Commercial Loans and Fun Blog

For decades I taught live classes in commercial mortgage brokerage   I am much too old now to stand and teach a nine-hour class.  They were sooo exhausting.

The single most important lesson in all of commercial real estate finance (“CREF”) is the Debt Service Coverage Ratio.  I would therefore spend an hour-and-a-half teaching the use of this ratio.

Then I would always pick some unsuspecting victim out of the crowd.  I would ask her, “Now what’s the name of this ratio that we have been talking about?”  The poor victim would reply something like, “The Debt Ratio?” “How about you, sir?”  He would stammer and stutter, and then he would reply meekly, “The Service Ratio?”  The audience would laugh, but they would all be secretly thinking, “I’m sure glad that he didn’t ask me.”

I would then ask them to say out loud, “Debt Service Coverage Ratio.”  Three times.  Out loud.  Like kindergarten.  Ha-ha!  In fairness, the name of this financial ratio doesn’t just trip off of the tongue.  How are we going to remember the name of this weird-sounding ratio?

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Q:  Do you know why you never see elephants hiding up in trees?
A:  Because they’re really good at it.

Q:  How does the elephant get out of the tree?
A:  He climbs out onto a leaf and waits until Autumn.

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 HOW C-LOANS WORKS IN PLAIN ENGLISH

We are talking about a loan, and obviously “debt” is another name for a loan.  But what does it mean to service the debt?  Think of a server at a restaurant.  He provides service to, and attend to, the diners.  He makes them happy and satisfied.  And how to do we make a lender happy and satisfied?  We make the payments on his loan!  So debt service means the annual payments on the loan. 

By the way, all debt service coverage calculations are, by custom, performed on an ANNUAL basis.  Darn!  You could squeak out a slightly larger loan if you could do the calculations on a monthly basis. Nice try.

Now back to the Debt Service Coverage Ratio.  Three times. Out loud.  Debt Service Coverage Ratio.  Debt Service Coverage Ratio.  Debt Service Coverage Ratio.

Okay, we've mastered Debt Service.  Now let’s tackle the word, “coverage”.

I rode horses for four years as part of the famous Culver Black Horse Troop - 100 all black horses.  I rode in President Nixon's second Inaugural Parade.  My son, George IV, rode in W's first Inaugural Parade.  Tom rode in W's second Inaugural Parade.  My daughter, Jordan, just rode in Trump's Inaugural Parade, as part of the Equestriennes, the girls counterpart to the Black Horse Troop.

I urge you to take a moment to look at some quick images of the Black Horse Troop and Culver Military Academy.  The academy is an incredible military high school, and it is why the Blackburne’s moved to Indiana, even though the company is still located in Sacramento.

Because I rode horses, when I think of “coverage", I think of a stallion covering a mare.  Do I mean...?  Yup.  Doing the wild thing.  It’s not a bad metaphor.  Normally the stallion is about 25% larger than the mare.  Commercial lenders want the Net Operating Income from the property to be at least 25% larger than the Debt Service.

Okay, and without talking about horses doing the wild thing again, the Debt Service Coverage Ratio (“DSCR”) is defined as:

DSCR = NOI / Debt Service x 100%

NOI stands for the property’s Net Operating Income, and the Debt Service stands for the annual principal and interest payments on the proposed loan, excluding taxes and insurance.  Residential lenders use PITI, principal, interest, taxes, and insurance.  In commercial real estate finance ("CREF"), we do NOT include taxes and insurance in the Debt Service because we have already deducted them from the Effective Gross Income when we computed the property's Net Operating Income.  We just include the annual principal and interest in the Debt Service.

The Net Operating Income is the bottom line number of the Pro Forma Operating Statement that you will prepare for your lender.

Commercial lenders today require that this ratio exceed 1.25.  On hotels and other business properties (any business where the owner has to be there everyday), commercial lenders require that the Debt Service Coverage Ratio exceed 1.45.

Interest rates have been going up.  The best rate offered by banks has increased from just 3.875% three years ago to 5.75% to 6.25% today. The Debt Service Coverage Ratio is once again important in sizing commercial loans.

Sizing a commercial loan means to compute the maximum loan amount that a lender will make on a particular commercial property.  It will usually be the smallest loan amount generated by the Loan-to-Value Ratio, the Debt Service Coverage Ratio, and for Conduits (CMBS lenders), the Debt Yield Ratio. 

Today's article is more about economics than commercial loans; but first I have to post an important message, just for commercial loan brokers.  If you do not work in the commercial real estate finance ("CREF") industry, you should simply skip to the section below entitled, Trauma From the Great Recession.

IMPORTANT MESSAGE FOR COMMERCIAL LOAN BROKERS

For the past year, in order to add more bankers to CommercialMortgage.com, C-Loans, Inc. has been trading our wonderful training courses about the commercial loan business to commercial loan brokers in exchange for the contact information of bankers making commercial real estate loans.  

The swaps have proven wildly successful, and we have now added around 4,000 commercial real estate lenders to CommercialMortgage.com.  If you are not using this free commercial mortgage portal several times per week, you are really missing the boat.

We now have enough commercial lenders on CommercialMortgage.com, so these swap offers ends on August 31, 2018, just one week away.   If you have a passion to learn commercial real estate finance, but you can't afford to pay hundreds of dollars for this invaluable training, this really is your last chance to get these courses for nothing out of pocket.  Here are the trades:

1. You can trade one commercial real estate loan officer working at a bank or a credit union for a free copy of my commercial mortgage marketing course, a free copy of my fabulous Income Property Underwriting Manual, a copy of my battle-tested commercial mortgage broker fee agreement, or a copy of a Regional Blackburne List with 750 commercial lenders.
   
   
2. You can also trade ten commercial real estate loan officers for a free copy of my famous 9-hour course, How to Broker Commercial Loans.  Please click here for details.
   
   
3. You can trade ten commercial real estate loan officers working at a bank or credit union for  a free copy of my super-important course, How To Find Your Own Private Mortgage Investors,.  It's all about the loan servicing income, folks!  Please click here for details.
   
   
4. Lastly, you can trade ten commercial real estate loan officers working at a bank or credit union for my very best course, the Practice of Commercial Mortgage Brokerage, which has over 60 important and practical lessons.  Please click here for details.

Remember, these trade offers will be withdrawn after August 31st.  However, the following incredible offer to commercial loan brokers will remain:

ENTER A COMMERCIAL LOAN INTO C-LOANS.COM
GET YOUR CHOICE OF TWO OF OUR TRAINING PROGRAMS

If you enter a bona fide commercial loan into C-Loans.com, using the six-step process, and submit that deal to six of our commercial lenders, we'll give you a choice of any TWO of the following prizes:

C-Loans Explained in Plain English

1.  Powerpoint presentation to our Commercial Mortgage Marketing Course.

2.  Income Property Underwriting Manual

3.  Commercial Loan Broker Fee Agreement

4.  Regional Blackburne List of 750 commercial lenders.

When you have submitted your commercial loan to six of our commercial lenders, please contact Tom Blackburne at 574-210-6686 and tell him which two gifts you want.  Borrowers and commercial brokers, feel free to take advantage of this offer as well.

