Commercial Loans and Fun Blog

Apart from construction loans, there are three types of commercial loans in first position - the permanent commercial loan, the mini-perm, and the bridge loan.

A permanent loan is a first mortgage on a commercial property with a term of at least five years.  A permanent loan will have some amortization.  While a permanent loan may have a term as short as five years, the payments will be collected as if the commercial loan had a 25-year term.  A twenty-five year amortization is the normal amortization schedule for commercial loans.  If the property is older than 20 years, a bank might even require a 20-year amortization.

Commercial loans with shorter terms are considered either mini-perms (2 years) or bridge loans (1-3 years).  What is the difference between a mini-perm and a bridge loan?

Mini-perms are first mortgage loans on brand-new commercial property that are typically given by the bank to give the sponsor time to develop an operating history.

Example:

Suppose Alpha Bank makes John Hotelier a $10 million construction loan to build a brand new Quality Comfort Inn.  The term of the construction loan was 12 months, and the developer (John Hotelier) finishes on time and on budget.  Alpha Bank would prefer to get paid off promptly at maturity, but the bank is wise enough to know that it is very difficult for a business property, like a hotel or RV park, to obtain a takeout loan until its has a two-year operating history.  (This being said, the SBA might possibly finance a brand new hotel?)

A takeout loan is just a special type of permanent loan.  It looks exactly the same as any other permanent loan, except for the fact that a takeout loan is a permanent loan on a brand new commercial property used to pay off a construction loan.  Therefore every takeout loan is a permanent loan, but very few permanent loans are takeout loans.

By the way, commercial construction loans are almost always made by commercial banks.  The rare exception is that some life insurance companies will sometimes make huge construction construction loans ($20MM+) on trophy properties, like office towers or huge shopping centers. In general, commercial banks like to make commercial construction loans because the loan term on a construction loan is short (12 to 18 months), and the bank gets to earn its points up-front.

Okay, so John Hotelier has just completed his hotel, but in order to qualify for a takeout loan, he needs to establish a two-year operating history.  Fortunately, John had negotiated with Alpha Bank for a two-year mini-perm at the conclusion of his construction loan.

The forward takeout commitment - a mini-perm is a form of forward takeout commitment - cost John one point.  If he chooses to exercise the forward takeout commitment, he has to pay Alpha Bank an additional half-point or one-point fee at the time that the mini-perm funds.

The typical terms of a mini-perm are prime plus 1% to prime plus 2%, twenty-five years amortized, two years due, and no prepayment penalty.

What is a forward takeout commitment?  A forward takeout commitment is just a letter from a bankable lender promising to deliver a takeout loan at some time in the future, assuming the developer has achieved certain things.  In John's case, those conditions were that he complete the project according to plans and specifications.  What was NOT a condition was the requirement that the hotel achieve a certain occupancy rate.  That's the whole purpose of the mini-perm commitment - for John to have time to open the hotel and start to increase his average occupancy rate.

Now third type of first mortgage (quite possibly a second mortgage) is the bridge loan.  A bridge loan is a commercial loan, usually with interest-only monthly payments, with a term of one to three years, which gives the borrower time to accomplish certain things, such as leasing out the property, renovating the property, or selling it.

So what the difference between a mini-perm and a bridge loan?  Mini-perms are almost always secured by brand new commercial property, and their interest rates are bank rates.  Even the cheapest bridge lender has rates that are 2% to 3% higher than those of the bank.

If you are an investor or a commercial property owner, you can skip down to the "Weaponizing the Yuan" section below.  Commercial loan brokers and commercial lenders will want to read this top section.

Last week I announced the opportunity for commercial lenders and commercial loan brokers to advertise on CommercialMortgage.com.  This opportunity should be especially attractive for commercial hard money / bridge lenders.

CommercialMortgage.com ("CMDC") is a commercial loan portal that competes against C-Loans.com.  I just happen to own both portals.  The advantage of CMDC is that is is far easier and faster to use, and it offers far more commercial lenders - 4,000 commercial lenders versus 750.  The advantage of C-Loans.com is that a commercial loan broker or commercial property owner can enter his commercial loan request and then submit it to all 750 commercial lenders, six lenders at a time.

