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Commercial Loans and Clearing Gangsters Out of Apartments

Posted by George Blackburne on Mon, May 20, 2019

Billie ClubI have an investor buddy who has made millions of dollars by buying up distressed apartment building in low-income, high-crime, and high-drug-use areas.  Many millions.  Many, many millions.

When he buys these buildings, they are largely vacant, dilapidated, and infested with gangsters.  So I asked him yesterday how he clears out the gangsters.  These guys have guns, and they have drug and prostitution businesses to protect.  One gang in one in one of his buildings even had the address of his building tattooed on their upper arms.

 

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Think about it.  How large of a private army would it take to clear one of these buildings?  After all, these gangsters have guns, and they are not afraid to use them.

So many gunshots did it take to clear out the worst of his buildings?  Not a single gunshot.  Not a single swing of a billy club.  Here is how he did it:

He put a fence around the entire building, thereby creating just one entrance.  Then he hired after-hours policemen to man the entrance.  These police guards visibly took pictures of every person entering the apartment complex.  They also required that every person produce a photo ID.  The names and license numbers were visibly written into a large journal.

 

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Now ask yourself.  If you were a young college student wishing to buy drugs, would you run this gauntlet?  Of course not!  Soon the gangsters had no customers, and they were forced to move out.  Haha!

Then, to keep the apartment complex safe moving forward, he enforced a "no baggy pants" rule.  If some gangster came to visit his mother or grandmother, and he was wearing baggy pants, the grandma would be fined $100.  If he showed up again dressed as a punk, his grandma would be evicted.

Before you think that my investor buddy is some evil ogre, you should know that these apartment rules were posted and carefully explained to grandma before she moved into the complex.

 

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As a result of these rules, the immediate neighborhoods surrounding his buildings now have a lower crime rate than the city as a whole.  This is an incredible accomplishment, considering he only buys buildings in the most crime-infested areas of the city.  The tenants enjoy a safe, quiet place to live.

Another thing that he does is that he holds monthly meetings with the police, attended by all of his apartment managers and assistant managers.  Nearby apartment owners bring their own managers too, but my buddy makes sure that these meetings always take place in one of his own buildings, in order to cement police rapport.

My buddy provides sodas and snacks, and at the meetings, his mangers tell the cops about units where drugs are being dealt.  Soon the cops set up stings, and the drug dealers are arrested.

 

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My buddy now owns and manages more than 6,000 apartment units, and his safe buildings are almost 100% occupied.  It helps that he pays a small finders fee to existing tenants who refer him potential tenants.  

Remember, my buddy bought these apartment buildings for just $10,000 to $30,000 per unit.  Some apartment units in California sell for up to $300,00 per unit.  He really loves buildings in war zones because he can buy them very, very cheaply.  

Renters with poor credit and/or the inability to provide proof of employment (illegals) typically pay much more in apartment rent per square foot than good credit borrowers.  Don't blame this on my buddy.  This is true for the vast majority of all low-income apartment units everywhere in the country.  The reason why is because the owners of low-income apartment buildings suffer from very high collection losses.

 

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But the renters in my buddy's buildings don't want to have to move because his buildings are so safe and quiet.  Loud music and big groups hanging out in the public areas is not permitted.  As a result of his buildings being so safe and quiet, my buddy enjoys higher than average rents and near-100% occupancy rates.  

These buildings are indeed cash cows.  A cash cow is a business, investment, or product that provides a steady income or profit.

Unfortunately (fortunately?) he can no longer find any deeply-distressed apartment buildings in the major city where his buildings are located.  He is now looking in other cities, where there is strong job growth and absolutely horrible areas.  Capitalism sometimes works, folks.  Remember, his 6,000 apartment units have a lower crime rate than the city average, even though they are located in war zones.  He doesn't use guns, billie clubs, or physical intimidation.  He just uses good property management techniques.

 

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Topics: Clearing Out Gangsters

Commercial Loans and the First Hints of a Main Street Recession

Posted by George Blackburne on Sat, May 18, 2019

CompetitionSince the nadir of the Great Recession, I have been wildly bullish on the U.S. economy.  Seven years ago, I told my 1,500 wealthy private investors that the U.S. was about to enjoy the strongest and longest recovery in the history of the United States.  By the way, nadir means the lowest point in the fortunes of a person or organization.

 

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Recently, however, I have been receiving anecdotal evidence that the U.S. economy may be slowing down.  Anecdotal evidence is not gathered scientifically.  It does not come from an expert.  Anecdotal evidence is evidence that is collected in a casual or informal manner and relying heavily or entirely on personal testimony.

Example:

Two auto industry analysts from different investment banks are chatting over beers.  One says to the other, "My brother-in-law works in the quality control department of Tesla, and he told me that they are getting tons of complaints about the blinker fluid system.  He thinks they may have to order a giant recall."  This would be anecdotal evidence that Tesla is having quality control issues.

 

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Guys, Tesla is NOT having quality control issues.  I am a huge fan of Elon Musk, and there is no such thing as blinker fluid.  Here is a hilarious YouTube compilation of blinker fluid pranks.  OMGoodness, soooo funny!