Now finally we can get to today's economic observations.

TRAUMA FROM THE GREAT RECESSION

My father and mother both lived through the Great Depression.  My father was at West Point during the worst of the Great Depression, and he was an Army officer in Hawaii during the rest of the slump.  On an officer’s salary, my father lived like a king.

Interesting Note:  In 1939, my father was an Army Captain in charge of the shore defenses on the island of O’ahu.  His artillerymen were armed with French 75 mm howitzers, which were strategically emplaced all along the shoreline.  The French 75’s were excellent artillery pieces, except my father’s guns had no ammunition!  He kept complaining to his General, until he was finally ordered to shut the heck up. My father also told me of a time when he was looking down a sextant to site one of his howitzers, when he spotted a Japanese “fisherman” plotting my father’s gun with his own sextant. Yikes!

But it was my mother who was the most traumatized by the Great Depression.  Her father worked in a factory, until he was laid off in 1930. My mother then had to quit high school, at the age of fourteen, and go to work in a factory in order to feed the family.

Money was incredibly tight for my mother’s family, and those years traumatized her.  Even though my father worked as an aerospace engineer for Lockheed for most of my childhood, earning a fine wage, my mother could never get over the trauma of the Great Depression.

The minister's little six-year-old girl had been so naughty during the week that her mother decided to give her the worst kind of punishment.  She told her she couldn't go to the Sunday School Picnic on Saturday. When the day came, her mother felt she had been too harsh and changed her mind.  When she told the little girl she could go to the picnic, the child's reaction was one of gloom and unhappiness.  "What's the matter?  I thought you'd be glad to go to the picnic." her mother said. "It's too late!" the little girl said. "I've already prayed for rain."

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My mother therefore scrimped and saved her entire lifetime.  “Turn out the lights!” she would admonish us, “You are wasting money.” Toothpaste?  We were taught to squeeze that roll incredibly tight, so as not to waste a single brushing’s worth of toothpaste.  We were also hoarders.  Anything that could possibly be re-used was saved.

My mother was not alone in her trauma.  Most working people who lived through the Great Depression were deeply affected.  Thrift became a very admired trait.  Savings and loan associations were even called “thrifts” because S&L’s, back in the day, were able to pay 0.25% higher interest than banks.

__________________________

My wife accused me of being immature.  I told her to get out of my fort.  Ha-ha! 

My wonderful parents took me to Disneyland when I was six-years-old.  To this day, almost sixty years later, I still remember the ‘coonskin cap and flintlock pistol that they bought me.  I still remember the butterflies of excitement I felt defending the fort on Frontierland Island against the attacking ‘Injuns.  And those dark, creepy Tom Sawyer tunnels… oh, my goodness, I was in heaven!

Okay, let’s finally get to it.  About five months ago, I predicted raging inflation this summer, caused by workers demanding higher pay.  I was wrong.

It’s true that the inflation rate has been increasing all year, and the figure for July was a strong 2.95%.  Net income, after taxes, has been increasing at the encouraging rate of over 3%.  It is also true that productivity has been increasing at the rate of 1.3% annually in recent months, the first increase in a number of years.  The reason why productivity is important to the inflation story is that increases in productivity often lead to higher wages.

But we have NOT seen the type of raging inflation figures that I was expecting.  Why not?  The unemployment rate is back down to 3.9% this week.  American companies are making money, and they can surely afford to pay higher salaries.  Why aren’t American workers demanding higher pay?

I submit that it is because American workers remain traumatized from the Great Recession.  If 2009 marked the beginning of the recovery – certainly that’s true with the stock market – American workers have had nine years to recover from the economic fright of their lives.  That should be long enough to “get over it”, right? (In the 1987 movie, Moonstruck, Nicholas Cage declares his love to Cher, who proceeds to slap him mightily – bam! - and replies, “Get over it!”)

But apparently not. It looks like Americans workers remain too traumatized by the Great Recession to risk their jobs by demanding higher wages.   Who’d have thunk it?

This practical marketing tip can be used by widget manufacturers, commercial mortgage brokers looking for commercial loans, and commercial brokers trying to sell a commercial property.  I've written around 300 blog articles, mostly about the commercial loan business.  This article may be my second most important article ever.

Whenever you market to a select group of recipients again and again, you should share a little bit of your life with them in each of your marketing pieces.   I am talking about price sheets (if you are a supplier or a manufacturer), newsletters (if you are a commercial loan broker), rate sheets (if you are a residential mortgage broker), or sales brochures (if you are a commercial broker).

By sharing your life, I mean just a one or two-paragraph story of something funny, entertaining, interesting, or heart-warming that recently happened in your personal life.  Here's an example:

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On a Personal Note...

Cisca (my darling bride of 35 years), our granddaughter, and I were on the way to the Indianapolis State Fair last weekend.  The turnoff into the parking lot of the Fair was right off a bustling boulevard.  Forty cars were stopped in line to make a right-hand turn.  We were the second to the last car in line.

Bam!  The car behind us smashed into the rear of our car, causing us to be heaved into our seatbelts.  Then, out of the corner of my eye, I saw a Jeep flying over the top of our car, like it was in slow motion.  This Jeep must have been twelve feet in the air.  The trajectory was such that my beautiful wife was about to crushed into mincemeat... Thankfully the Jeep continued its flight and landed on its side, just three feet to the left of my beloved wife.

Have you told your wife, husband, or children recently just how much you love them?  Bam - and they could be gone.  (This actually happened two years ago.  Thank God no one was seriously hurt, including the airborne astronaut.)

Let's suppose that you sell solvents, and every week you send a price sheet by email to your list of 127 local purchasing agents.  Three competing companies send a similar price sheet to the same purchasing agents.  Your owner would be immensely wise to include a personal paragraph at the top of each price sheet.  Suddenly ADR Solvents becomes... Adam Richter, his lovely wife Mary, and cute, little Adam Richter, Jr. (age six), who just got his first hit in a Little League game and who grinned with the greatest of joy when he looked over and saw his father, Big Adam, doing dog-flips in the stands.

What purchasing agent wouldn't be touched by such a story?  When the buyer looks at the competing price sheets, and he sees that all four solvent companies are offering about the same prices, which solvent company do you think is going to get the order?

"But George, that is so unprofessional!"

Nonsense.  I sell 7% to 12% first mortgage investments for a living to a very distinguished group of accredited investors - doctors, attorneys, CPA's, and the owners of large and successful businesses.  We service over $55 million in first mortgage loans and properties for these well-heeled investors.

Nevertheless, I try to share a little bit about my personal life with them in every newsletter.  If anyone was going to be put off by my "unprofessional behavior", it would be these wealthy, conservative folks.  Let me assure you, the overwhelming majority of my investors seem to really enjoy my little stories.  They are why many of them invest with us.