Here's the deal.  For just $1,000 per year, a direct commercial lender can be listed near the very top of the Lender List and receive a copy of every loan that enters CMDC that fits its profile.  If you close a deal from CMDC, you do not owe C-Loans, Inc. a dime.

If you want to advertise on CMDC as well, you will NOT be listed in the absolute top spot because Red Star Mortgage, a huge C-Loans producer, has already sent in their dough and reserved that top spot.  The next direct commercial lender - it should be another commercial hard money shop - will be listed third, after Blackburne & Sons (my own commercial loan company) and Red Star Mortgage.

I make some dough from C-Loans.com and CommercialMortgage.com, but my biggest payoff for owning these commercial loan portals is that they generate leads for my private money commercial mortgage company.  Therefore bridge lenders, sub-prime, non-prime, and hard money lenders cannot be listed on CMDC for commercial loans of less than $1 million.  I am saving these leads for Blackburne & Sons.

I have been telling you guys for years that the real money in the commercial loan business is in loan servicing rights.  We charge our investors 1.9% per year to service our loans.  If you think this is excessive, keep in mind that we need to make enough dough to keep our doors open during the 45% slumps that appear every 12 years or so.  Therefore, if Blackburne & Sons syndicates a single commercial loan of $1 million, we typically earn 3 points up-front and roughly 2% per year for servicing.  If the loan stays outstanding for five years, that's roughly $130,000 in loan fees and servicing income for syndicating a single loan.

Now you can see why we won't sell leads for less than $1 million (our preferred maximum).

But if you work for a hard money shop that regularly closes commercial loans greater than $1 million, you would be absolutely crazy-nutso not to jump on this offer.  Just $1,000?  Really?  Write to Tom Blackburne.

WEAPONIZING THE YUAN

If you have been following my blog for the past two weeks, you will recall that I have written extensively about the trade war between the U.S. and China.  This trade war is NOT going well.

I have pointed out that because the Chinese import far less from the U.S., they are running out of goods upon which to levy a tariff.  Their companies are losing their best customer, the United States.

China had pipe dreams of making the yuan a competing world currency, but since the start of the trade war, the yuan has fallen around 8%.  Their stock market is off 25% since earlier in the year.  

Lastly, the Chinese current account is down to breakeven; i.e., they are importing just as much as they are exporting.  They are no longer adding to their $3 trillion of foreign reserves.  This war chest was $4 trillion just a few years ago.

But the Chinese refuse to cave.  Jack Ma, the Chinese billionaire founder of Alibaba (much like our Amazon.com) said last week that he thinks that the trade negotiations will fail and that this trade war will last for 20 years.  The world will end up getting divided up into two huge trading blocks.

We also discussed how the Chinese have actually been propping up their currency, the exact opposite of the currency manipulation charged by President Trump.  The market is selling yuan because foreign investors are not in the mood to buy Chinese stocks.  As a result, the yuan has fallen 8% or so in recent days, and the Chinese allowed this to happen.

This week the Chinese announced that they had no intention of "weaponizing the yuan."  If the Chinese allowed their currency to fall 25%, the decline would wipe out the effect of Trump's tariff's.  It would also send our stock market crashing down because suddenly Chinese products would be 25% cheaper than American prices in world markets.  U.S. companies selling internationally would get hammered.  Profits would fall dramatically, and so would the U.S. stock market.  (I have sold 100% of my stocks.)

To me, the statement that, "We're not going to weaponize the yuan," is like saying, "We're not going to release a virus this week that would wipe out every English-based computer in the world."

Weaponizing the yuan.  Yikes.

In a moment I am going to introduce you to three self-directed IRA custodians, but first I have some disturbing news coming out of China.

Alibaba is China's largest internet retailer.  You can think of Alibaba as the Amazon.com of China.  Jack Ma is their President, and he is very much the peer of our Jeff Bezos.  Jack Ma is a very smart guy.

Mr. Ma said today that there is no solution to the trade war taking place between China and the U.S.  The trade negotiators will be unsuccessful, and this trade war will last for 20 years.  It will still continue long after President Trump has left office.  In Jack Ma's opinion, the world will end up getting divided up into two huge trading blocs.  