This being said, anecdotal evidence should NOT be dismissed as unreliable.  It comes from people right on the front line.

So above I said that I have been receiving anecdotal evidence recently that the U.S. economy may be slowing down.  Here is what I have heard.  One of my golf buddies is a freight broker.  He matches up independent truck drivers with loads that need to be moved about the United States.  With truck drivers so much in demand, you would think that his business would be booming.

 

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My buddy said that in his 35 years as a freight broker, he has never seen such a lack of loads.  "Is it due to the China trade dispute?"  "No," he said, "it started before then."  "Is there a lot more competition among freight brokers?"  "No, my buddies are all saying the same thing.  It's a lack of loads.  We have never seen truck transportation this depressed.  I am thinking seriously of retiring."

For almost twenty years, this guy has been my leading economic indicator.  I would meet him on Tuesday nights for golf league, and I would always ask him, "So how's my leading economic indicator (his business)?"  Yikes.  But he is only one guy, right?

 

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I also spoke on Tuesday with the guy who runs the main office of one of the largest independent pension plan administration companies in the entire country.  It's interesting that this large pension plan administration company is based in the little corn field town of Plymouth, Indiana; but it makes sense.  The housing costs and wage rates in Plymouth, Indiana are among the most reasonable in the country.  Hooray for the internet!

My pension plan guy told me, "I'm a little concerned.  In all of my years in pension plan administration, I have never seen more companies shutting down their pension plans.  If in a typical year, we might have 40 or 50 companies get so financially battered as to shut down their plans.  This last year we had over 500 (!!) companies shutter their plans.  Holy crepe suzette.  It's important that you appreciate that he did not lose this business to a competitor.  These companies were losing so much money that they couldn't afford to keep these plans open anywhere.

So what is happening?  I think in the euphoria of this wonderful recovery that a bazillion trillion new companies have been formed on Main Street, USA.  Now I please want you to focus.  As my dear old father used to say to me, "Look alive, Blackburne."

 

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It is a fundamental axiom of economics that, "Whenever there is ease of entry into a field, competition continues until competition is ruinous." 

This is one of the reasons why I push you desk-and-a-phone mortgage brokers to becomes hard money lenders.  You will never make BIG money in commercial mortgage brokerage until you graduate to becoming "the lender".  You need to separate from the guys who will work on a loan for the cost a copier lease payment.  "It's the servicing income, sillies."  But no one ever listens to me.

 

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Anyway, just as tens of thousands of new brokers are now competing for commercial loans, I suspect that this phenomenon is happening in many, many different industries all across the country.  For a great many small businesses, profits are getting squeezed by new competition.

What we need is a garden-variety recession to scrape off the weaker companies.  Warships during the Napoleonic wars used to have to go to dry dock every three years to scrape off the crud that would accumulate on their bottoms; otherwise, they would be become incredibly slow.

 

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"Gee, George, that sounds so mean to wish for a recession that would force tens and tens of thousands small American businesses into bankruptcy."

The famous economist and Harvard economics professor, Jospeh Schumpeter, would argue that recessions (but not depressions) have an important "cleansing effect" that promotes future economic growth, much as forest fires clean out the choking undergrowth of healthy forests.

It's time for a recession.  Just sayin'.

 

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Topics: Recession Coming?

Commercial Loans and Wire Fraud

Posted by George Blackburne on Thu, May 9, 2019

Wire FraudAs I handed my dad his 50th birthday card, he looked at me with tears in his eyes...  Then he said, "You know, just one card would have been enough."

Yesterday I took my seven-hour annual update course for my NMLS license.  During the class, my wonderful NMLS instructor shocked me with a statement.

The FBI received last year on the order of 3,150 complaints about con men who had stolen - using wire fraud - over $1.2 billion!

 

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Here is how the con sometimes works.  A prospective real estate buyer receives an email from the title company containing wiring instructions for the downpayment.  The trusting buyer wires his $60,000 ... and then discovers to his horror that the email didn't come from the title company.  It came from a con man, who used a fake email account that had a URL that was just one letter off from the real title company.

Of course, the dough is gone.  The bad guys close the account shortly after the money arrives.  The victim has no recourse.  He is totally and completely screwed.

Our instructor then opened the discussion to the other students to tell their own wire fraud war stories.  One lady told the tale of what happened to the large real estate brokerage firm for whom she worked.  One of the firm's clients wired FIVE-HUNDRED THOUSAND DOLLARS to one of these con men.  Poof!  All gone.  No recourse.

 

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As a result of the con job, none of the hundreds of real estate agents for this big real estate brokerage are allowed to deliver wiring instructions to the buyer.  The wiring instructions now have to come directly from the title company because of the legal exposure.

I could easily see a similar con job and wire fraud happening to a hard money mortgage company like mine.  Yikes!  Angela, Justine, Jesus - be very, very alert!

Many years ago, right out of college, I worked for a personal finance company.  We made personal loans secured by vacuum cleaners, furniture, and used auto's.  I got to actually go out and repossess vacuum cleaners and sticks.  Sticks were the borrower's furniture, stereo, and other personal property.