This practice - becoming a pen-pal with your customers - will separate you from the crowd.  Those of you who a residential mortgage brokers, you simply MUST start doing this.  You sell a fungible product - a conforming loan from Fannie Mae or Freddie Mac - so the only reason why a residential sales broker is going to choose you is because he likes, trusts, and respects you as a person.

By the way, a fungible product is one that is perfectly interchangeable with another.  For example, a bushel of corn sold on the Chicago Board of Trade is fungible with any another bushel sold on the Exchange.  In plainer words, "There ain't nothing special about it."  So back to residential loan agents, they all their loans to the same buyer, Fannie Mae or Freddie Mac.   You therefore need to develop a more personal relationship with your residential sales brokers.  Don't just send rate sheets.  Include a personal paragraph!!!

This leads me to a very important lesson.  I call it the Newsletter Effect.  If you send a fun, folksy, and personal newsletter every three weeks to the same recipient for nine months, he will swear that he has known you forever. You laugh, but when I used to go to trade shows (I sent a lot of faxes back in the day), mortgage brokers would approach me and tell me that they had been receiving my funny faxes for years.  When I would later check my data base, I would find that they had only been on my fax list for nine months.

If you write to someone every three weeks for nine months, he will consider you to be extremely trustworthy.  After all, it does takes a certain amount of character to religiously send out a newsletter every three weeks.  Or perhaps you are considered extremely trustworthy because you have not been arrested in the "years and years" that he has known you.

If you are a consistent pen-pal, you will discover that your reader considers you a personal friend and the back-up godparent to his kids.  And that's a very good thing.  We are NOT trying to manipulate people here.  We love our friends, and we are darned grateful and humble to to have them.  We are just trying to become even richer in friendships.

So today's lesson is to include a personal paragraph or two in every one of your marketing pieces.  Those of you who are commercial loan brokers and commercial brokers (experts who sell commercial real estate), you have probably been added to our funny newsletter lists.  You may recall that you have been assigned to a particular loan officer at Blackburne & Sons (my commercial hard money shop), and that this loan officer always includes a personal paragraph in his newsletter.    My loan officers kick and scream a little when I make them write their little stories, but I have read some very funny and incredibly heart-warming stories from them.

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Commercial Loan Brokers Please Continue

IMPORTANT WARNING ABOUT BANKER TRADES:

If you are a regular reader, you know that you can trade one commercial real estate loan officer working at a bank or a credit union for a free copy of my commercial mortgage marketing course, a free copy of my fabulous Income Property Underwriting Manual, a copy of my battle-tested commercial mortgage broker fee agreement, or a copy of a Regional Blackburne List with 750 commercial lenders.

You can also trade ten commercial real estate loan officers for a free copy of my famous 9-hour course, How to Broker Commercial Loans, a free copy of my super-important course, How To Find Your Own Private Mortgage Investors, or my very best course, the Practice of Commercial Mortgage Brokerage, which has over 60 important and practical lessons.  Please click here for details.

That's the good news.

The bad news is that so many brokers have taken advantage of this offer that our latest commercial mortgage portal, CommercialMortgage.com is now packed with over 3,000 commercial lenders.  We really don't need any more.  We have dozens of banks and credit unions for every state (although Alaska is admittedly a little light).

My offer to make any of these trades ends on August 31st.  Any list submitted after August 31st will be ignored.  Fair warning.

BUT THE FOLLOWING OFFER REMAINS:

If you enter a bona fide commercial loan into C-Loans.com, using the six-step process, and submit that deal to six of our commercial lenders, we'll give you a choice of any TWO of the following prizes:

1.  Powerpoint presentation to our Commercial Mortgage Marketing Course.

2.  Income Property Underwriting Manual

3.  Commercial Loan Broker Fee Agreement

4.  Regional Blackburne List of 750 commercial lenders.

When you have submitted your commercial loan to six of our commercial lenders, please contact Tom Blackburne at 574-210-6686 and tell him which two gifts you want.  Borrowers and commercial brokers, feel free to take advantage of this offer as well.

Heavens, salaried commercial loan officers working for banks sure can be lazy.  This is especially true for salaried guys over the age of 50, and loan officers over 50 constitute over 70% of all bank commercial real estate loan officers.

These sleepy, old, privileged white guys all have their stable of repeat customers.  They are mainly on salary (zzz), and they are going to close enough commercial real estate loans to meet their quota and earn their bonus.  Why close even one more commercial loan?  They might have to exert themselves.  Arghhh.

Oh my goodness, you submit a super-cherry commercial loan application to an old banker.  All he has to do is click on the attached PDF.  You have spoon-fed the guy.  The PDF contains some great color pictures.  You have prepared a Pro Forma Income and Expense Statement.  You have computed the the Loan-to-Value Ratio, and it is less than 70%.  You have computed the Debt Service Coverage Ratio using the proper loan constant, and it exceeds 1.25.  The borrower has good credit, and its clear that his Net-Worth-To-Loan-Size Ratio exceeds 1.0.  It's a slum-dunk deal.

But the lazy bum won't even click on your PDF.  You call him four days later - you have foolishly been waiting patiently by the phone - and you ask him what he thought about the deal.  He replies, "I was just about to open it.  I'll do it right now."

This reminds me of an old joke.  A man finds in his old raincoat pocket a shoe repair ticket (receipt) from ten years ago.  He had dropped off a pair of expensive dress shoes to be reheeled.  "I wonder if that old shoe repair shop is till open?"  He goes into the shop, and the old cobbler is still there. The old man takes the ticket to the back, comes back, and says, "They will be ready by Thursday."  Ha-ha!

The lesson:  You must always call your commercial lender about three hours after emailing your commercial loan to him "to confirm receipt of the package."  You're not really calling to confirm receipt of the package.  You're calling him to boot him in the tush to read the package!

Just as I despair for old, white commercial real estate loan officers, I absolutely love-love-love Asian women commercial loan officers.  When you call her three hours later, she has already called the borrower, gotten the last of her required documents, and is ordering a BPO.  A BPO is a Broker's Professional Opinion, a quick estimate of value by a local real estate broker.  Human dynamos.

Okay, but 70% of the time we are going to have to deal with the lazy old guys.  This is reality.  How are you going to get this old-timer to look at your deal.  After almost 40 years in the industry, I have concluded that you can't submit your commercial loan as a PDF.  He simply won't open it.

You should therefore just initially submit your commercial loan as a simple  Executive Loan Summary, not as an attachment, but rather as the email itself.  Remember, the sleepy, old banker is not going to click on an attachment.  Here's a sample for you to copy:

ABC APARTMENTS
345 MAIN STREET
SACRAMENTO, CA

EXECUTIVE LOAN SUMMARY

TYPE OF LOAN REQUEST:  Permanent First Mortgage

AMOUNT OF LOAN REQUEST:  $1,000,000

TYPE OF PROPERTY:  Apartment Building

NUMBER OF UNITS:  88

GROSS RENTABLE AREA:  34456 sf

NET RENTABLE AREA:  23340 sf

AGE:  8 years

PROPERTY DESCRIPTION

88-unit garden apartment project. The units consist of 78 one-bedroom units of 1,112 square feet each plus 10 studios of 836 square feet.  The property is in good condition, but the parking lot needs to be resurfaced.  The proceeds will be used to resurface the parking lot and install washers and dryers in each unit.