Also disturbing was an announcement by China that it would indeed be retaliating against the U.S. for this latest round of tariffs.  Okay, we knew that; but what sent a chill down my spine was the comment, "... at a time of our own choosing."

In my last blog article, I explained that China's last remaining economic bullet was to suddenly devalue the yuan by 25%.  This would almost completely neutralize the 25% tariff that Trump has promised to impose on Chinese goods in about three weeks.  

Such a sudden and dramatic devaluation of the yuan would likely lead to a  crash in the U.S. stock markets.  Why?  Suddenly, across the globe, Chinese goods would be 25% cheaper.  U.S. companies selling overseas would see their sales and profits crumble.

"... at a time of our own choosing.  How about one week before the elections in November?  There is nothing like 20% to 30% sell-off in the stock market to ensure that the Republicans lose both houses.  Impeachment suddenly has the votes.

You will recall that I have sold every penny of equities in our company pension plan, my 401k, and my IRA.

Now let's talk about using your IRA to make investments other than those sold by stock brokers.  If you have a self-directed IRA, you can invest in real estate, partnerships, trust deeds, coin collections, physical gold and silver, and even art.

An IRA is, by definition, a bank account.  A number of banks have therefore set up fee-based custodial trust accounts, and the bank, as custodian for your IRA, holds title to the assets.  If you want to invest in first trust deeds, the following three self-directed IRA custodians will serve you very well:

PENSCO Trust Company
http://www.pensco.com
866-818-4472

Mail to:
PENSCO Trust Company
P.O. Box 173859
Denver, CO 80217-3859

Overnight/Express Shipping:
PENSCO Trust Company
1560 Broadway, Suite 400
Denver, CO 80202-3308

IRA Services

http://www.iraservices.com
(800) 248-8447
Fax:  (605) 385-0050

Mailing Address:
IRA Services
PO Box 7080
San Carlos, CA 94070-7080

Express Delivery Address:
IRA Services
1160 Industrial Road, Suite 1
San Carlos, CA 94070-4128

Polycomp

http://www.polycomp.net
800-952-8800

6400 Canoga Avenue, Ste. 250
Woodland Hills, CA 91367

You would be wise to immediately lessen your exposure to U.S. equities.  Two weeks ago I sold every penny of stocks in our company's pension plan, in my personal 401k, and in my IRA.  This article explains why.

In a recent article, Commercial Loans and China is Getting Financially Slapped Around, I wrote that China is suffering mightily in this trade war.

Do you remember the days when China was exporting far more to the outside world than it was importing?  For decades, China was amassing vast hoards of foreign reserves, as it exported far more than it imported.  At one point (2014), China's foreign reserves reached a staggering $4 trillion.

Those days are over.  Several years ago China was forced to spent over a trillion dollars to prop up the yuan.  China had pipe dreams of having the yuan challenge the U.S. dollar as the world's preferred currency for international financial transactions.  Uh, huh.  In the past three years, the yuan's share of international financial transactions has fallen from 2.8% to just 1.8%.  China's trove of foreign reserves has fallen to a "mere" $3 trillion.

The gag is that Catmando is the biggest city in Nepal.

Since the start of the trade war, China's current account is lucky to stay at breakeven.  In plain English, China is lucky these days to export as much as it imports.  China still has to import vast quantities of commodities to fuel its manufacturing industry, but it is losing its biggest customer, the United States.  As a result, Shanghai Composite Index of Chinese stocks, is down 25%, since its high in early 2018.

Today President Trump levied a 10% tariff on over $267 billion on Chinese goods.  The only reason why these tariffs were limited to just 10% was to give U.S. manufacturers time to find alternative sources of supply.  In November, those tariffs increase to a whopping 25%.

China, of course, retaliated by increasing tariffs on... a whopping $60 billion in U.S. exports.  Huh?  China is running out of imports upon which to levy a tariff!  Remember, China exports far more to the U.S. than we export to China.

