Commercial Loans and Fun Blog

Today we are going to talk about equity, a concept that may be a little confusing to you.  Of course you understand the concept of the equity in your house, but there is far more to the concept of equity.

Those of you who have been following Blackburne & Sons Realty Capital Corporation for a long time probably remember when the company used to be called Blackburne & Brown Mortgage Company, Inc.  When my sons joined the company, we also changed the second half of the company name to Realty Capital Corporation.

 

 

 

As it pertains to real estate, capital includes debt, equity, and certain hybrids of the two, like mezzanine loans and preferred equity.  When we changed the second half of the company name to Realty Capital Corporation, we were sending a signal that we were now providing more than just mortgage loans.  We were now also providing equity.

Right now the staff of Blackburne & Sons is mobilizing to raise $2 million in development equity for the developer of a hotel in Oregon.  The hotel will cost $15 million, and the construction lender will only go 60% of cost.  This means that the developer will have to raise a whopping $6 million in equity - 40% of the total cost.  Yikes!  

Such is life in the post-Great-Recession era in which we live.  Banks got crushed in construction lending during the Great Recession, so they now require developers to put up vast amounts of equity.

 

 

 

 

Okay, so what is equity?  It depends on the context.  In everyday life, it means the difference between value of your house and the total amount of the mortgages.  "I have $150,000 in equity in my house."

In the context of the capital markets, equities means investments in stocks, as opposed to investments in bonds, gold, or other commodities.

In the context of the development of real estate, equity refers to how much money the developer has contributed to the project.  It consists of the actual cost of the land, any legal fees the developer spent in changing the zoning, any property appreciation resulting form that zoning change, any additional value created when the developer successfully assembled several adjoining parcels into a prime building site (called assemblage); any prepaid expenses, like toxic reports, title reports, and surveys; any pre-construction costs, such as clearing the land or demolishing structures; and any cash that the developer is prepared to bring to the construction loan closing.

 

 

 

 

Equity is often called the developer's skin in the game.  It is a measure of how much of the developer's blood will the banker find pooled on the doorstep, if the bank is forced to foreclose.  

What about any appreciation in the value of the land?  The developer bought the land years ago and since then the land has appreciated by 75%.  Nope.  Banks will no longer consider that appreciation, unless it has been almost a decade.  Bank regulators now forbid it, and banks make 98% of all construction loans.   Thank you, Mr. Great Recession.

 

 

 

 

Here is how we define equity to our own private investors:

"An equity investment is not a loan.  There is no promise to pay, there is no interest rate, and there are no monthly payments.  Instead, an equity investment is the purchase of a share of the ownership of the business, in this case a very popular hotel franchise called the Fairfield Inn and Suites...

"The reward to the equity investor for the success of this construction venture is a share of the distributed positive cash flow, a share of the principal reduction on the underlying first mortgage, and a share of the net sales proceeds when the property is sold.."

 

 

 

 

 

Almost done.  In the context of a hotel, what is the difference between rooms and keys?  In the days before hotels with suites, it was customary to refer to an 80-room hotel.

But many 80-unit hotels these days have 120 rooms because the suites have a sitting room, where a lady businesswoman might meet a client, and a separate bedroom, where mom and dad might quietly kiss at night, while the kids slept on a fold-out bed in the other room.  The unit still only has one entrance, and therefore is has become commonplace to refer to these hotel units as keys.

 

 

 

 

 

Development equity historically offers yields to private investors much higher than first mortgage investments.  Are you an accredited investor?  Please contact Angela Vannucci at 916-338-3232.  Blackburne & Sons - Since 1980.

 

This article is more about economics than than commercial loan training.  I hope that you investors will find it interesting.

The US bull market has now lasted for over nine years.  The big question on the minds of many investors is therefore, "Is a recession imminent?"  Ryan Detrick, a senior market strategist at LPL Financial, commented a few months ago on CNBC's "Trading Nation", "Bull markets do not die of old age. They die of excess — overspending, over-leverage, overconfidence."

 

 

 

 

 

In other words, this bull market does not have to end, as long as consumers and corporations don't overload themselves with debt and as long as speculators stick to only modest, carefully-considered bets.

