Commercial Loans and Fun Blog

This article will eventually lead you to the perfect place to find a commercial loan on a bed and breakfast inn; but first a reality check.

In terms of cash-on-cash return on your money, however, the single worst real estate investment on earth is the bed and breakfast inn ("B&B").  In addition to earning an almost zero percent return on your life savings, the buyer also gets to enjoy rising early every single day of the week to cook breakfast.  Is this a great country or what?

 

 

 

 

Don't get me wrong.  Bed and breakfast inns are usually gorgeous properties.  The big winner here is the previous seller (phew) and the guests, who get to enjoy a relaxing getaway with their favorite someone.  But the inn keeper?  He is totally and completely screwed.

What seems to the problem?  Bed and breakfast inns are so gorgeous that the buyers  fall in love with them... and then they grossly overpay for them.  In many cases, the buyers will put down a whopping $500,000 and take out a commercial loan of $800,000 or more.  Then the buyers try to service the debt on this massive commercial loan by renting out fewer than ten (just four?) guest rooms.  

These commercial loans simply don't pencil.  Sure, the B&B might generate enough dough to make the mortgage payments, but there is seldom any money left over on which the retired couple can live.  Therefore the buyers have to go deeper and deeper into credit card debt in order to survive.  Eventually they have to sell, and the Old Maid is passed on to the next sucker.  Phew.

 

 

 

 

You will recall that a cap rate is the return on your money if you bought an income property for all cash.  For example, suppose you buy a 36-unit apartment building.  You start with your Gross Scheduled Rents, and you lose some potential rent when you have some vacancies and credit losses (5%).  Then you have your operating expenses and some replacement reserves that you have to set aside for the roof and AC units.  

When you are all done, you are left with your net operating income ("NOI"), which is your dollar return on your investment.  (Important note:  Do NOT deduct the payments on your commercial loan when computing your NOI.)  Your cap rate is simply your NOI divided by what you paid for the building.*

You can buy decent apartment buildings for a 5% to 7% cap rate.  In other words, if you buy the apartment building for all cash, you will enjoy an income of around 6% on your money.  You can buy good office buildings and retail properties for 6% to 8% cap rates.  But bed and breakfast inns?  B&B's sell at 2% to 4% cap rates!

 

 

 

 

"But George, the owners also get to live in the beautiful property rent free."

True.  It's an appealing lifestyle, until the cost of the repairs and replacements eats up your cash reserves.  Now if you have a huge, outside retirement income on which you can survive, and you don't need the B&B's income to buy groceries, then the B&B lifestyle may be for you.  But as an investment to generate a cash-on-cash return on your retirement savings, bed and breakfast inns are stinkers.

What about making commercial loans on bed and breakfast inns?  From a lender's perspective, they are not the best kind of collateral.  (But they are not the worst.)  B&B's seldom generate enough dough to pay for professional management.  As a result, in the event of a foreclosure, the bank has to immediately close the inn.

 

 

 

 

A foreclosure destroys years and years worth of marketing effort.  "Oh, honey, let's sneak off and stay at that little B&B where (giggle) little Johnny was conceived.  Oh, no... it's closed down!"

Now let's talk about personal property.  If a buyer pays $1.5 million for a bed and breakfast inn, at least $300,000 of that price will be for the gorgeous, antique furnishings.  Guess what happens when a lender forecloses?  Poof.  They are all gone.  Empty building.

That being said, B&B's are not the absolute worst collateral for a commercial real estate loan because they are usually gorgeous and the setting is heavenly.  They are far-far better collateral than, say, an apartment building in the ghetto.

 

 

 

 

Okay, suppose you are looking for financing on a bed and breakfast inn.  Where should you go?  Banks don't like to finance B&B's because they are money-losers.  The borrowers almost never have large enough cash reserves to attract a bank.  

I don't think the SBA will finance bed and breakfast inns; but I could be wrong.  I just wrote to my SBA loan buddies and asked them, and I'll post the results here.  This just in:  Riley Risto, an SBA loan officer for Gulf Bank, just replied, "Yes, those are tougher deals to get done, but there’s no SBA restriction.  The zoning has to be correct."

If I needed and SBA loan, I think I would apply to a local credit union.  The key is the word, "local".  You can find scores of suitable credit unions for your B&B deal on CommercialMortgage.com.  

 

 

 

 

By the way, guys, when you use CommercialMortgage.com to place a commercial loan, be sure to scroll down past the Recommended Lenders section to the Hungry Lenders section, where you will find your thirty DIRECT LENDERS (banks and credit unions).  You may not be scrolling down far enough.

My own hard money shop, Blackburne & Sons will make small commercial loans on bed and breakfast inns.  Our biggest limitation is that our maximum loan size is $800,000 for such properties.

Be sure to check out our updated Blackburne and Sons web site.  Purdy.  :-)

 

 

 

 

* Multiplied by 100% to put the number into a percentage format.

When underwriting commercial loans, commercial lenders need to be very careful about properties that are leased out for far more than their fair market value.  A story will make this clear.

GrandpaJack was a brilliant man.  He was also a darned fool.   Forty-five years ago, he spotted the fact that Silicon Valley on the San Francisco Peninsula was inching southward towards the cheaper land in San Jose.

Grandpa Jack therefore bought a large, vacant lot on the corner of First Street and Trimble Road, where it approached Milpitas, figuring it would be great location someday for R&D and flex space.

 

 

 

 

Thirty years later, the world was beating a path to his doorstep, begging to build and lease back a 200,000 square foot high-tech manufacturing facility.  Anxious to provide for his family for several generations into the future, Grandpa Jack leased the entire facility in 2004 to Oracle Corporation for a flat fee of $1.92 million per year ($9.6 per square foot per year).

When discussing commercial lease rates, it is customary to always speak in terms of rent per square foot per year.