To make matters worse, the yuan is tumbling in value.  After all, who wants to buy yuan in order to buy Chinese stocks, when the Chinese stock market is taking such a drubbing?  (Actually some brave value investors might find the Shanghai Composite Index an interesting speculation.  The Chinese are first and foremost businessmen, not world hegemonists.  This trade war is bad for business, and reason will probably prevail over the personal pride of China's dictator-for-life, President Xi.)

Do you guys remember in the late-1980's, when Japan was kicking our butts?  Seven of the world's ten largest commercial banks were Japanese.  "I think I'm turning Japanese, I really think so."  Uh, huh.  Japan was nothing but a big-time financial bubble.  Forty years later and Japan has  still has not recovered.

Okay, we're finally getting to the point of today's article.  President Xi of China is not just going to roll over to the pressure being exerted by President Trump.  He is going to find some way to retaliate against America, and the last remaining bullet in Chinese President Xi's financial arsenal is to suddenly, massively devalue the Chinese yuan.

Bam!  If the Chinese were to suddenly devalue the Chinese yuan by 25%, the 25%, U.S. tariffs would be completely offset.  It is ironic that President Trump has criticized the Chinese as being "currency manipulators", when the truth is that they have been spending unimaginable amounts of their foreign reserves propping up their currency!!!  

And here is the downside for the U.S. stock market.  China competes against the U.S. to sell products in most of the countries of the world.  If China were to suddenly say, "Forget this!" and allowed their currency to freely float, American manufacturers would suddenly find themselves priced out of many markets.  International sales would plummet.  The profits of S&P 500 companies would plummet, and so would the U.S. stock market.

I've still got it!

I'm out of U.S. stocks for the moment, thank you very much.

Today we're going to talk about using an IRA to either buy real estate or to invest in 7% to 12% commercial loans.  There are some pitfalls that can get a commercial loan broker sued or get an IRA investor totally screwed.

First of all, is it legal for an investor to buy real estate with his IRA? Absolutely!  Tens of thousands investors nationwide legally do so.

But the investor must be absolutely sure not to personally guaranty any mortgage on the property!

If the investor personally guarantees a mortgage secured by a property owned by his IRA, the IRS will declare the personal guaranty to be an illegal contribution to the IRA.  It is the position of the IRS that personally guaranteeing the loan produces a lower interest rate from the bank.  The entire IRA will be declared invalid, and the investor will pay billions and billions of dollars in income taxes, penalties and interest to the IRS.  (Who remembers old Carl Sagan, the astronomer?  He popularized the term when he told us about the billions and billions of stars in the galaxy.)

Commercial loan brokers, you need to know this stuff.  If you arranged a commercial loan for an IRA to buy a property, and that commercial loan required a personal guaranty, you can bet that the borrower is going to come after you for the billions and billions of dollars in penalties that he will have to pay.

But the IRA investor can simply get a non-recourse commercial loan, right?  'Rots of ruck with that challenge.  After the Great Recession, very few banks will make non-recourse commercial loans.

My own hard money shop, Blackburne & Sons, however, will gladly make non-recourse commercial loans for your IRA.

You may have noticed that Blackburne & Sons has recently been pitching the idea of 9% first trust deeds to the wealthy investors who use C-Loans.com.  We have been doing this for over 30 years - turning former commercial property borrowers into trust deed investors.  It's an easy sell.  These wealthy guys are already comfortable with commercial real estate.

One of our private clients called the office this week asked if he could use his IRA to invest in first trust deeds.  The answer, of course, was yes; but he has to set up a self-directed IRA first.  He can't just hold title to a first trust deed as "Bob Smith's IRA".

An IRA is, by definition, an account at a bank.  The operative words here are,"at a bank."  Your investment has to be in a type of bank account.  Self-directed IRA accounts, where some bank serves as the custodian, have been existence for over 30 years.  "Bank of Colorado, as custodian for the IRA of Bob Smith" would be the proper vesting.

You guys know that I am an attorney, and I have to take Continuing Legal Education classes to maintain my license.  I took a CLE class this week about retirement accounts, and our instructor told us this story.

Are you going to eat that last piece of cake?