By the way, there is a short, easy-to-read book that every investor and every real estate broker should read.  The book, Extraordinary Popular Delusions and the Madness of Crowds, was written way back in 1841 by a Scottish journalist named Charles Mackay.

 

 

 

 

The author described three huge investment bubbles, Tulipmania (when simple tulip bulbs in Holland skyrocketed to thousands of dollars apiece), the Mississippi Scheme (a paper money bubble that led to the French Revolution and the guillotine), and the South Sea Bubble (when the stock of the British East India Company went to Amazon-like levels).

Is this 1841 book still relevant? Ha-ha!  If Charles Mackay was alive today, he would simply expand his book to include the Dot-Com Mania and the Sub-Prime Bubble.

 

 

 

 

Now back to the question at hand, "Is a recession imminent?"  We can state the question differently.  Are consumers, corporations, and investors taking financial matters to excess?  Are consumers and corporations overspending?  Are they borrowing too much money?  Are investors overconfident?

A black swan is an event or occurrence that deviates beyond what is normally expected of a situation and is extremely difficult to predict.  Black swan events are typically random, unexpected, and material.  According to Nassim Taleb, the author who first coined the term, "black swan event", examples of black swan events include the rise of the Internet, the personal computer, World War I, and the September 11, 2001 terrorist attacks.  No investor can be blamed for not foreseeing these black swan events.

 

 

 

 

But gray rhino events are different.  Gray rhinos are obvious dangers that are often ignored.  Don't feel bad if you've never heard of the term, "gray rhino."  The term wasn't used much before a 2016 book by Michele Wucker entitled, "The Gray Rhino: How to Recognize and Act on the Obvious Dangers We Ignore."  It uses examples of threats that were highly probable but neglected, such as Hurricane Katrina and the fall of the Soviet Union.  Relatively recently, just back in 2017, Chinese authorities actually used the term, "gray rhino", when they warned of the build-up of non-bank debt in China.

Last month, Jack Bogle, the beloved founder of Vanguard Investments, passed away.  In his final interview, Mr. Bogle warned of a new gray rhino stalking the financial markets. U.S. corporations have been binging on cheap credit since 2009.  Corporate debt levels in the US alone have doubled to more than $9 trillion since 2009.

(How many times I have told you guys?  It's the loan servicing income, sillies.)

 

 

 

Right now most highly-leveraged U.S. corporations can service their debt because the interest rate on their debt is very, very low.  But corporations cannot borrow for 30 years, like the U.S. Treasury.  Much of their debt has a maturity of less than five years, and when they have to roll over this debt, they will have to pay considerably higher interest rates.  "Aye, there's the rub."

Arguably, the biggest, baddest gray rhino is that quite a few large U.S. corporations may find themselves unable to service their debts at today's higher interest rates.  Yikes!

 

 

 

 

Bottom line:  There is a gray rhino heading our way, folks, and his name is higher interest rates.  He is obvious, and he is being ignored.  Perhaps President Trump has pressured the Fed enough to slow down interest rate increases.  If so, this bull market may not yet be ready to die.

As for my personal portfolio, I intend to invest in a short fund (make a bet that stocks will decline) shortly after President Trump announces a positive outcome in his trade negotiations with China.  "Buy the rumor, and sell the news."

 

 

 

 

I also just invested a big portion of my own portfolio into a 8.5% first trust deed.  I'll let the "brilliant" speculators invest in double-digit first trust deeds, deals yielding 10% or more.  I am quite content to be a 8.5% coupon clipper.  Back in the old days, bond holders would take their bonds to the bank, which would pay the investor his monthly interest payment and then clip off a piece of the bond, called a coupon.  Hence the term, coupon clipper.

You business owners are reminded that a declining stock market does not guarantee a recession.  Remember, I am predicting a declining stock market but a booming economy.  You would be foolish to stop expanding your own business, just because the stock market is declining.  A recession will only come after investors and business owners make a ton of malinvestments.

 

 

 

 

A malinvestment is a bonehead investment that does not generate enough return to service the debt taken on in order to make the investment.  Examples of malinvestments include the failed dot-com investments and sub-prime mortgages.