 

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My boss would say, "Go out and pop the sticks."  Obviously, pop meant to repossess.    You have never had an adrenaline rush like popping someone's car.  The loan officer meets the tow truck driver and together you follow the debtor.  The moment the debtor parks his car and goes into McDonalds, you rush into the parking lot, hook up his car, back out, and try to get away before he comes running out threatening to beat the crap out of you.  "Hey, dude, someone is hauling away your car!"  Some of these debtors were pretty big.  Yikes!  Haha.  It's funny now that I survived, but at the time your heart is pounding like a drum.

Here's an interesting legal fact.  Would I have been allowed to physically restrain the debtor while the tow truck driver drove off with his car?   Could I have pushed myself into an apartment to repossess a vacuum cleaner?  No.  A lender is only legally allowed to repossess personal property if he can do so without breaking the peace.

And then there were leg loans.  A leg loan is a loan made when some pretty young thing comes into the loan office, bats her long eyelashes, tells her sad story, and implicitly suggests to the branch manager that he may get "kissed".  Now the thing about leg loans is that the pretty girl never, ever makes a single monthly payment.

 

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I remember being sent out after work to collect a leg loan made by my boss.  She tried to feed me this this nonsense that she was not the debtor, but rather just the debtor's roommate. Uh-huh.  After working for a personal finance company for a year, you see the wrong side of hundreds of lowlifes.  The experience in the gutter proved to be very helpful later in life.  Therefore I didn't buy what she was selling, including possible romantic favors; but I still failed to collect a dime.  The law didn't permit me to go all Tony Soprano on her (shapely tush).  

My branch manager had to pay off the leg loan from his personal pocket.  The big finance company for whom I worked actually had a "leg loan policy".  Haha!  Apparently it happened to branch managers all over the 60-branch system.  If you make a leg loan, you either collect it or repay it yourself.

 

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I was surprised that my branch manager got conned.  He was a finely-tuned bullpucky detector.  He once taught me a VERY important lesson about con men.

"George," he said, "here is how you spot a con man.  If you are in a room full of 100 people, pick out the one person who you are absolutely SURE is not the con man.  He will be your con man."

On a beautiful sunny Saturday afternoon my buddy and I stood on the first tee of our golf club.  He had just pulled out his driver when a young woman in a wedding dress came running up to him, crying.  She slaps him in the face, turns, and runs away.  My buddy turns to me and says calmly, "I don't know what her problem is.  I distinctly told her only if it rained."

 

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"My ex drove me nuts.  She was awful.  We're watching a television show once, and it was about euthanasia - you know, mercy killings.  And she said, 'Would you do that for me if I was really sick?'  I said, 'I'll do that for you if you get the flu.  Just let me know.’” — Mike Destifano

 

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Topics: Wire fraud

Commercial Loans and the Look-Back Yield

Posted by George Blackburne on Fri, May 3, 2019

Looking backwardsGolfer:  "I'd move Heaven and earth to be able to break 100 on this course."

Caddy:  "Try Heaven. You've already moved most of the earth."

A look-back yield is typically computed when a high-cost lender is preparing his payoff demand on a commercial loan.  The borrowers asks, "Hey, lender, I want to pay off your commercial loan.  How much do I have to pay you?"

 

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The commercial lender will look back at the loan origination points that he charged, the interest rate on the loan, the prepayment penalty, any exit fee, and the size of the balloon payment to make sure that he has earned a certain minimum annual return.  This look-back yield is all agreed to in advance between the lender and the borrower, so there is no sneakiness here.

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Why would a lender add a look-back yield requirement (minimum annual return) to a commercial loan?

Let's suppose a lender makes a commercial loan to a borrower who specializes in flipping rundown apartment building.  It's a super-risky deal.  The note rate was 8% interest.  There were three loan origination points to the bridge lender, ten discount points to the bridge lender's mortgage fund, and a five-point exit fee.  Since the term of this commercial loan was scheduled to be just two years, the lender expected to earn over 17% annually.

But a problem developed.  The existing apartment tenants refused to move out, so the apartment builder flipper had to spend 18 months in court to finally evict them.  Then he was finally able to start the two-year project of renovating and selling the building.  Even though the flipper was 18 months late in paying off his balloon, the lender saw no point in foreclosing of him because the flipper was very competent, and he moving as fast as he legally could.

 

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When the loan finally paid off 18 months past maturity, the lender realized that he had gotten seriously shafted.  During that extra 18 months, the lender had earned just 8%, which was the nominal rate, and not 17%.  The nominal rate is the rate on the face of the note.

His yield was thereby diluted by the delay in the balloon payment to just 14.5%.  Had the high-cost bridge lender included a minimum look-back yield provision, he would have earned the 17% that he was expecting. 

 

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One day, when a golfer was playing golf on a famous golf course in Mumbai, some tourists pointed and said, "Tiger Woods!! Tiger Woods!!” The golfer was feeling pretty cocky because he had indeed just hit a great shot… until a tiger came out of the woods. 