An investor bought a commercial property using his IRA, but he ordered his IRA custodian to just send a check to the title company for the purchase price.  Title to the property was vested as "Bob Smith's IRA".  At the end of year, the IRA custodian reported to the IRS a withdrawal of $900,000.  Oopsie.  The buyer didn't use a self-directed IRA to serve as the custodian for his IRA's purchase of the property.

The IRS then socked this poor guy with income taxes, penalties, and interest amount to - all together, class:

Billions and billions of dollars.

I learned something today.  A $1.1 million commercial loan on an assisted living facility was entered into C-Loans.com this afternoon.  With a hope and a prayer, I forwarded the loan application by hand to one of our SBA lenders, even though the borrower didn't specifically ask for an SBA loan.

I reserve the right in our Terms of Use to forward deals by hand to lenders that the borrower might not have considered.  For example, maybe the borrower had never thought of an SBA loan for his assisted living facility.

Not surprisingly, my lender emailed me back several hours later.  "Sorry, but we can't do this deal."

I then wrote back to him, "Because its an assisted living facility, right?"  I figured that since the SBA won't guaranty loans on apartment buildings, the SBA wouldn't finance assisted living facilities either.

I was wrong.  The SBA will, in fact, guaranty loans on assisted living facilities!!!  Huh, I learn something new every day.

"No, he replied.  "As an SBA lender, we CAN finance assisted living facilities.  The problem in this case was that the borrower wanted the loan proceeds to make some investments (speculations), and he also wanted a line of credit.  The SBA does not guaranty lines of credit or money to be used for investment; other than in the company.

I often hear borrowers say, "I applied for an SBA loan, but I was turned down.   ABC Bank didn't like my property.  I guess I'll have to get a far-more-expensive conventional loan."

No, no, no.  SBA lenders have to retain a substantial portion of every SBA loan that they originate; and while one SBA lender might reject an otherwise qualified loan (still gotta be 51% owner-occupied, etc.), another SBA lender might happily jump on the deal.

Eeuuu.  That was random.

C-Loans.com has over 200 SBA lenders.  If you take four minutes to fill out our online application form, you can instantly submit the deal to all 200 of our SBA lenders, six at a time, until one of them says yes.

Listen to this:  I live in some rolling hills surrounding a beautiful lake.  Lots of houses on the hillsides can look down into the yards of their neighbors.  Sadly a hillside homeowner reported this week that a hawk swooped down and grabbed his neighbor's cute little Bichon puppy.  The hawk obviously killed and ate the puppy.  :-(

This has been a bad month for animals around Geist Reservoir in Indianapolis.  A pack of coyotes killed two full-grown Golden Retrievers in another neighbor's backyard.  The dogs were barely alive when the owners returned, and they had been bitten so often that they died at the vet.  [Sob]  My son, Tom, has a beautiful, one-year-old Golden Retriever.  That dog is soooo sweet and loving.  I couldn't imagine if that had been his beloved Bernie.

Indiana teems with water, and therefore it teems with lush-green trees and wildlife.  A black mink (ferocious, 2.5 pound fighters) often runs through our yard.  There were three deer in my yard tonight.  Last year, across from Tom's house, my wife and I spotted a whole family of foxes.  They are pretty animals, but Tom has chickens.  Yikes.

Are you and your spouse on NextDoor.com?  I love that site.  Whole neighborhoods can share tips and juicy gossip.  Plus NextDoor.com is 100% free.  Just like C-Loans.com and Ajox.

Today's article is not so much about commercial loans, but rather it is about economics and the status of the trade war with China.  If you are not a commercial real estate lender or a commercial loan broker, kindly ignore the next three sections to get at my latest economic observations. 

But first a comment to our commercial loan brokers.  The big trades for commercial loan officers at banks and credit unions are now over.  With CommercialMortgage.com currently stocked with over 4,000 different commercial banks and other commercial lenders, we now have enough of them.  You can no longer trade lists of banks for hard copies of my popular commercial loan brokerage training courses.