VALUE OF THE PROPERTY:  $2,000,000

LOAN TO VALUE RATIO:  66.7%

DEBT SERVICE COVERAGE RATIO:  1.35 based on a 5.25, 30-year constant

INTEREST RATE DESIRED:  5.25%

LOAN FEE DESIRED:  1 point

AMORTIZATION SCHEDULE REQUESTED:  30 years

TERM DESIRED:  30 years

SPECIAL ISSUES

The borrower was forced to declare a Chapter 11 bankruptcy when he suddenly inherited in the property from his grandmother, only to find that she was just two weeks from a foreclosure sale. He liquidated some stocks and bonds, brought the loan current, and dismissed the bankruptcy, all within 30 days of inheriting the property. His personal credit has always been immaculate.

NAME OF BORROWER:  Steve & Marsha Smith

TYPE OF ENTITY:  Individuals

OCCUPATION:  Attorney

ANNUAL INCOME:  $450,000

NET WORTH:  $5,000,000 to $10,000,000

CREDIT:  Very Good

CREDIT SCORE:  760

Bob the Loan Officer,

I have a complete package ready for you.  Just call me, Tom Blackburne, Blackburne & Sons Realty Capital Corporation, at 916-338-3232.

Now your commercial loan officer at the bank has no excuse for not looking at the deal.

IMPORTANT WARNING:

If you are a regular reader, you know that you can trade one commercial real estate loan officer working at a bank or a credit union for my commercial mortgage marketing course, my fabulous Income Property Underwriting Manual, a copy of my battle-tested commercial mortgage broker fee agreement, or a copy of a Regional Blackburne List with 750 commercial lenders.

You can also trade ten commercial real estate loan officers for a free copy of my famous 9-hour course, How to Broker Commercial Loans, a free copy of my super-important course, How To Find Your Own Private Mortgage Investors, or my very best course, the Practice of Commercial Mortgage Brokerage, which has over 60 important and practical lessons.  Please click here for details.

That's the good news.

The bad news is that so many brokers have taken advantage of this course  that CommercialMortgage.com is now packed with over 3,000 commercial lenders.  We don't need any more.  We have dozens of banks and credit unions for every state (although Alaska is admittedly a little light).

My offer to make this trade ends on August 31st.  Any list submitted after August 31st will be ignored.  Fair warning.

Guys, if you are a commercial mortgage broker, and you are not using CommercialMortgage.com several times per week, you are a stupido.  Geesch, it has over 3,000 different commercial lenders, and its free!

We all know that another great recession is coming eventually, but its anybody's guess as to when it will hit.  It could be next year, next decade, or even three decades from now.  This week I think I have at least figured out what will be the cause of the next great recession.    

You guys have no doubt heard of the Monetarist School of Economics, headed once by the late Nobel-prize-winning economist, Milton Friedman.  Friedman famously said back in 1963, "Inflation is always and everywhere a monetary phenomenon."

Then there is the Keynesian School of Economics, which says that the Federal government should prime the pump to get out of bad recessions.  Even though I am a Republican, I think that President Obama and Treasury Secretary Timothy Geithner did an incredible job during the Great Recession to save this country from a full-blown deflationary depression.  They successfully used many of the fiscal policies suggested by John Maynard Keynes.

My greatest kudos, however, go to former Fed Chairman, Ben Bernanke*, who performed some amazing miracles during the Great Recession.  At one point, during the nadir (low-point) of the crisis, the commercial paper market completely froze up.  Our largest corporations don't borrow from banks to meet short-term cash flow needs.  Instead, they issue short term bonds (30 to 270 days) directly to the commercial paper market, where life insurance companies, pension trusts, bond funds, endowments, and family offices (some people are so filthy rich that they actually create a little company whose sole job it is to invest their money) buy the short term IOU's issued by S&P 500, investment-grade companies.

At one point in late-2008, investors became so terrified that they stopped buying commercial paper altogether.  Our largest corporations, companies like a Federal Express or a Lowes, needed to be able to roll over their short term debt and to sell new short-term debentures (unsecured corporate bonds) in order to meet payroll.  Suddenly these gilt-edged companies couldn't raise a dime. Can you imagine a world where most of the companies in the S&P 500 had to layoff half of their workers because they lacked short term cash flow?  Directly or indirectly, tens of millions of workers would have been thrown out onto the street, and the economy would have collapsed.

So what did the courageous Ben Bernanke do?  Our friend Ben just sent out an announcement.  "The Fed is hereby guaranteeing all commercial paper."  Bam!  Just like that the commercial paper market immediately began to function again.  America was saved.  Courageous?  The Fed did NOT have the authority to guarantee all commercial paper (oopsie), but Bold Ben just did it.  God bless him.

But there is another school of economists called the Austrian School of Economics.  The Austrian School rejects mathematical modeling and believes instead in the concept that social phenomena results from the motivations and actions of individuals.  It's called the "Austrian School" because the original proponents of these ideas in the mid-20th century were three Austrian economists, each building on the work of the others.  Frederich Hayek, the 1974 winner of the Nobel Prize in Economics, is arguably the "Champion" of the Austrian School.  The causes and remedies suggested by the Austrian School received great praise from economists during the Great Recession.  In other words, they were largely proven right.

Okay, time to wake up again.  Good stuff coming.  According to the Austrians, recessions and depressions occur after lots of companies and the investing public makes some serious malinvestments (bonehead investments).

Mal is Latin for bad.  A malinvestment is an investment that doesn't generate enough return to service and pay down the debt taken on to make the investment.  For example, let's suppose that I borrow $20 million to build a buggy-whip manufacturing plant.  It is unlikely that I am going to be able to sell enough buggy-whips to make monthly payments of $200,000.  My company is going to go bankrupt, and the lenders who loaned me $20 million are suddenly going to be a whole lot poorer.  If too many banks and investors make bonehead investments; e.g., see-through office buildings, dot-com stocks, bitcoins, and subprime real estate loans; suddenly the economy is in a recession or depression.

Okay, now to the point of today's article.  Do you remember how the banks packaged up subprime residential loans, got them rated by the (lying, disloyal) rating agencies (Fitch, Moodys, etc.), and then securitized the loans?  The banks were pushing junk, but they didn't care.  They were immediately selling off the bonds to trusting investors.  As long as the bank didn't get caught with a lot of subprime loans in its portfolio when the music stopped, the bank was golden.  "Too bad, sucker!"