 

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Topics: Look-back yield

What's the Difference Between a Mixed-Use Property and a Mixed-Commercial Property?

Posted by George Blackburne on Tue, Apr 30, 2019

Mixed UseA mixed use property is one that has both residential and commercial units, like three apartments over a storefront in an older, East Coast city.  The issue with mixed-use properties is either sound and/or odors.

Suppose you have been renting an apartment unit over the top of a bookstore for ten years, and you have been quite happy there.  You're of Italian descent, and your whole clan is congregated in the central business district of this small, New Jersey town.  Your mom lives just three buildings down the street, and your three aunts and uncles all live within walking distance.  You meet them regularly for breakfast and gossip at a coffee shop just block away, and you absolutely love the lifestyle.

 

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Then the bookstore closes, and the landlord leases out the former bookstore unit to an Artesian restaurant.  The Artesians create delicious dishes, but they spice their food with pooh-pooh spice.  Pooh-pooh spice?  Yup.  It's smells horrid, but it gives their food a unique and mysterious flavor.

The problem, however, is that the pooh-pooh spice smells exactly like, well, pooh-pooh.  The noxious odor wafting up from the floor below makes living in your unit unlivable.  Even your clothes are soaked with the smell of pooh-pooh, and people on buses go out of their way to avoid you.

What are your rights?  One of the rights you enjoy as a residential tenant is the right of quiet enjoyment.  As long as you pay your rent and follow the rules, you have the right to be free of obnoxious sounds and odors.  This Artesian restaurant is arguably a nuisance.

 

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You could move, but there is rent-control in Middleton, New Jersey.  Your rent is therefore 30% below market.  There is also the cost of moving and the fact that you will no longer be able to watch over your aging mother.

You therefore file suit against the property owner.  When the property owner goes bankrupt, you amend your complaint to add the lender who just foreclosed.  But what is the lender going to do?  The family with the Artesian restaurant recorded their lease, and they have fifteen years remaining on the lease.  They also spent $400,000 on tenant improvements for their restaurant.  Even worse for the lender, the Artesian family is making money hand-over-fist from their restaurant.  If they had to move their restaurant, it would cost them over $1 million.

How would this case come out in court?  I am an attorney, and I don't know.  The residential tenant has a strong case because he didn't come to nuisance.  He didn't move in after the restaurant.  The residential tenant was there first.

 

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This unfortunate mixed-use conflict happens even more often because of noise.  The landlord leases the ground floor storefront to a nightclub, and the loud music and pounding of the drums makes the residential units above unlivable.  

Whatever the outcome, you can bet that the poor commercial lender is going to have to shell out hundreds of thousands of dollars in legal fees, moving expenses, legal settlements, and new leasing commissions.  

As a result, during the 1980's it was almost impossible to convince a bank to finance a mixed use property.

 

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Over the years, this mixed-use issue seemed to subside, perhaps because of improved sound-proofing and odor venting.  In recent years, I have not heard of any banks having any reluctance to finance mixed-use properties.  In fact, both Fannie Mae and Freddie Mac will permit a few commercial units on the ground floor of the apartments that they finance.

Okay, so what is a mixed-commercial property?  A mixed-commercial property is one with two or more different types of commercial units.  By different types, I mean office over retail space, industrial space behind retail space, or even self-storage behind office space.

 

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Normally there is no problem financing mixed-commercial properties.  Most lenders are happy to finance the Four Major Food Groups - multifamily, office, retail, and industrial - or just about any combination of the later three property types.

Okay, so mixed-use properties refer to a combination of residential and commercial uses.  Mixed-commercial properties refer to a combination of office, retail, industrial, self-storage, or even business properties, like hospitality (hotels, motels, etc.) or even bowling alleys, amusement parks, etc.

 

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Commercial Loans, Exit Fees, and the Coupon Rate

Posted by George Blackburne on Fri, Apr 26, 2019

Coupon rateThere a lot different ways to earn income on a commercial loan.  You have the interest rate on the face of the note.  You have the discount for which you might have purchased an existing commercial loan.  You have the late charges.  You have the prepayment penalty.  You have default interest rate and maybe even a late charge on the balloon.  You have the exit fee. 

 

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By the way, an exit fee - maybe five points - is like a prepayment penalty, except the lender is entitled to his exit fee whether the commercial loan is paid off early, late, or exactly on time.  Think of an exit fee like gum on your shoes.  No matter what you do, you can't get rid of it.

Why would a lender charge an exit fee on a commercial loan?  Maybe the commercial loan is exactly 75% loan-to-value on a commercial property, and there is not enough room for even loan points.  The lender has to wait until the end to get his loan origination fee.

More commonly the deal is quite risky, and the lender will only make the commercial loan if he enjoys a huge return.  The exit fee is a yield sweetener that bumps up the return to the lender.

 

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Why not just increase the interest rate?  Usually the answer is that the property cannot service the debt initially.

Example:

Roger and his partners are experts at buying distressed apartment buildings in low-income, blue-collar areas and then turning them around.  They get a chance to buy a rundown 400-unit apartment project that originally cost $25 million to build for just $10 million.  Only 35% of the units are habitable.  