However, we will, at the moment, still give you $300 off of one of our $549 training courses (Commercial Mortgage Brokerage, Practice, or Finding Investors) in exchange for a list of ten commercial loan officers working for FDIC-insured banks or NCUIF-credit unions.  Watch, no one will take advantage of this trade because they could have gotten an even better deal during the summer.  Its human nature.  And then they will kick themselves when this offer ends on November 30th.  [Shrug]

Helloooo?  If you have been paying attention, there are now over 4,000 different commercial real estate lenders available to you for free on CommercialMortgage.com.  Every search produces a different list of commercial lenders on the Lender List.

If you are a commercial hard money lender, pay attention!  We are now selling listings on CommercialMortgage.com for just $1,000 per year.  Listed lenders will also get free leads on deals that fit their requirements.

The first commercial lender to sign up gets listed first (after my own hard money shop, Blackburne and Sons).  The second commercial lender to sign up gets listed second, and so on.

A couple of important Terms and Conditions.  We are NOT taking listings for sub-prime, non-prime, or hard money commercial permanent loans of less than $1 million.  We want these small leads for ourselves.  If you normally make loans from $100,000 to $3 million, you can still get listed for commercial loans between $1,000,001 to $3 million.

If someone later offers us $1,500 per year, he gets to jump ahead of you.  But within the $1,000 per year category, if you are the #3 lender to sign up, and lenders #1 and #2 don't renew next year, you get to move up into the #1 spot.

If you are a commercial hard money lender, you would be flipping retarded not to instantly jump on this offer.  Les Agisim of Trevor Cole Financial was the first hard money lender to join C-Loans.com.  He has since closed 51 commercial loans for us and earned over $1 million in fees.  Contact Tom Blackburne at 574-210-6686.

But no one ever listens to me.  Been telling you guys for over three decades that the real money in commercial real estate finance ("CREF") is in loan servicing fees.  "Its the servicing income, silly."

George's Latest Economic Observations:
CHINA IS GETTING SLAPPED AROUND FINANCIALLY

The press has been giving substantial coverage recently to the suffering of American farmers and American manufacturing companies because of President Trump's trade war.  You should know, however, that the suffering has been far from one-sided.  Financially, China is getting seriously slapped around.  With the U.S. economy continuing to expand, one could even make an argument that the U.S. is “winning”.  "Hey, let’s both slit our wrists and see who bleeds to death sooner.” Ha-ha!

On September 4th, Bloomberg had an excellent article on the subject:

"Donald Trump’s trade war couldn’t have been more poorly-timed for the world’s second-largest economy.  China’s current account surplus has plunged to near zero and is threatening to tip into a deficit.  The yuan’s real effective exchange rate against a basket of trading partners is hovering near a record high, signaling the currency may have room to depreciate.”

I had forgotten the definition of a current account, so I looked it up in Investopedia:  "The Current Account measures imports and exports of goods and services; payments to foreign holders of a country's investments and payments received from investments abroad; and transfers such as foreign aid and remittances.”  In other words, China is no longer exporting immensely more stuff to the rest of the world than it is importing.

It true that China's trade surplus with the U.S. soared to over $31 billion this past month, but a big reason for this is because China is rushing to ship to the U.S. lots of stuff before Trump’s 25% import duty on $267 billion worth of Chinese goods.

The Chinese obviously will slap U.S. imports with an equally painful tariff, but here’s the thing:  Because China exports far more to the U.S. than the U.S. exports to China, the Chinese will eventually run out of goods upon which they can levy a tariff.

Back in March  of 2018, Trump sent out his famous tweet on trade wars:  "When a country (USA) is losing many billions of dollars on trade with virtually every country it does business with, trade wars are good, and easy to win. Example, when we are down $100 billion with a certain country and they get cute, don’t trade anymore - we win big. It’s easy!”  Of course his tweet is a gross over-simplification and ignores the severe damage that inflation will cause, but its hard to argue with the numbers. The Chinese will eventually run out of American exports upon which they can levy a tariff.

But let’s get back to the September 4th Bloomberg article:  "The twin pressures pose a challenge to China’s efforts to keep yuan volatility to a minimum and may also undermine a core economic objective: Gaining an enhanced role for the yuan as a means of international payments.  The currency’s share in global transactions has fallen to just 1.8 percent from 2.8 percent three years ago.  Shanghai stocks have underperformed emerging-market peers in 10 of the past 12 quarters and trade near the lowest valuations in four years.”

