyment, free from obnoxious noises and unwanted intrusions by others.   Another arrow is the right to rent out the property and keep the proceeds.

The last arrow is the right to own the property in fee simple.  Fee simple absolute title to real estate, according to Wikipedia, is "a permanent and absolute tenure (length of occupancy of a position) of an estate in land with freedom to dispose of it at will, especially in full fee simple absolute a freehold tenure, which is the main type of land ownership."  You and I want to own our real estate in fee simple absolute.

This last arrow is kept by the seller in a contract of sale until he is paid off.  The seller is known to hold bare legal title.  The seller may have a claim to the property until he is paid in full, but he does not have the right to occupy the property, to trespass on the property, to exclude others, or to collect the rents.  The seller no longer possess those rights.

Modernly there is very little difference between a normal mortgage and a contract of sale.  In the old days, sellers would write their contracts of sale so that if the buyer fell behind in his payments by as little as 45 days, the seller could declare the buyer in breach of the contract of sale and reclaim the property (evict the buyer).

This is still true today if you buy a vacuum cleaner using a contract of sale. If you fall behind by even one day, the store can knock on your door and repossess your vacuum.

The courts, however, could not allow such injustice to stand.  Imagine a buyer under a contract of sale who had spent many tens of thousands of dollars fixing up his home, only to lose it in 45 days when his employer went bankrupt and failed to pay his wage.

In every state, courts have ruled that the foreclosure of a contract of sale must be conducted in a manner identical to that of a mortgage, and most states have actually codified this ruling.

So why do sellers still use contracts of sale?  In many cases, neither the seller, nor the buyer, knows the law.  In addition, the buyers, who cannot qualify for a home loan from a conventional lender, are usually very anxious to close the deal and are unwilling to "rock the boat".

Sophisticated sellers will often use contracts of sale as a hammer with which to extract monthly payments out of their borrowers.  "Listen, Bucko, it says right here in our contract of sale that I could evict you from the property right now, so you better send in your payment today!"

But if push comes to shove, the seller can foreclose no faster under a contract of sale than a mortgage.

The Huns were not the same race of people as the Mongols.  Genghis Khan led his hordes into China, across Russia, and into Europe in the 13th Century (1210-1260).  The Huns were from a much earlier time.  The Huns were a nomadic people who lived in Central Asia, the Caucasus, and Eastern Europe, between the 4th and 6th century AD.

The Huns and the Mongols, however, were the same type of people. They were steppe people.  Steppe people spent their lives on horseback, moving their vast flocks and herds across the steppes (vast grasslands) of Eastern Europe, Russia, and Mongolia, according to the season.

Now the tribes of the steppe fought on horseback using recurved, composite bows, each of which took more than a year to build and cure.  These powerful bows could punch an arrow right through the shield and armor of an opposing warrior and continue out his back.  Young Hun warriors would train from childhood to put an arrow through a coffee can-sized target from the back of a galloping horse.  These bows and this training made the armies of the steppe virtually unstoppable.

Have you ever heard of the expression, “Richer than Crassus?”  Crassus was the richest man in Rome, and he was a frustrated Roman general.  It was Crassus who put down the famous slave rebellion lead by Spartacus; but his glory was stolen by a competing general, Pompey, who put down a smallish army of slaves and raced to Rome first to claim the big victory over the slaves.

At the same time, Julius Caesar was conquering province after province in Gaul (France).  His legions captured hundreds of thousands of slaves, who were later sold in Rome, making Caesar incredibly wealthy as well.  Pompey got his triumph (a lavish parade through the center of Rome); and Caesar, who paid for lavish gladiatorial games, was the darling of the people.  Crassus was pea green with envy.

My favorite cartoon of all time shows two vultures sitting in a tree. One turns to the other and says, “Patience, my (rear end).  I’m gonna go out and kill something.”  A frustrated Crassus therefore assembled and trained, at his own cost, an army of 46,000 Roman legionnaires - the best foot soldiers in the world – and marched out into the desert to conquer the Parthians.

Uh, oh.  The Parthians, a desert people who bordered the steppe, fought in an identical manner as the steppe people - from horseback with recurved, composite bows.  The proud army of Crassus – 46,000 of the best Roman foot soldiers on earth – met up with just 11,000 Parthian horse archers at Carrhae, a small town in what is now southeastern Turkey. The Parthian archers drowned the Romans in arrows.  The Parthians brought with them vast trains of camels carrying spare arrows, and the arrows would pin the arms of the Roman soldiers, after piercing their shields, to their body.

The slaughter was complete.  After losing his first-born son [George IV – sob], the elder Crassus was captured and killed by pouring liquid gold down this throat.  (I’ve found that gargling with salt water works better on a sore throat.)

This leads to the first of three messages today:  You don’t mess with a race of people with recurved, composite bows.  A recurved, composite bow can even punch a hole through a bullet-proof vest.

In the latter part of the 4th Century, the Huns came roaring out of Hungary, sacking and burning everything in their path. They marched south through the lands of the barbarians, north of the Danube River.  The Danube River, which runs East and West, marked the northern boundary of the Roman Empire, just as the Rio Grande River marks the southern boundary of the United States.

Directly in the path of the Huns were the Visigoths.  The Visigoths were of Germanic stock, part of a race of people called the Goths.  The Visigoths had fled from southern Denmark in the Great Migration to settle in southern Romania, just north of the Danube River.  The Visigoths tried to bravely stand in their shield walls facing the Huns, but they were repeatedly cut down by the Hunnish archers.  (Can you imagine kissing your sons goodbye as they marched off to die under a cloud of Hunnish arrows?)  City and after city fell.  The men were typically all killed, and the younger women were enslaved.  The Huns were unstoppable.

The Visigoths were in a real pickle. They were stuck between the raging Huns coming down on them from the north and the Roman Empire and the Danube River to the south.  To the south of the Danube River was the Roman province of Thrace, which is now the country of Bulgaria.

The Visigoths had little choice, so on a misty morning in the year 376 AD, the Roman commander guarding the norther border of the Empire woke up to find tens of thousands of Visigoths streaming across the Danube River and establishing a beachhead on Empire territory.  Assembling his legion, the Roman commander marched out to repel the invasion.

But it wasn’t an invasion.  It was a migration.  The Visigoths were landing more women and children than warriors.  The Roman commander, almost certainly a Christian, was forced with the decision to either send these people back to their certain death (or rape and enslavement) or to allow them to settle in the vast, lowly-populated areas of Thrace.  He just couldn't send these people to their deaths.  He had compassion.

This leads to the second message of this letter:  Sometimes, through no fault of their own, people become desperate refugees.  They deserve our compassion.

This tale would have made make a great Hallmark movie, except for one thing.  War broke out between the Visigoths and Romans just two years later, and the Romans were defeated in one of their worst and final defeats in their history at the Battle of Adrianople.  The Roman Emperor Valens was even killed.  In 406 AD the Visigoths sacked Rome.

This leads to my final message of this letter:  As prosperous Americans, we should be compassionate about immigration; but a migration is different than immigration.  As sea levels rise in the coming decades, hundreds of millions of people worldwide will be on the move.  Bangladesh, for example, with its population of 150 million people, will be underwater by the end of the century.  Yikes.