Roger goes to several banks for a commercial construction loan to buy and renovate the property.  The bankers drive by the property and flee in terror.  Many bridge lenders do the same thing.  Finally they locate a capitalistic bridge lender who wants a 22% return.

 

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They structure their commercial loan with an 8% coupon rate, six origination points, and an exit fee of six more points for one year.  They can't have a higher interest rate than 8% because, at a 35% occupancy rate, the property doesn't generate enough cash flow to make higher interest-only monthly payments.

Roger, his partners, and their established crew of workman tear into the property, and within five months, the project is looking like a decent place to live.  The lowlifes are evicted, and new tenants arrive in droves.  At the end of one year, Roger and his partners refinance the now-handsome property with a traditional lender and pay the capitalistic bridge lender his $8 million commercial loan, plus his exit fee of $480,000 (six points).

 

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Coupon Rate:

So what is a coupon rate?

A coupon rate is the yield paid by a fixed-income security - in this case, a commercial loan.  A fixed-income security's coupon rate is simply just the annual coupon payments (interest payments) paid by the issuer relative to the bond's or commercial loan's face or par value.  The coupon rate is the yield the bond paid on its issue date.

Example:

In 2004, General Motors issues a 20-year debenture at 6% interest.  A debenture is simply an unsecured corporate bond.   The coupon rate is 6%; i.e., the holder of the debentures enjoys 6% interest payments.

 

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Fifteen years later, General Motors only has to pay 2.875% on any new five-year debentures.  This makes those old 6% debentures worth a fortune because the coupon rate is so high.

The old 6% debentures are actually selling at a premium in the secondary market.  A premium occurs if a buyer of these old debentures pays more than their face value.  A buyer might pay $115,000 for a $100,000 debenture because he gets to enjoy a 6% coupon rate for the remaining five years of the term.  Because he paid an 15-point premium, the new investor's yield-to-maturity might be just 3.0%.

Bottom line:

The coupon rate is just the interest rate on the face of the note.

 

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Commercial Loans and Asset-Backed Securities

Posted by George Blackburne on Tue, Apr 23, 2019

Asset-Backed SecurityFor the last forty years, hard money commercial lenders and their private investors have been making money hand-over-fist by making subprime and nonprime commercial loans.  

Both sub-prime and non-prime commercial loans share the same characteristic.  The deal isn't quite good enough for a bank.  At least one of the Three C's of Underwriting - capacity to repay, collateral, and credit - is weak.

 

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What is the difference between a subprime commercial loan and a nonprime commercial loan?  Here's an easy and fun way to remember it.  A subprime commercial loan is loan to an axe murderer.  A nonprime commercial loan is also a loan to an axe murderer, but the axe murderer has to first provide a bunch of paperwork.  No-doc loans became taboo after the Great Recession.

 

But here's the thing about subprime commercial loans.  In my lifetime, commercial real estate has crashed by 45% three times - once during the S&L Crisis, once during the Dot-Com Meltdown, and once during the Great Recession.  And you know what?  Even though the 65% LTV hard money loans in our portfolio suddenly became 120% LTV deals after the crash, the vast majority of our smaller deals kept making their monthly payments!

Wall Street has figured out a way to securitize nonprime commercial loans using asset-backed securities.

 

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What is an Asset-Backed Security?

According to Investopedia, an asset-backed security (ABS) is a financial security collateralized by a pool of assets such as loans, leases, credit card debt, royalties or receivables - all kinds of different stuff.  For investors, asset-backed securities are an alternative to investing in corporate debt.  An ABS is similar to a mortgage-backed security, except that most of the underlying securities are not mortgage-based.

The basic concept behind the asset-backed security is that you investment is backed by lots of different types of collateral.  A tax law change may crater commercial real estate estate values, like it did in 1986, but aircraft leases might keep purring along.  An investor does not have all of his eggs in one basket.

Asset-backed securities allow lenders (more precisely, issuers) to generate more cash, which, in turn, is used for more lending, while giving investors the opportunity to invest in a wide variety of income-generating assets.  Usually, the underlying assets of an ABS are illiquid and can't be sold on their own.  However, pooling the assets together and creating a financial security, a process called securitization, enables the owner of the assets to make them marketable.

 

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Real quick:  Securitization is the process of taking a bunch of loans, sticking them into a giant pool, and then issuing little pieces of paper (securities) that say that the holder gets, say, 1/100,000th of any cash flow coming back to the pool.  

The underlying assets of these pools may be home equity loans, automobile loans, credit card receivables, student loans, scratch-and-dent residential loans (deals that got kicked out of another securitization), subprime commercial loans, or other expected cash flows.

Issuers of ABS can be as creative as they desire.  For example, asset-backed securities have been created based on cash flows from movie revenues, royalty payments, aircraft leases and solar photovoltaics.  Just about any cash-producing situation can be securitized into an ABS.

 

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Example of an Asset-Backed Security

Assume that Company X is in the business of making automobile loans.  If a person wants to borrow money to buy a car, Company X gives that person the cash, and the person is obligated to repay the loan with a certain amount of interest.  Perhaps Company X makes so many loans that it runs out of cash to continue making more loans.  Company X can then package its current loans and sell them to Investment Firm X, thus receiving cash that it can use to make more loans.