After the Great Recession hit, and tens of millions of Americans who were invested in residential mortgage-backed securities lost tens of billions of dollars, the Federal government passed the Dodd-Frank Act.  Under Dodd-Frank, any bank involved in the selling of securitized bonds was required to retain 5% of all classes of the bond (AAA, AA, A, BBB, and the junk).  The idea here is that no bank would want to own 5% of the first-loss piece if this unrated piece was gawd-awful.

Wall Street has now come up with a new way to trim unsuspecting investors out of their money.  The Big Boys are now securitizing adjustable-rate junk bonds and selling the bonds to the public.  An investment broker recently offered me some adjustable-rate junk bonds yielding over 4%!  Some of these tranches are even rated AAA, just like Wall Street turned subprime residential loans into AAA bonds!  Here we go again!

Now please get a barf bag handy.  The industry appealed last year a ruling by a lower Federal court that held if a bank is going to sell securitize junk bonds, the bank has to retain 5% of all classes of the security (to insure that the bank is not selling unconscionable investments).  Well, the Federal three-judge Appellate Court just reversed the ruling of the lower court!  The issuer does NOT have to eat a healthy portion of its own cooking.  In effect, banks can sell as much of this potential poison as they want.

This is going to be awful.  The public will be unable to resist adjustable-rate, investment-grade (!!) bonds in a rising interest rate environment.  The early offerings will be okay, but then - as things inevitably happen - the quality of the junk bonds going to these pools will greatly decline, until finally - bam - the Second Great Recession will be here.

What has been will be again,
what has been done will be done again;
there is nothing new under the sun.

 -- Ecclesiastes 1:9

* In 2007, I published a financial novel entitled, The Reverse Multiplier Effect, about a horrible deflationary depression.  In my story, Fed Chairman Ben Bernanke is a bona fide hero. Then real life happens, and Ben Bernanke proves to be an even bigger hero.  I would vote for one more head on Mount Rushmore.

We are going to depart from my usual training articles about commercial loans and how to underwrite them.  None of us is going to be making a lot of commercial loans or selling a ton of commercial real estate if the U.S. loses this trade war with China.  So, how is the trade war going?  Below is this month's Investor Letter to our Private Clients (accredited investors).

INVESTOR LETTER

In my last Investor Letter, I made the point that if the U.S. must engage in a trade war with China, now is probably as good of a time as ever.  Ideally there would be no trade war at all.  There can be little dispute that free trade has been wonderful for the purchasing power of the U.S. consumer.  To this day, I am still amazed at the low prices of goods whenever I go into Wal-Mart.  Bicycles and baseball mitts cost just a fraction of what my loving father paid 55 years ago.  I still remember the day when he bought me a brand-new Rawlings baseball mitt.  I stayed up very late that night oiling my glove and making a pocket.  Summer and a new baseball mitt.  I was truly in little guy Heaven.  I fell asleep with that glove still on my hand.

My dad paid over $25 for that wonderful, top-of-the-line baseball glove in 1962.  Adjusted for inflation, that’s a whopping $208 in today’s dollars.  I went online today and found a Rawlings baseball glove at Target for just $39.95.  Folks, I do not want a trade war.

But if we are going to have a trade war, it might as well be now.  According to the Austrian School of Economics, recessions and depressions occur when companies and consumers make malinvestments.  A malinvestment is an investment that doesn’t generate enough income to service the debt taken on in order to buy it.

In 1928 and 1929, investors bought investment trusts on margin.  In the years leading up to the S&L Crisis, syndicators intentionally bought apartment buildings with large negative cash flows for the tax benefits. When the Reagan tax change went into effect, commercial real estate crashed by 45%.  In 1998, 1999, and 2000, the investing world poured tens of billions of dollars into dot-com stocks that did nothing but bleed money.  Between 2004 and 2008, consumers and investors poured hundreds of billions of dollars into residential real estate.  A depression and three severe recessions followed these horrific malinvestments.

This why I did dog flips when Bitcoin crashed so severely.  Bitcoin crashed early, before tens of millions of Americans could lose another huge chunk of their life’s savings.  What a blessing!  In the euphoria following Trump’s election victory, U.S. stock prices started soaring 100 to 200 points per day.  The last thing the U.S. needed was a stock market blow-off, where the smart money got out and U.S. consumers poured their life’s savings into a skyrocketing market, only to lose 40% of their investments when the top exploded. Fortunately, the stock market settled down when President Trump, though a series of tweets, picked this trade war.

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An old man was relaxing at his 100^th birthday party when a reporter went up to him. "Sir, what is the secret of your long life?"  The man considered this for a moment, then replied, "Every evening at 9 p.m. I have a glass of port.  Good for the heart I've heard."  The reporter then asked, "That's all?"  The man smiled, "Well, canceling my voyage on Titanic sure didn't hurt."

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So, are we going to win?  Don’t assume that China holds all of the cards.  “The S&P 500 remains on track for a fourth consecutive month of gains…, while Chinese stocks have entered a bear market, with the CSI 300 Index down about 20 percent from its January peak, that’s occurred alongside softening growth and worries over rising corporate defaults.”  In other words, through the early days of this trade war, our market is going up while theirs is going down.  That being said, I’m glad I’m not a whiskey distiller in Kentucky.  (The Chinese targeted whiskey.) 

In order to soften the blow of our tariffs, the Chinese have been allowing the renminbi (the People’s money) to fall around 5% over the past few weeks, prompting President Trump to angrily tweet about their currency manipulation.  While the Chinese could simply ignore Trump’s fierce rhetoric, they cannot ignore the risk of capital flight.  After all, who wants to own renminbi when Trump is threatening tariffs on all Chinese imports? 

About 10 years ago the Chinese suffered a similar flight of capital after a severe (40%-ish) stock market meltdown.  The Chinese were forced to spend around one trillion dollars in foreign reserves propping up their currency.  The Chinese “only” have around $3T in foreign reserves.  “June saw $10.7 billion in cross-border outflows, Morgan Stanley estimates.”

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A woman visited a psychic of some local repute.  In a dark and gloomy room, gazing at the Tarot cards laid out before her, the Tarot reader delivered the bad news: "There is no easy way to say this, so I'll just be blunt.  Prepare yourself to be a widow. Your husband will die a violent death this year." Visibly shaken, the woman stared at the psychic's lined face, then at the single flickering candle, then down at her hands.  She took a few deep breaths to compose herself.  She simply had to know.  She met the Tarot reader's gaze, steadied her voice, and asked, "Will I get away with it?"

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“A 2016 Urban Institute study found that 38 percent of American families in 1979 were middle class (defined as households earning between $50,000 and $100,000 annually, adjusted for inflation) vs. 32 percent in 2014.  That sounds terrible.  What happened to all those middle-class families?”