The reason I don't see an imminent recession is because I just don't see a lot of malinvestments being made right now.  I do see the FAANG stocks falling for a decade.  I also see some over-leveraged corporations staggering from excess debt.  I see the stock market falling; but I just don't see Main Street faltering.  Bazillions of Americans are working overtime these days, and unemployment claims last month were at their lowest levels since 1969.  Main Street is cooking with gas.

 

 

 

 

Therefore I urge you to keep investing in your own business.  My own business,  CommercialMortgage.com, has been producing giddy results recently.  We are constantly trading our commercial real estate training courses for new, hungry bankers to add to the portal.

And folks, CommercialMortgage.com ("CMDC") truly is 100% free.  In other words, if you go onto CMDC and close deal, we here at C-Loans.com don't make a dime.  Our banks are NOT jacking up their interest rates and points to pay us some sort of backend fee.

 

 

Using CommercialMortgage.com does not cost you a dime.  You would therefore be crazy not to use the portal if you needed a commercial loan.  We boast of 3,159 commercial real estate lenders on CommercialMortgage.com, but the truth is that the actual number is much higher.  

Lastly, here are a couple of practice tips:  (1) Always have at least three banks looking at your commercial loan at all times.  Banks are notoriously unpredictable, based on their liquidity and their recent commercial loan loss experiences.  (2)  The closer a bank is located to your property, the more likely that your commercial loan will be approved.  Using CommercialMortagage.com, it's easy to find 30 banks located close to your property.

 

 

 

 

 

 

My own hard money shop, Blackburne & Sons, does NOT make private money construction loans.  One more time:  Blackburne & Sons does NOT make private money construction loans.  Watch, I'll still get a bunch of applications for construction loans.  Ha-ha!

Very few other hard money commercial lenders make ground-up commercial construction loans either.  The problem is that construction loans have to be funded in a series of draws or invoice payments.  Funded does not mean that the loan closed.  Funded means that the loan proceeds are actually released to the borrower.

 

 

 

 

Example:

Billy "White Nose" Johnson is a developer, who also has a penchant for fast cars, pretty girls, and cocaine.  Billy applied to Rookie Bank for a $2 million construction loan to build a small apartment building in Indianapolis.  At the closing of the construction loan, Rookie Bank gave Billy a $1.8 million check to go build the apartment building.  The bank held back $200,000 for the interest reserve.

One year later, when the interest reserve had run out, the bank called Billy to ask that he start making monthly payments.  After the bank had left a dozen messages, many of them threatening, the bank sent an inspector out to look at the apartment building.  There was no apartment building, just an empty field.

 

 

 

 

Six months later, a private investigator from the bank located Billy in a local homeless shelter, suffering horribly from withdrawal symptoms.  Apparently Billy had gone on a partying binge with the loan proceeds.  Almost $1.8 million had gone up Billy's nose.

By the way, while a commercial property is under construction, it's not generating any rental income.  Therefore most construction lenders will hold back nine-months' or one-years' worth of monthly interest payments in an interest reserve, out of which the construction lender pays itself a monthly interest payment.

 

 

 

 

Obviously construction lenders must therefore never release the construction loan proceeds entirely to the developer.  Instead, construction loan proceeds are released using either a five-draw system or the bank pays the invoices of the subcontractors directly, after the developer has signed off on their work and after a progress inspector from the bank has inspected the work.

The five-draw system of funding construction loans is an older, almost obsolete method of controlling the loan proceeds.  The proposed work is divided up into five, roughly equal phases.  At the closing, the construction lender funds the first draw, and the developer cannot get at draw number two until he has completed the first phase.  The problem with the five-draw system is that the construction lender still has to release $400,000 to the developer and to pray that he doesn't have a drug problem.

 

 

 

 

Progress inspections are site visits by the commercial loan officer or by a progress inspector, hired by the construction lender, to verify that the work is being completed according to the plans and specifications.  A progress inspector might charge $200 to $350 per inspection, and the the cost of these progress inspections is paid for by the developer.

It is now time to get to the point of today's training article:

Very few private money (hard money) lenders make ground-up construction loans.  There are several reasons.  First of all, private money loans are much more expensive than bank loans, so few good developers will pay their prices.