Investment Firm X will then sort the purchased loans into different groups called tranches.  These tranches are groups of loans with similar characteristics, such as maturity, interest rate and expected delinquency rate.  Next, Investment Firm X will issue securities (bonds) that are similar to typical bonds on each tranche it creates.

Individual investors then purchase these securities and receive the cash-flows from the underlying pool of auto loans, minus an administrative fee that Investment Firm X keeps for itself.

 

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An ABS will usually have three tranches: Class A, B and C. The senior tranche, A, is almost always the largest tranche and is structured to have an investment-grade rating to make it attractive to investors.  An investment-grade rating is BBB or higher according to Standard & Poors.  The reason this is important is because many trust documents forbid investments in any deal that is not investment grade.

The B tranche has lower credit quality and, thus, has a higher yield than the senior tranche. The C tranche has a lower credit rating than the B tranche and might have such poor credit quality that it can't be sold to investors.  In this case, the issuer would keep the C tranche and absorb the losses.

 

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Why Do We Care About Asset-Backed Securities?

Many of the commercial lenders making nonprime commercial loans today ultimately get their lending dough, not from deposits or from private investors like Blackburne & Sons, but rather by sprinkling their nonprime commercial loans into ABS pools.

 

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Topics: ABS

Airballs, Exiting, and Some Surprising Uses of SBA Loans

Posted by George Blackburne on Thu, Apr 18, 2019

SBA loansYou experienced commercial loan guys, I promise that I am about to share some surprising, cool, and new stuff about SBA loans.  I just please need your patience for a few paragraphs.

SBA lenders are NOT the same.  As often as I harp on this important concept, I am far from convinced that all of my readers completely grasp it.  Sure, the Small Business Administration guarantees a large portion of all SBA loans; but it does NOT guaranty the entire loan.

 

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The unguaranteed portion is still flopping out there in the breeze, just waiting to get written off as a complete loss when the loan defaults.  Since each and every SBA lender has a significant amount of its own dough at risk, they will each underwrite an SBA loan request differently.

It would therefore be foolish to ever say, "Oh, I don't qualify for an SBA loan.  I applied to the SBA, and they turned me down."  First of all, you never apply to the SBA.  You apply to one of twelve bazillion SBA lenders.

And since every SBA lender underwrites its loans differently, you would be crazy to quit after just one turndown.  Eighteen is the magic number.  If you use C-Loans.com to quickly shift your SBA loan application to eighteen different SBA lenders, and they all turn you down, then you can finally admit defeat.

 

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C-Loans is the absolutely perfect tool to place SBA loans because we have a TON of SBA lenders, and you only need to create your loan application once.  You then submit that single application to suitable and hungry SBA lenders, six at a time, with just one click.

Finally the Surprising, Cool, and New Information:

One of our SBA lenders wrote to me today and said, "George, you should consider opening your marketing efforts up to business acquisitions and debt refinances through the SBA program."

 

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I wrote back, "Does the SBA finance the purchase of businesses without real estate involved???"

My buddy replied, "I’m doing one now. It is a $1.5 million purchase of a service business.  The business leases space from an unrelated third party, so there is no real estate collateral.

The buyer put down 20%, and we financed the rest with a SBA guaranty.  The lender is required by the SBA to try and get to a 1:1 collateral position.  Business assets are heavily discounted by the SBA, so typically we have to take a second mortgage on a house, IF there is equity.  Some banks will do these loans with up to a $1 million to $1.5 million airball, meaning a collateral shortfall.  It depends on the bank's risk appetite.

 

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"What, then, is a debt refinance?  Refinancing a conventional loan?"

A debt refinance may or may not involve real estate.  It can be any debt a business has incurred, where the SBA loan can reduce the monthly payment by 10%.

Example 1:

Joe Business Owner has a hard money loan at 12%, with a 2 year call.  He can get a SBA loan to refinance it at a lower rate and a 25-year amortization.

Example 2:

Joe Business Owner is being exited (i.e. kicked out) of a big bank for a covenant violation.  A covenant is a contractual promise (in a loan agreement), like a borrower promising to pay off his line of credit and maintaining a zero balance for at least 30 days per year.   Joe Business Owner needs to refinance his $1 million line of credit.  He can get a SBA term loan with a 10-year amortization, if he qualifies.

 

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Another cool use of an SBA loan is to buy a franchise.  There are nationwide SBA lenders that specialize in the purchase of franchises, like restaurants, like a KFC franchise; hair salons, like Pro Cuts; and shipping stores, like MailBoxes, Etc.

You get more dollars, a longer amortization, and a lower credit it score requirement when you finance your franchise purchases through these specialized franchise SBA lenders.

 

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Commercial Loans and the Acceleration Clause

Posted by George Blackburne on Tue, Apr 9, 2019

Bad boyI was speaking with one of my very wealthy private investors about commercial loans last week.  He is an attorney and a very sophisticated investor, so I was shocked when he revealed that he had just made a very large second mortgage on an apartment building in Houston.