Translation:  While the U.S. stock market continues to climb, the Chinese stock market is getting beaten down.  To make matters worse, investors are moving out the yuan.  Who wants to buy Chinese companies during a trade war with the U.S.?  Yes, its true that the Chinese have $3 trillion in foreign reserves, but they had $4 trillion in reserves just four year ago.  About ten years ago China spend around $1.3 trillion of their foreign reserves in a single year propping up the yuan.

And to make matter even worse, China has already committed $1 trillion to its Belt and Road Initiative, an ambitious plan to rebuild the old Silk Road both on land and by sea, giving them trade access to 60% of the people on Earth.  If the yuan continues to decline, a “mere” $3 trillion in foreign reserves will not last forever.

Real short article today.  An article just came out today in American Banker Magazine, where I was quoted on financing gentlemen's clubs.

“I think I’d rather finance a gentlemen’s club than just about any other type of property,” Blackburne said.  “You know what the biggest problem is?  Those borrowers make so much money that they keep doubling up and tripling up on their payments.  They pay me off.  I’m not a bridge lender. I want my money to stay outstanding.”

https://www.americanbanker.com/news/should-strip-clubs-still-be-on-banks-blacklist

There is also an important lesson here.  Did you notice how I complained about getting paid off.  You don't really want to be a bridge lender.  That's far too much work.  Every month your portfolio shrinks, and you have to hustle up new business.  Instead, you want to make long-term private money loans and earn loan servicing fees.

"It's the loan servicing income, silly!"  -- George Blackburne III, circa 1902

But no one ever listens to me.

By the way, in addition to gentlemen's clubs, Blackburne & Sons has also financed a number of adult book stores and adult lingerie stores.  We are currently working on a swingers club.  Sad note:  We have been forced to foreclose on every  church loan that we have ever made.  :-(

Today were are going to talk about two advanced types of commercial loans - mezzanine loans and preferred equity.  Together they comprise most of the field of structured finance.

Above I referred to preferred equity as a type of commercial loan.  More precisely, preferred equity is NOT a commercial loan, but rather an infusion of fresh equity into an existing limited liability company ("LLC").  The effect, however, is the same.  

Example:

John Livingston is a very wealthy real estate investor who owns a huge office tower in New York City.  Title to the huge office tower is held in the name of Livingston Ventures, LLC., a single-asset, bankruptcy-remote entity.

A single-asset, bankruptcy-remote entity is usually a LLC that owns nothing else, other than the building.  Hence the expression, "single-asset entity". "Bankruptcy-remote" means that title to the property is held in the name of some entity that is NOT John Livingston personally.  Mr. Livingston could get drunk someday and plow into a group of 30-year-old surgeons.  Their wives could win a $20 million wrongful death action against Mr. Livingston, forcing him into a Chapter 11 bankruptcy, as he rearranged his assets to pay the judgment.  The operation of Livingston Ventures, LLC. would be unaffected by such a personal bankruptcy.

Many commercial lenders today therefore require their borrowers hold title to the property in a single-asset, bankruptcy-remote entity.  In truth, virtually all sophisticated real estate investors today already hold title to their commercial properties in a single-asset LLC.

Now back to how Mr. Livingston needs cash.  He has a $20 million first mortgage on his huge office tower from New York Life at 4.5%.  The loan has an enormous prepayment penalty, known as a defeasance prepayment penalty.  The first mortgage still has four years until maturity, at which point the borrower can refinance without penalty.  Unfortunately Mr. Livingston needs cash now.

The good news is that Mr. Livingston has a ton of equity in his building.  The building is worth $35 million, and he only owes $20 million on his first mortgage to New York Life.  

He can't apply for a second mortgage for three reasons.  First of all, his first mortgage balloons in just four years.  The second mortgage lender might have to pay off the $20 million ballon payment in order to protect its  $7 million second mortgage.