 

I am actually pro-Trump, but in the interests of equal opportunity humor...

 

 

The second problem is that construction loans need to be made by local lenders.  Pay attention here.  This is important:  Construction loans are almost always made by local lenders because the bank needs to go out and drive by the project on a regular basis to make sure that work is progressing.

The smart developer or commercial loan broker will immediately see that in order to find a construction lender, he needs to find a bank located close to his project.  How? Go to Google Maps and type in the address of the property.  Then hit the "Nearby" icon and type in "Banks".  In most areas, he will find scores of different banks.

 

It's the servicing income, guys!

 

 

The second reason is because private money lenders are usually one-office lenders.  Few have offices located across a state or region.  Therefore they are very limited geographically in their construction lending area.

A buddy of mine, Mike Cleaver of Emerald Creek Capital, makes construction loans and renovation loans of over $2 million in New York City.  Brooklyn is hot right now.  Even though he is limited to New York City (guys, I really mean NYC only), he still gets to make a fair number of these loans because of the population.  You can reach Mike with your NYC construction loans and renovation loans of over $2 million at 212-239-6845.  Did I mention New York City only?

 

 

 

 

The third reason why few private money lenders make construction loans is because many private money lenders raise their lending capital by syndicating private investors.  A private money lender might have 50 private investors in a single deal.  If the lender is using an invoice system of funding his construction loans, it is very awkward to fund a $2,000 invoice by asking for $400 from each of 50 private investors.  My buddy, Mike Cleaver, solves this problem by using his mortgage fund.

Okay, now I need your help.  Between C-Loans.com and CommercialMortgage.com, I have given you guys access to over 4,000 commercial real estate lenders for free.  Free!    

 

 

 

 

So this is my appeal.  Do you know of a private money lender who makes commercial construction loans?  Won't you please-please share him with me by sending me his contact information at george@blackburne.com?  Thanks so much!.

 

 

 

 

  

 

 

 

 

 

 

 

 

 

 

 

Before I get into the subject of placing a commercial loan with a bank, I have two great TV show recommendations.

As you know, Netflix is now producing its own movies, and it just released the movie, Bird Box, starring Sandra Bullock.  What a fantastic movie!  It creates the same kind of eerie suspense as Signs and A Quiet Place.  I was squirming like a worm on a hot sidewalk - but it was an exciting and fun discomfort.  "Oh, my goodness, Cisca, I can't look," as I buried my head under a blanket.  Ha-ha!

 

 

 

 

Also on Netflix is the TV series, Damnation.  In the 1920's in America, many business owners treated their workers heartlessly.  And if the workers dared to organize and strike, the cigar-smoking robber barons would simply bring in strike-breakers.  These strike-breakers were not just club-wielding thugs.  They carried firearms and committed the outright murder of the leaders of the strike.  This is the fascinating story of a reformed strike-breaker who discovers Jesus - but who does NOT forget how to shoot a gun.  It's a shoot 'em up, bang-bang kind of show that offers a fascinating glimpse into the dark chapter of America's past.  My wife and I binge-watched it.

Okay, now onto some training in the commercial loan business.  Placing a commercial loan with a bank should be easy.  If it's not, you simply need to move onto a new bank.

 

 

 

 

Commercial banks are moody and unpredictable.  For example, one moment they might love loans on self-storage facilities, and the next moment - usually after taking a loss - they wouldn't touch a loan on a self-storage facility with a ten-foot pole.  

Another reason for the wild mood swings of a bank is liquidity.  If a bank is fully-invested, even the tiniest black hair is a deal-killer.  A black hair is a flaw in a commercial loan.  There is no such thing as a perfect commercial loan.  Every commercial loan ever funded had some black hairs.

 

 

 

 

 

But if a bank has gotten a ton of pay-off's, and it is sitting on a pile of uninvested cash, the pressure to lend is tremendous.  If you catch the right bank at the right time - a bank that is loaded with liquidity - you can even finance an ax murderer. 

Now there is no way for an investor or a commercial loan broker to know a bank's mood in advance.  Therefore the trick to closing near-bankable commercial loans is to present your loan to at least 15 banks, three at a time.  Only if all 15 banks turn you down should you give up on the sweet interest rates offered by banks.