If you don't immediately recognize the issue, and if you are not thinking to yourself, "This guy is absolutely nuts," today's training lesson will be very instructive.

 

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You will recall that an acceleration clause is the language in a trust deed or mortgage that gives the lender the right to demand to be repaid in full immediately.  Normally you make monthly payments to your mortgage lender.  If you fall behind, you can usually just bring your past due payments current, pay your late charges, and get back on a regular monthly repayment schedule.

But at some point; like if you fall behind by too many payments; or if you do something horribly wrong; like if you get caught mishandling toxic substances on the property; the lender will no longer allow you to reinstate your loan.  Reinstate means bringing your past due payments currents or curing some defect on the property and then getting back on a monthly payment schedule.

An alienation clause in a trust deed or mortgage is language that gives a mortgage lender the right to accelerate his loan; i.e., to demand to be immediately paid in full.  Alienate? Does that mean peeing on a Martian?  Haha!  No.  Alienate means to transfer any part of the title to the property to any other person or entity.  

 

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"Okaaaay, George, but your wealthy investor didn't buy the apartment building.  He didn't take any ownership interest in the property.  He didn't buy the property subject to the mortgage.  He merely placed a second mortgage on the property."

Mortgage lenders, modernly, define alienation to mean transferring all or part of the title to the property, placing a second mortgage on the property, obtaining a mezzanine loan secured by the membership interests of the LLC that owns the property, or issuing preferred equity to a preferred equity investor, without the lender's permission.

By the way, taking title to a property subject to a mortgage means that you don't notify the lender of the purchase and you don't assume the mortgage.

 

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Now back to my "crazy" mortgage investor who made that second mortgage on the apartment building.  Was he crazy?  If the underlying lender finds out, the lender could demand that the entire commercial loan be repaid in full.

Whether the investor is crazy depends on the size of the underlying first trust deed.  If my investor gets to earn 9% on a $1.5 million second trust deed investment, and if the underlying first trust deed was only $1.1 million, then my investor my investor was crazy like a fox.

By the way, you may have noticed that I used "trust deed" rather than "mortgage".  Texas is a trust deed state, which is a big deal.  It means a lender - especially a second trust deed lender - can foreclose much faster.

 

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Can you imagine making a $1 million second mortgage behind a $6 million first mortgage and then being forced to keep the underlying first mortgage current for the 18 months it takes to foreclose a mortgage in a mortgage state?  The monthly payments on a $6 million commercial loan are in the range of $38,000 per month.  After 18 months, the second mortgage lender would have to shell out $684,000 to protect a $1 million investment.  Yikes!

So if you are ever going to make a second mortgage investment, make sure that you are in a trust deed state, like California or Texas, and that your commercial loan is a second trust deed and not a mortgage.  This way you only have to keep the first trust deed current for five months or so while you foreclose.

In how much danger is my investor?  Even if the underlying bank somehow discovered the new second mortgage and accelerated its loan, my guy is rich enough to simply pay off the first mortgage - assuming it's not insanely large.    And in real life, very few banks ever bother to check the title to property securing their commercial loans for presence of a junior lien (mortgage, mezzanine loan, or preferred equity).

 

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The party who is real danger is the borrower.  Many large commercial loans these days are non-recourse; i.e., if the market goes south and the borrower loses the property in foreclosure, the borrower is NOT personally responsible for any loses the lender suffers after foreclosing.

This assumes, however, that the borrower doesn't commit any Bad Boy Acts.  Voluntarily placing a second mortgage on the property is a Bad Boy Act and will trigger a springing personal guaranty.  A springing personal guaranty is a guaranty that becomes effective upon the occurrence of a certain condition, e.g., a bankruptcy filing, toxically contaminating the property, intentional waste, etc.

 

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Suppose commercial real estate crashes by 45% (a magical number I urge you to remember).  The second mortgage lender decides to simply walk away from his investment.  The first mortgage investor forecloses, and in the chaos of the real estate crash (think the S&L Crisis, the Dot-Com Meltdown, and the Great Recession), the property gets neglected.  The roof leaks, and mold starts to grow.  Vandals break in and steal the copper and appliances.  Squatters poop in the halls.

The result is a huge loss for the first mortgage lender, and because of the springing personal guaranty, the lender can now come back against the borrower for his losses.  Word to the wise.  Don't commit Bad Boy Acts.

 

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Commercial Loans and The War of the Worlds

Posted by George Blackburne on Thu, Apr 4, 2019

War of the WorldsWe're gonna have some fun today, and it's is not about commercial loans.  There is a good marketing lesson, however, to be learned today, whether you're a commercial broker, a general contractor, a real estate investor, or a commercial loan broker.  

Your marketing pieces do not always have to be about business.  The idea is to keep the name of your widget business in front of the customer.  

The most successful marketing piece I ever wrote was about the book, The Hot Zone, and how the Ebola virus almost killed us all.  You probably don't know this, but about 25 years ago the Ebola virus dangerously mutated in a lab in Restin, Virginia.  The Ebola virus became transmissible by air.  Holy poop!  No longer did you have to touch the blood.  Just breathing the same air would kill you.