“The study divided households into five income groups: poor, lower middle class, middle class, upper middle class, and rich.  Of those groups, the bottom three got smaller over the decades while the top two grew.  The ranks of the poor shrank by 4.5 percentage points, the lower middle class by 6.8, the middle class also by 6.8 points. But the upper middle class got a lot bigger, expanding by 16.5 points, while the rich grew by 1.7 points.  So, what happened to the middle class?  It disappeared because it got richer.  There has not been a middle-class meltdown.  There’s been a melt-up!”

When I grow up, I want to be Robert Ringer.  Mr. Ringer was the  best-selling author of several business books.  I last saw Robert Ringer in Playboy magazine, where he was sitting in a hot tub at a party at the Playboy Mansion with two gorgeous, topless Bunnies.  It was lucky that I just happened to notice the picture because normally I only look at Playboy for the articles.  Ha-ha!

The book teaches you that the world is full of snakes.  In fact, Mr. Ringer once wrote that there are only three types of people in business:  (1) The type who will screw you; (2) The type who tell you in advance that they are going to screw you and then who will screw you; and (3) The type who will swear to high heaven that they are not going to screw you and then who will screw you.

So why am I confessing my sins (Playboy and lust) today?  The answer is that Robert Ringer happened to be a hard money broker who specialized in making commercial loans on apartments!  His book was read by hundreds of thousands of lawyers, accountants, salesmen, and widget manufacturers, and it became a #1 business bestseller.  The really awesome twist is that all of his examples of people in business doing dastardly acts were from his real-life experiences in the hard money commercial loan business.  Talk about relevant, huh?

One of the dastardly acts that Ringer wrote about was Rent Roll Fraud.  You will recall that a Rent Roll is a long list, by unit number or letter, of all of the units in an apartment building, as well as the configuration (bedrooms and baths), the tenant's name, and the rent currently being paid by the tenant.  Sometimes a Rent Roll will even include the square footage of the unit.

Rent Roll Fraud occurs when the owner of an apartment building applies for a commercial loan or lists his apartment building for sale.  Either the owner or his broker submits to the commercial lender a Rent Roll with dummy numbers.  Even a small increase in the Rent Roll can make a big difference in the valuation of the apartment building or the size of the commercial loan for which the borrower qualifies.

Robert Ringer learned about Rent Roll Fraud from painful experience.  Dastardly borrowers?  You betcha.  He learned to knock on a few doors and to audit the Rent Roll.  "Hello, Mr. Smith.  My name is Robert Ringer, and I am doing an appraisal of the property.  Would you mind please telling me what you pay in rent?  Just $1,200 per month?  The Rent Roll says $2,000.  Hmmm."  "Mrs. Rodriquez, how many bedrooms and baths do you have?  Just two bedrooms and two baths?  That's strange.  The Rent Roll says you should have three bedrooms and two baths.  Hmmm."  [To himself:  "This entire Rent Roll may be fraudulent.  I better audit a half-dozen more units to confirm my suspicions."]

The reason why I am writing to you today about Rent Roll Fraud is because I got a call today from a reporter from the Wall Street Journal.  He is writing a piece about a big criminal case involving mortgage fraud in the upstate New York area.  According to the indictment, tens of millions of dollars in commercial loans on multifamily projects were fraudulently obtained, in part using fraudulent Rent Rolls.  These defendants allegedly went as far as placing doormats and shoes in front of vacant units.  They are also accused of placing radios in empty units and leaving the radios on in order to create the illusion of occupancy.  Yikes!

The Wall Street Journal's reporter found me while researching Estoppel Agreements in connection with commercial leases.  He found my blog article on estoppels.  Pop quiz.  What is an Estoppel Agreement or Estoppel Certificate (same thing)?  An Estoppel Certificate from a tenant is a statement admitting the rent, the maturity date of the lease, the size of the unit, the fact that the tenant has NOT prepaid his rent, and that the owner has performed all of his obligations in connection with the lease.  

When a tenant has a signed an Estoppel Certificate, he is estopped (fancy word for stopped) from later claiming, after a lender has foreclosed on his commercial loan, that the rent is $2,000 per month less than that listed on the Schedule of Leases.  A Schedule of Leases is the commercial-industrial equivalent of a Rent Roll.  A Schedule of Leases lists the units by address, the square footage, the name of the tenant, the monthly rent, and who (landlord or tenant) pays which expenses.

Here's a story that will raise the hair on the back of your neck.  Blackburne & Sons, my private money commercial mortgage company, foreclosed on a row commercial building in the foothills of California.  After we had taken possession of the property, we notified the tenant to send all future rent payments to us.  At that point, the tenant notified us that he didn't have to make any more rent payments.  In exchange for an 80% discount from the guy losing the property in foreclosure (I am shocked, shocked I tell you, that there exists snakes in business), the tenant had prepaid his rent for the next five years!  Can you now see why Estoppel Certificates demand that the tenant disclose any prepaid rent?  In this case, the tenant had made this rent prepayment after we had recorded our loan, so his claim to prepaid rent was cut off by our foreclosure.  Phew!

Here's another issue in connection with Estoppel Agreements.  A lender makes a commercial loan on an office building, and after the lender forecloses, the tenant tells him that he doesn't owe any rent until the landlord builds out the tenant improvements that the former owner had promised.  These tenant improvements could cost 18 months worth of rent.  This is why an Estoppel Certificate asks the tenant to admit that the landlord has performed all of his conditions precedent (the landlord has already completed everything that the landlord has promised to do prior) to payment by the tenant.

Its pretty obvious why commercial lenders, before making a commercial loan on a multifamily property, can't get an estoppel certificate from every apartment tenant.  The paperwork would be impossibly enormous, and 90% of the tenants would have no clue as to how to fill out the Estoppel Certificate.  Therefore commercial lenders have to rely on the appraiser to do an audit of some of the apartment units on the Rent Roll.

To my own staff, let's please try to ask our multifamily appraisers in writing to audit 5% to 10% of the units on the Rent Roll before completing the appraisal.  Thanks!

Nationwide the vacancy rate for office space is 16.7%, plus or minus fifty basis points.  Remember, a basis point or bip is 1/100th of one percent.  Therefore fifty bps. (called 50 bips) is equal to one-half of one percent.

You are applying for a commercial loan, so you begin preparing a Pro Forma Operating Statement - an operating budget for the next twelve months.  Your property is an average office building in the downtown area of an average U.S. city.  Do you use as your Reserve for Vacancy and Collection Loss the national or city-wide average of 16.7%?  Or do you use 5%?  This is the subject of today's commercial real estate finance (CREF) training lesson.

A good argument can be made that office building investors in the U.S. are lousy capitalists.  How could they allow 16.7% of their space to sit vacant?  Capitalism says that they should lower their rent in order to attract enough tenants to fill their buildings.  It makes good sense to lower their rent from $25 per square foot to $22 per square foot if they can fill the whopping 16.7% vacancy.

Let's do the math.  C'mon, guys, this is fifth grade math.  Stay awake.  Let's assume that the office building has 100,000 net leasable square feet.  If 83.3% of the space is leased at $25 per square foot, the office building generates $2,082,500 in gross rent.  If all 100,000 sf was leased at $22 per square foot, the office building would generate $2,200,000 in gross rent.  The owner picks up extra $117,500 by lowering his rent!