 

 

 

 

"But George, where am I going to find 15 banks?  I only know two or three."

Finding banks making commercial loan is easy!  The Blackburne List - freshly scrubbed and updated - contains a list of 2,500 commercial real estate lenders.  You also have free access to C-Loans.com and CommercialMortgage.com.  A blind, cripple could find 15 banks for any commercial loan request.

 

 

 

 

I use a similar business plan when placing my hard money commercial loans with our private investors.  We prepare a one-page Mortgage Investment Bulletin, and then we blast it out to about 1,200 wealthy private investors.  On any given day, at least 50 of them have dough that they looking to place.

You commercial loan brokers, if you are not working daily to get into the hard money business, you're a dummy.  Imagine being Loan Committee and having the authority to approve or decline your own loans.  (You still have to be very prudent and responsible.)  And once you become a hard money lender, you can earn loan servicing fees, which provide crucial cash flow during recessions.

 

 

 

 

"Oh, my goodness, George.  I could never service loans.  That's much too hard!"

Absolute nonsense!  You can hire a sub-servicing company to service your first 30 performing loans for just a handful of dollars per loan per month.  And once you become a hard money lender, you'll have plenty of dough to later buy your own loan servicing software.

Quick summary:  Plan on submitting your near-bankable commercial loans to fifteen banks, three at a time.  To find these banks, consider The Blackburne List - freshly scrubbed and updated.

 

 

 

 

 

Every two-and-a-half years, I suck it up and write a check for thousands of dollars to my staff to update The Blackburne List.  The Blackburne List is a huge list of commercial real estate lenders.  

It's a Herculean task to update a list of 2,500 commercial lenders, and it takes weeks.  If you need a commercial loan, this is the tool for you!  The list contains the name of the commercial loan officer, the name of commercial loan company, their address, the commercial loan officer's phone number, and his email address.

 

 

 

 

It used to be that most bank branches had their own commercial loan officer, someone trained in both commercial finance and commercial real estate finance.  Commercial finance includes secured and unsecured lines of credit, equipment loans and leases, inventory loans, and accounts receivable financing.

Commercial real estate finance includes commercial loans on income properties, mezzanine loans (banks very seldom ever make them), and preferred equity investments (banks never make such investments).

 

 

 

 

 

Modernly, banks typically assign a single commercial real estate loan officer to cover four or five branches.  The modern commercial real estate loan officer, working for a bank, seldom comes into the office; but rather he is usually out in the field calling on good bank customers and prospective customers.  A good bank customer - a very important term of art for us in the commercial loan business - is someone who regularly maintains large cash balances at the bank.

A very good way to get your commercial loan closed is to tell the commercial loan officer that your borrower is willing to transfer all of his bank accounts to the bank.  Please read this last sentence again.  It is hugely important.

 

 

 

 

This offer to create a deposit relationship works great with community banks and regional banks.  The larger money center banks, however, couldn't give a hoot.  They have more than enough money to lend and a severe shortage of good borrowers.

A community bank is a commercial bank that derives funds from, and lends, to the community where it operates, and it is not affiliated with a multi-bank holding company.

 

 

 

 

A regional bank is a depository institution; i.e., a bank, savings and loan, or credit union, which is larger than a community bank, which operates below the state level, but smaller than a money center bank, which operates either nationally or internationally.

A money center bank is similar in structure to a common bank; however, its borrowing and lending activities are with governments, large corporations, and regular banks. These types of financial institutions (or designated branches of these institutions) generally do not borrow from or lend to consumers.

 

 

 

 

I was talking with my own commercial loan officers this week, and I made the point that a commercial loan broker will often submit his deal to as many as fifteen different commercial lenders.  Armed with The Blackburne List, you will never again have any more trouble finding fifteen commercial lenders to whom to submit your deal.

 

 

 

 

 

 

Any commercial loan broker with more than six-month's worth of experience will tell you, "Daisy chains never close." A daisy chain occurs when one commercial loan broker takes a loan to another commercial loan broker, rather than directly to a commercial lender.