 

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Dozens of monkeys in a research lab in Reston started bleeding out from their eyes, noses, mouths, and tailpipes; and then they would die.  The monkeys were in different rooms, so obviously the pathogen was traveling through the air ducts.  

The scientists doing the autopsies on the monkeys had no clue that the monkeys had been exposed to Ebola, so when their petri dishes started turning purple, they had no reluctance about sniffing the petri dishes for a contaminant that made the petri dishes smell like fermentation.

But when the scientists sniffed the petri dishes, they did NOT smell alcohol.  Hmmm.  What was happening?  So the scientists put the samples under an electron microscope, and - oh, my goodness - there was the Ebola virus.  It was now transmissible by air, and they had been taking big sniffs.

 

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Worse yet, these scientists had been going home every night and kissing their wives and kids.  And then the wives had gone to the grocery store, thumped melons, and handled vegetables.  They had spread the virus all over Restin.

So why didn't every person on earth die?  You'll have to read the book.  Okay, that was mean.  It was true.  The Ebola virus had indeed mutated to make it transmissible by air; but that same mutation made the virus harmless to humans (but still 100% fatal to primates).  The scientists were fine, and after spending three weeks in an isolation chamber, they were released.  

But today we are going to talk about H.G. Wells classic book, The War of the Worlds.  The book is about a Martian invasion of earth, and it was written... get ready for it... in 1898.  The Martians launched scores of huge cylinders from the surface of Mars that plowed into the Earth's crust and then unscrewed themselves back up to the ground.  Then these scary, slug-like creatures emerged, complete with slimy tentacles.

 

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When a peace deputation was sent in to make first contact, the Martians used a heat ray to melt the unfortunate envoys.  Remember, folks, this book was written in 1898, about 80 years before the first laser beam.  When the Army was sent in, they too were melted by the Martians.

Then the Martians unleashed giant, three-legged tripods - war machines that were were four-stories high, armored, and armed with a pivoting heat ray cannon.  The destruction of mankind began in earnest.

And we haven't even gotten to the good stuff yet...  Scroll forward 40 years to the year 1938.  People didn't have TV sets yet, so the whole family would sit in the living room and listen to radio shows.

 

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At the beginning of the one-hour show, Mercury Theater on the Air, the announcer, a 23-year-old Orson Wells, informed the listening audience that the coming show was just a story.  Then the radio began playing ordinary music, which was suddenly interrupted by a new flash from Orson Wells describing a pitiless invasion by creatures from Mars.

Many of the radio audience had been been listening to The Chase and Sanborn Hour with Edgar Bergen and tuned in to "The War of the Worlds" during a musical interlude, thereby missing the clear introduction that the show was a drama.  The urgent, horrified performance by Orson Wells was so believable that almost one-million Americans poured into the streets in terror.

Haha!  The whole reason this came up is because I recently downloaded a modern, well-done performance of the War of the Worlds as an audiobook, complete with sound effects, multiple voice actors, and absolutely eerie music.  What fun!

 

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Be on the Lookout For Real Estate Developers Who Need Equity:

Please be on the lookout for real estate developers of multifamily, office, retail, or industrial projects who are just a little short of construction equity.  Banks will no longer lend up to 80% loan-to-cost.  For some properties, banks are demanding that the developer contribute as much as 35% of the total cost of the project as a condition of their construction loan.

Blackburne & Sons Realty Capital Corporation can raise tiny amounts of equity for such projects - up to $1.5 million to $2 million.  Got a deal that needs less than $1.5 million in additional equity, please call Angela Vannucci at 916-338-3232.

 

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Notice that I did not describe our private loans as bridge loans, but rather as permanent loans.  Blackburne & Sons makes first mortgage loans with a 30-year amortization (essentially interest-only), but with a 15-year term.

This means that your borrower will never have a refinance his loan during a bad recession, when the value of his building might have fallen by 45% in value.  To make our loans even more attractive, there is no prepayment penalty.  In other words, you can use our loan as a bridge loan, with the added reassurance of the extra term.

 

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Is your four-year degree in advanced basket weaving?  If you are well-spoken and a natural salesman, you can earn a handsome income as a commercial mortgage broker.  You can learn the entire profession of commercial mortgage brokerage in one weekend.

Do you own a mortgage company or a real estate brokerage company?  If so, you should have in your library our 9-hour video training course ($549) in commercial real estate finance.  You just sit your new agent in front of a computer, and nine hours later he is in a position to make you money.  You can use our training course again and again.  This is what Les Agisim of Trevor Cole Financial does.  Over the years, he has trained thirty or forty agents using his one copy of our video training course.  

 

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By the way, Trevor Cole Financial just closed yesterday its 55th commercial loan for C-Loans.com.  Are you a commercial lender?  Get carefully-scrubbed commercial or SBA loan leads delivered to your email box at no out-of-pocket cost to you.   We are especially looking for bridge lenders capable of funding commercial loans larger than $1 million.  

 

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