This brings up an important training point.  Above I talked about rents of $25 or $22 per square foot.  It is the customary in commercial real estate to talk about rental rates in annual terms.  Therefore $25 per square foot works out to $2.08 per square foot per month.  If you are renting 2,000 square feet for your property management company, you would be paying $4,160 per month in rent (2,000 sf. times $2.08 per square foot per month).

So why aren't office building owners better capitalists?  For one reason, the higher the occupancy rate, the higher the operating expenses, such as common area heating, cooling, electricity, and wear and tear on the common areas.

There is another reason why office building owners don't lower their asking rents in order to fill their building.  Suppose you own a mortgage company in the building, and you sign a lease at $25 per square foot.  Then the owner starts advertising identical space for just $22 per square foot.  Are you going to be a happy camper?  Is your higher rental rate going to eat at you like an ulcer?  And what is going to happen when your lease comes up for renewal?

But the most important reason why office building owners won't reduce their rents enough is that the lower asking rents will lower the value of their office buildings.

[Commercial mortgage brokers:  You are making exactly 63 bonehead mistakes running your commercial mortgage brokerage.  Bonehead mistakes.  Sixty-three of  them.  I can fix you.]

How could increasing an office building's gross income possibly decrease the property's value?  It has to do with the Pro Forma Operating Statement that will be prepared by the real estate broker representing the owner.  When the selling broker prepares his Pro Forma Operating Statement, he will employ a concept called stabilized rent.

In theory, stabilized rent should represent the rental rate that would allow the entire building to find tenants.  In real life, stabilized rent, as used by selling brokers, is the actual rent of any currently rented space, plus the possible rent that could be received if all of the vacant space was rented at the highest rental rate that the owner has ever received for any of his space.

Stabilized rent is an important concept, so please let me go over it one more time.  The real estate broker or commercial mortgage broker is preparing a Pro Forma Operating Statement in preparation of either selling the property or refinancing it.  He has prepared a Schedule of Leases that shows the existing tenants.  But what does he do about the vacant units?

If he is one of my students, and he has read my blog article about getting the largest possible commercial loan (it received the most Linked-In likes I've received in two years), he uses the market rent of any vacant unit.  But what is the market rent of this vacant office space?  In truth, its $22 per square foot; but some idiot owner of a commercial mortgage company once paid $25 per square foot (sorry, but that was you).  So the real estate broker uses $25 per square foot for the vacant space.

[Mortgage brokers:  If you are not working every day towards building a loan servicing portfolio... get the hell out of the business!  The only way to survive the next regular real estate crash is to fall back on your loan servicing income.  The easiest way to build a servicing portfolio is to become as hard money lender.  I service a $55 million portfolio at 1.9% annually.  That's $87,000 every month, whether I close a new loan or not.]

But what about commercial lenders?  What if you are applying for a commercial loan?  Are commercial lenders stupid enough to fall this stabilized rent concept.  Why yes... yes they are.  Ladies, please cover your ears.  Why do dogs lick themselves?  Because they can.  Translation:  In real life, almost all commercial lenders will allow you to get away with this stabilized rent nonsense.

So the question I posed at the beginning of this training article was this:  Should you use 16.7% as the Reserve for Vacancy and Collection Loss when you are preparing a pro forma operating statement on an average office building in an average big city?  No!  You should use stabilized rent and a 5% Reserve for Vacancy and Collection Loss.  Why?  Because you can.

Interest rates on commercial permanent loans have increased sharply since the end of the Great Recession in 2009.  At one point - about three years ago when the yields on ten-year bonds in Germany and Switzerland went negative - fixed interest rates on commercial loans to prime borrowers reached as low as 3.75%.  Today even very good borrowers are likely to pay 5.6% to 6.0% for the same commercial loan from a regional bank.  Small town banks are quoting rates as high as 6.25%.

We are clearly in an era of increasing interest rates.  It sure would be great if you could lock your rate when while your commercial loan is in process.

Now if you are buying a house, its possible to get the lender to lock his interest rate for 30 days or so.  The reason why residential lenders can do this is that they buy huge fixed-rate forward-commitments from Fannie Mae or Freddie Mac.  The same is NOT true for commercial loans.  As a general rule, commercial real estate lenders do NOT lock their interest rates.

If you had a commercial loan in process with a bank, and the bond market suddenly collapsed; i.e., interest rate spiked sharply higher, the bank would not be legally obligated to fund your loan at the interest rate originally quoted.

Example:

Big Pebble Bank is processing a $700,000 commercial loan on an office building on Main Street in Big Pebble, New Mexico.  The bank has quoted 5.75%, 1 point, twenty-five years amortized, ten years due, with a rate readjustment at the beginning of year 6, and a 3% prepayment penalty for the first 4.5 years.

Suddenly China, angry over the trade war, sells all of its $2T in Treasury bonds in a single day.  The bond market collapses, and interest rates spike sharply upwards.  (When interest rates spike upwards, the price of existing bonds crash.  This is why the first picture above shows a down arrow.)  By the way, a permanent loan is merely a garden-variety first mortgage on a standing commercial property with a term of at least five years and at least some amortization.  Twenty-five years is the most common amortization for bank commercial loans.

Example Continued:

After China dumped its bonds, the current rate for commercial permanent loans from Big Pebble Bank increased to 7%.   Will Big Pebble Bank honor its original quote of 5.75%?  Probably not.  The jump in interest rates is just too big.  Rather than candidly saying, "Interest rates have jumped upwards, so we can no longer make your loan at 5.75%," they will probably find some goofy qualitative reason to turn the deal down, like the bricks on the building are red or the property is on the left-hand side of the street.  A quantitative reason might be that the deal no longer produced a 1.25 debt service coverage ratio at the higher 7% rate.

Now the example above was an extreme one.  What would happen if interest rates merely drifted 0.25% higher during the 65 days that it took Big Pebble Bank to process the commercial loan?  Will the bank likely honor its original quote?

Probably.  While a term sheet is not legally binding on the bank, most banks will hold their quoted rate if the rate change is not terribly dramatic.  You will recall that a term sheet (or loan proposal or conditional commitment letter) is merely an expression of interest in making a commercial loan and a good faith estimate of the eventual terms.  A term sheet is not legally binding on the lender, but it does have some moral influence.

You will recall that a conduit is a commercial mortgage company that specializes in originating commercial loans destined for re-sale into the CMBS market.  CMBS stands for commercial mortgage-backed securities.  CMBS loans are large commercial loans, typically $5 million or more, secured by the Four Basic Food Groups - multifamily, office, retail, and industrial.

Conduit lenders will NOT lock their interest rates.  Your rate will float with the credit markets while your huge commercial loan is in process.  That being said, most conduits will usually hold true to their margins or spreads.  Let me explain.