 

 

 

 

So why do daisy chains never close?  There are three reasons:  First of all, the points get too high.  The lender charges points, the second broker charges points, and the originating broker charges points.  At some point the borrower says, "There is no way I am going to pay three (or more) points!  Sayonara."

The second reason is that the communication process is very unwieldy.  The lender asks the second broker a question, who has to ask the originating broker the question, and then the originating broker has to ask the borrower the question.  By the time the question goes down the line and the answer comes back, the answer is often garbled junk.  It's like that game many of us played in kindergarten.  Eight kids stand in a line, and the first kid whispers a sentence into the ear of the second kid, who whispers the sentence into the ear of the third kid.  By the time the sentence gets to the eighth kid, the final sentence has no relation to the original sentence.

 

 

 

 

The third reason why daisy chains never close is because the process is incredibly slow.  In the meantime, the borrower is shopping his commercial loan to direct lenders all over town.  

Since commercial loan brokers know that daisy chains never close, a commercial loan broker will exhaust every direct commercial lender that he knows before bringing his commercial loan to a wholesaler.  By wholesaler, I mean a commercial loan broker trying to act like a middle-man between direct commercial lenders and other commercial loan brokers.

 

 

 

 

This means that the typical commercial loan brought to a wholesaler has already been turned down by a half-dozen direct lenders.  The deal is a stinker, and it will never close with anyone.

To make matters worse, the originating commercial loan broker will NOT tell the wholesaler that the deal has already been shopped all over town.  He will NOT tell the wholesaler why the loan was turned down - horrible area, toxic issues, vacancies, problems with the borrower.  He hallucinates that the wholesaler will never discover the huge black hairs.  A black hair is a flaw in a commercial loan application.

 

 

 

 

The result is that the wholesaler spends hours and hours working on trying to place a commercial loan, only to learn what the originating commercial loan broker already knew - that the property was located in a horrible area, that the property was toxically contaminated, that too many units were vacant, or that the borrower has more problems than Doan's has pills (poor credit, unpaid income taxes, judgments, unpaid child support, delinquent real estate taxes, etc.).

Working as a commercial loan wholesaler is a huge waste of time that produces very little income.

 

 

 

 

So how should a commercial loan broker work with other commercial loan brokers?  Answer:  You should work only on a name-and-number referral basis in exchange for a 20% referral fee basis.  Make the originating broker get the heck out of the way so that you can work directly with the borrower.

The originating commercial loan broker has to be content that the second commercial loan broker will get as large of a loan brokerage fee for the team as he can, and then he has to be content to take just 20% of the total fee to the team.  What if the originating commercial loan broker insists on adding a point?  You will have to tell him, "Don't let the door hit you on the back of the head on your way out."

 

 

 

 

But guys, you have CommercialMortgage.com!   "Wholesaler?  We don't need no stinkin' wholesalers."  You can find all of the banks and credit unions that you need using CommercialMortgage.com ("CMDC").  Every day we add two to three new banks.  We literally now have thousands of banks and credit unions on CMDC.

And guys, CMDC is free!  You deal directly with these banks, and neither CMDC nor any stinkin' wholesaler will try to insert a fee between you and the lender.

 

 

 

 

So how does C-Loans, Inc., the owner of CommercialMortgage.com, make any dough?  Because we own the portal, we get to see every lead.  We then solicit you to allow our hard money shop, Blackburne & Sons to make your commercial loan.  Between loan fees (pretty modest for a hard money shop) and our loan servicing fees (it's the loan servicing income, dummies), we make a ton of money on every hard money loan that we close from CMDC.  In truth, CMDC is a honey trap, and because it is 100% fee, you would be crazy not to dip your wick into this delicious databank of commercial lenders.

And guys, if you are working daily to build a loan servicing portfolio - which pays you monthly even during recessions - you are truly blowing it.  I make $76,000 per month in loan servicing income, whether I close a new loan or not.  And servicing performing loans is a piece of cake.  You will pay a sub-servicing company a few dollars per loan per month to service your first 30 loans, and later, when you are loaded with dough, you can simply buy your own loan servicing software.  Easy-peasy, if you make good loans.

 

 

 

 

It's the loan servicing income, dummies!