Secondly, the monthly payments on the $20 million first mortgage are around $80,000 per month.  It can often take 18 months to foreclose a mortgage in New York State.  Can you imagine making $80,000 payments on the first mortgage for 18 months?  Ouch!

Most importantly, however, is that the commercial loan documents on the first mortgage specifically prohibit placing a second mortgage on the property. The moment that a second mortgage is recorded, New York Life can declare it an unauthorized alienation of title (transferring an interest in the property without the lender's permission).  They could immediately call their loan and demand to be paid off in full, along with a $3.8 million defeasance prepayment penalty.  No way!  Yes, way.

Okay, clearly a second mortgage is out of the picture.  How about a mezzanine loan?  You will recall that a mezzanine loan is not a real estate loan.  It's a loan against the membership interests (think of stock) of the LLC (think of a corporation) that owns the property.  Because mezzanine loans are personal property loans, not commercial real estate loans, they can be executed upon (foreclosed upon) in a matter of two months.  That's a whole lot faster than the 18 months it takes to foreclose a mortgage in New York.

Dave Attell on Breastfeeding:

Ladies, it is amazing how you do that, with a beverage coming out of your nipple, did you know that?  Guys, we can't do it.  Because if we could, we'd spend the whole time squirting each other.

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Unfortunately for Mr. Livingston, the commercial loan documents from New York Life specifically prohibit mezzanine loan financing as well.  This is true with the commercial loan documents of virtually all life companies, conduits (CMBS lenders), and banks today.

Wait a minute.  If mezzanine lenders are prohibited from making their loans after the first mortgage is recorded, when do they ever get to make their mezzanine loans?

Please pay attention here.  This is important:

Mezzanine loans must be recorded simultaneously with the big permanent loan in front of it.  For example, Citibank might record a $120 million first mortgage, while the Carlyle Group simultaneously records its $35 million mezzanine loan.

Mezzanine loans are large loans.  You will seldom close a mezzanine loan of less than $2 million behind a first mortgage of less than at least $8 million.  Let me say this again:  The first mortgage usually has to be at least $8 million before any mezzanine lender will pay attention to you.

But Mr. Livingston still needs dough.  How is he going to tap the huge amount of equity in his building?

What about preferred equity?  As it relates to commercial real estate, preferred equity is an injection of fresh capital (money, dough) into an existing LLC.  Preferred equity does NOT have required monthly payments.  Instead, the preferred equity only gets paid if the property is generating a surplus of cash flow, but only up to a certain yield; say, 15%.

Now this is important:

If there is a surplus of cash flow, the first member of the LLC to get paid a dime is the preferred equity holder.  He's special.  Think of the Church Lady from Saturday Night Live.  Isn't he special?  He is preferred.  The other members of the LLC - known as the common members (like common stockholders) - might not get a penny of that surplus cash flow.

The preferred equity holder might not get his full 15% return until the property is sold.  For example, there might only be enough surplus income, after paying the first mortgage and any required reserves, to pay the preferred equity holder 8%.  The balances of his preferred equity return merely accrues and compounds until the property is refinanced or sold.

What happens if the preferred equity never gets paid at all? If the problem is that the market is crumby, then too bad, so sad; but if the problem is poor management, the preferred equity holder can seize the management of the property.

This brings up an important point.  Most commercial loan documents prohibit preferred equity holders from owning more than 49% of the total number of membership interests.  We already know that if the LLC sells the property that the first mortgage has the right to call their loan and collect a huge defeasance prepayment.  The same is also true if the LLC sell 50% or more of their membership interests.  The reason for this is that the lender wants to be able to rely on the experience of his particular borrower.  The preferred equity "lender" is unknown to him.

How about the cost of a mezzanine loan versus the cost of preferred equity?  The all-in cost of a mezzanine loan today, including the interest rate, the points, and any exit fee, is typically between 8% to 11% today.  The all-in cost of preferred equity, including the preferred return, any points, and any exit fee is typically between 12% to 15% today.  Mezzanine loans are 2% to 4% cheaper than preferred equity.  Just remember, mezzanine loans have to be recorded simultaneously with the first mortgage.

One final point.  There are preferred equity providers who will "loan" as little as $750,000. 

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.