Conduit loans are priced at some margin or spread, say, 225 bps. (2.25%) over ten year Treasuries or ten-year swap spreads.  A basis point or bip is 1/100th of 1%.  Therefore 25 bps. is equal to one-quarter of 1%.  Fifty basis points is one-half of one percent.

What is this ten-year swap spread thingee?  A swap occurs when a lender assumes the risk of rates going up by swapping his adjustable rate bond for a fixed rate bond.  Remember, if you own a fixed rate bond - say a ten-year Treasury bond at 2.5% - and interest rates increase so that new ten-year Treasuries start yielding 3.5%, then your 2.5% bond will fall painfully in value.  

Since the guy swapping his adjustable rate bond for a fixed rate bond is taking a risk, he will normally demand some sort of sweetener to do the deal.  That sweetener is known as a swap spread, and it it expressed as an interest rate.  Today, ten-year swap spreads and ten-year Treasury bonds (also known as the long bond), are about the same value.

Conduits today are pricing their big commercial loans using the higher of either ten-year swap spreads or ten-year Treasuries.  For example, a conduit might issue a term sheet today for a $7.2 million ten-year permanent loan on a shopping center in Los Angeles.  They might price the commercial loan at 225 bps. over ten-year swap spreads.  The 225 basis points, in this example, is the conduit's margin.

Above we mentioned that conduits will NOT lock their interest rate during the 75-day processing period of one of these huge commercial loans.  Most conduits, however, WILL hold true to their proposed margin or spread under most circumstances.  It's kind of a moral thing.  Conduits are not legally obligated to lock in their margins; but unless there is absolute chaos in the market, they will usually not change it.

Occasionally, however, the credit markets will plunge into chaos; and the appetite of bond buyers (pension trusts, insurance companies, family offices, etc.) to buy bonds backed by commercial mortgages will disappear.  For example, suppose English jets sought out and destroyed a Russian destroyer in retaliation for a second poisoning attack on English soil.

When this happens, conduits have little choice but to keep increasing their interest rates until CMBS bond buyers return to the market.  "Dude, we're sorry to do this, but with the chaos in the marketplace, we are going to have to re-price your loan."  In other words, the conduit will only make the big $7.2 million loan if the borrower agrees to an increase in the conduit's margin or spread to 325 bps.

Guys, below you will see some trade offers, where I give you a chance to trade a commercial real estate loan officer worker for a BANK for either a free Regional copy of The Blackburne List, a free commercial mortgage marketing course, or a free copy of my famous fee agreement.  Heavens, guys, you know what a banker is, right?  A banker (NOT a mortgage banker!) works in a big building with a fifty-ton vault, several ATM machines, and FDIC insurance signs all over the walls and counters.  C'mon, guys.  This trade is based on the Honor System.  YOU are NOT a banker.  Please click to view my new Hall of Shame.

A mortgage broker named Nathan traded me ten bankers two weeks ago for my popular nine-hour video training course, How To Broker Commercial Loans.   He was so pleased with the course that he came back today and traded me another ten bankers for my four-hour video training course, How To Find Your Own Private Mortgage Investors.

Do you have a real estate related web site?  You can add a link to C-Loans.com in minutes.  Our software automatically captures the URL from which our commercial mortgage borrowers come.  When a deal closes, we go back to the owner of the website and pay him a referral fee.  We once paid Alan Dunn of Spydercube a referral fee of $21,250 for merely putting a link to C-Loans.com on his website.  He was even sleeping when the referral came over!  Can you imagine that call, "Alan, we've got some good news for you..."  If it were me, I could splash links all over my web pages, maybe three per page.  "Commercial Loans."  "Need a Commercial Loan?"  "Commercial Financing."  Just point these links to C-Loans.com, and you're done.

I often tell the following story to my commercial loan brokerage trainees.  Goliath Bank offers a $2 million commercial loan to the borrower at 5.75%, 1 point, 25 years amortized, ten years due, with a rate readjustment at the beginning of year 6.  The prepayment penalty is 3% in years one through five.  Caution:  While the above quote accurately reflects today's market for bank commercial loans, rates are definitely going up.

A mortgage broker, competing against Goliath Bank, brings in a quote of $2,150,000 at 6.25% interest and two points.  The broker is making one point.

Guess which commercial loan quote the borrower will most likely chose?  Nine times out of ten, the borrower will choose the 6.25% offer, even with a one-point higher fee, because the broker is getting him more dollars.  With most commercial mortgage borrowers, it all about max cash.  They want as large of a commercial loan as possible, as long as the interest rate is not too much higher.

So how did this experienced commercial mortgage broker get a larger loan for his borrower?  The key to getting the largest possible commercial loan is to pay attention to the TOP LINE of the Pro Forma Operating Statement.

When you look at a Pro Forma Operating Statement - a projected budget for the property for the next twelve months - the very top line is typically listed as the Gross Potential Income.  This line item represents the amount of rent that the property could generate if every single unit was rented.

When submitting a Pro Forma Operating Statement to a commercial lender, many borrowers and commercial mortgage brokers repeatedly make the same mistakes:

(1)  They fail to show the market rent of any vacant units.  They will submit an apartment Rent Roll showing 58 units occupied, with the actual rent next to the number of the apartment; but they will leave the rent showing as zero for the two vacant units.  By the way, a Rent Roll is a list of the rentable units / spaces by number or letter, the name of the tenant, the size of the unit, and the current rent.

(2)  If the borrower fails to show the market rent of vacant units, the lender will often just take the Total Rent from the bottom of the Rent Roll and multiply it by twelve in order to compute the Gross Potential Income.  If this happens, the borrower is screwed.  He might lose ten to fifteen percent off the size of the loan that the commercial lender might have offered.

(3)  Another common mistake is to fail to show the onsite manger's unit at market rent.  Borrowers to often cut $500 to $1,000 off the manager's rent as compensation for his work.(4)  The reason why your Gross Potential Income line item must appear as large as possible, especially when applying for an apartment loan, is because many lenders will simply grab the Gross Potential Income and lop off 35% for Operating Expenses.  The lender will often totally disregard your projected expenses.

(4)  Let's go back to the Onsite Property Manger.  If the borrower had wisely shown the manager's unit at market rent and had deducted $1,000 per month down below in the "Property Management - Onsite" line item, then the lender wouldn't even have deducted the $12,000 per year ($1,000 per month) from the Gross Potential Income.  He would simply have ignored this line item expense in favor of using a 35% Operating Expense Ratio.  Wow, huh?  This is huuuuge.

(5)  When choosing the market rent of a vacant unit, be sure to use the highest rent that you have ever achieved for a unit of that size.  Let's suppose you have six identical units.  Five of the units are rented at $2,000 per month, and one is rented at $2,200 per month.  If a seventh unit is vacant, be sure to show the market rent as $2,200.

If you want to obtain the largest possible commercial or apartment loan, pay particular attention to the top line of the Pro Forma Operating Statement - the Gross Potential Income.