Judging by his vision, Grandpa Jack was brilliant.  Judging by his choice of Oracle as his tenant, Grandpa Jack showed even more brilliance.  Oracle Corporation, the financial behemoth, sailed comfortably through the Great Recession.  Grandpa Jack's three children got every single rent payment on time.

 

 

 

 

But Grandpa Jack made one bonehead mistake.  He leased his massive R&D building at a fixed rental rate for a whopping thirty years.  He didn't even build in an annual CPI increase.  Today the market rent for R&D space in San Jose is $20 per square foot (per year).

We are now finally able to discuss a leased fee estate.  A leased fee estate is the ownership interest that the landlord or lessor maintains in a property under a lease, with the rights of use and occupancy being conveyed or granted to a tenant or lessee. In other words, it is the ownership interest in a leased property.

In plain interest, the property you own is leased out to someone.  What is your property worth when it is burdened or blessed with the existing lease?  

 

 

Hey guys, do you know any filthy rich investors?

 

Now the concept of a leased fee estate comes up most often in MAI appraisals.  A good MAI appraiser will usually only bring up the concept of a leased fee estate when the property is leased out for a long term at far under the market rate or at far over the market rent.

Now Back to Grandpa Jack:

Let's suppose the huge R&D building was not burdened with the below-market, long-term lease to Oracle.  If it was rented out at $20 per square foot (pop quiz:  per month or per year?), the building would be worth - at a 7.5% cap rate - $40.5 million.

But the property is NOT leased out at $20 per square foot.  It is burdened with a long-term lease of just $9.60 per sf, which is less than half the market rate.  At a 7.5% cap rate, the leased fee value of the property is just $19.5 million.

 

 

 

 

 

"But George, what about the fact that in 15 more years the lease expires, and the owners can renegotiate the rental rate to market?"

A good MAI appraiser will take out his trusty Hewlett Packard 12C hand-held calculator and will perform a discounted present value calculation, taking into account a rental rate of $9.60 sf for 15 years and $20 sf thereafter.

Unfortunately for the heirs (Grandpa Jack passed away in 2006), the reversionary value of the property fifteen years hence, when the old lease expires, does not affect the present value of the leased fee estate as much as you might think.  It has to do with the fact that the big pop in value doesn't happen for a long period of time.  By the way, reversionary value refers to the value of property upon the expiration of a given time period.  

 

 

 

 

Another Example - It Works Both Ways

Sun-Mei Chang is a dynamic, Chinese-American woman.  Sun-Mei is always on the move, and she could sell anything to anyone.  She is a bona fide Alaskan icebox saleswoman.

She buys a closed elementary school (30,000 sf) from the county for pennies on the dollar, and then she spends just $25,000 sprucing it up a little.  Next she convinces a state-sponsored trade school to rent the property for a whopping $15 per sf.  The market rent is just $6 per sf - but like I said, Sun-Mei is a world-class saleswoman.

 

 

 

 

Then Sun-Mei applies for a loan against this property.  If the property was valued solely on an income approach, this former school would be worth a fortune.  If the appraiser is a good MAI appraiser, he should quickly spot the fact that the existing lease rate is much higher than the market.

A competent MAI appraiser would therefore submit his finished report with two different values, the value of the leased fee estate and the fair market value - assuming the big lease did not exist.  The value of the leased fee estate would be on the order of $3.8 million, but the fair market value might only be $1.52 million.

When underwriting commercial loans, commercial lenders need to be very careful about properties leased for far more than their fair market value.  Not every MAI appraiser is well-trained enough to produce a report with two different values.  The lender has to be careful not to make too large of a commercial loan because if the property comes back in foreclosure, the lender will probably only be able to lease it back out at $6 per sf. 

 

 

 

 

  

 

 

I 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.

 

 

 

 

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.

 

 

 

 

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.

 

 

 

 

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.

 

 

 

 

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.

 

 

 

 

 

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.

 

 

 

 

 

 

 

Since 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.

 

 

 

 

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.

 

 

 

 

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.

 

 

 

 

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?

 

 

 

 

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."

 

 

 

 

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.

 

 

 

 

 

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.

 

 

 

 

 

"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'.

 

 

 

 

 

As 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!

 

 

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.

 

 

 

 

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.

 

 

 

 

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.

 

 

 

 

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.

 

 

 

 

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."

 

 

 

 

"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

 

 

 

 

Golfer:  "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?"

 

 

 

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.

"You know you're too high when you're eating cereal naked, and your girlfriend says, 'Put your clothes on,' and then you realize it's not your girlfriend.  It's some woman on a bus.” -- Dov Davidoff

 

 

 

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.

 

 

 

 

 

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. 

 

 

 

 

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. 

 

 

 

 

 

A 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.

 

 

 

 

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.

 

 

 

To Receive Trust Deed Investment Offerings

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.

 

 

 

 

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.

 

 

 

 

 

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.

 

 

 

 

 

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.

 

 

 

 

 

 

There 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. 

 

 

 

 

 

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.

 

 

 

 

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.

 

 

 

 

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).

 

 

 

 

 

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.

 

 

 

 

The average hard money broker makes ten-times
what a desk-and-a-phone mortgage broker makes.

 

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.

 

 

 

 

 

 

For 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.

 

 

 

 

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.

 

 

 

 

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.

 

 

 

 

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.

 

 

 

 

 

 

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.

 

 

 

 

 

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.

 

 

 

 

 

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.

 

 

Oooo.  He was just kidding, and he apologizes.
Please put down that knife!  Please, plea.... Uhhh  :-)

 

 

 

You 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.

 

 

 

 

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.

 

 

 

 

 

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."

 

 

 

 

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.

 

 

 

 

 

"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.

 

 

 

 

 

 

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.