Commercial Loans and Fun Blog

When applying for a commercial loan to buy a small apartment building, you are likely to run into the following problem:  When the lender applies a 1.25 Debt Service Coverage Ratio to the Net Operating Income, the property will only qualify for a loan of 62% Loan-to-Value.  The commercial lender will then insist of a down payment of a whopping 38% of the purchase price!  Remember, purchase money second mortgages, behind bank or conduit first mortgages, are forbidden nowadays.

Who the fiddlesticks has 38% to put down????  What the hellions is going on?

The problem when trying to finance small apartment buildings - I am talking about multifamily properties of 5 to 20 units - is that everyone wants to own them.  The Apartment Game has been played for generations in America.  You buy a four-plex, rent it out, and run it for five years.  In the meantime, the rents go up by 35%.  Then you sell it for a nice profit and use your profits, plus your original down payment, to buy a ten-unit property.  Five years later you sell that 10-unit building and use your big profit to buy a 20-unit project.  By the age of 55, you are ready to retire and live off your rents.  Your success is virtually guaranteed, as long as inflation continues.

Because the Apartment Game is a virtually guaranteed path to a comfortable retirement, everyone wants to play.  If a small apartment building comes on the market, there is a feeding frenzy.  A 15-unit apartment building might have a NOI only $212,000, but the bidding is likely to go as follow:

"I'll pay $2,650,000 for that $212,000's worth of income."  This works out to an 8% cap rate.

"I'll pay $3,029,000 for that $212,000's worth of income."  This works out to a 7% cap rate.

"I'll pay $3,533,000 for that $212,000's worth of income."  This works out to a 6% cap rate.

When the bidding stops on this 15-unit apartment building, the price is likely to end at $4,348,000 - which equates to a cap rate of just 4.875%.  

Then, when the lender takes the $212,000 in NOI and divides it by the 1.25 Debt Service Coverage Ratio, he arrives at a loan amount of only $2,709,000 - assuming he used a 4.75%, 30 year constant.  Constant is just a fancy word for using a 4.75% interest rate on the new multifamily loan and a 30 year amortization.

Quick Review and Summary:

An investor is buying a 15-unit apartment building that has a Net Operating Income of just $212,000 per year.  The bidding to buy the building is fierce.  Everybody and their brother is bidding to buy it.  The investor is forced to pay around $4,350,000 for the building.  The loan officer at the bank working to make the loan can only get the deal to pencil at $2,710,000 - using a 4.75% interest rate and a 30 year term.

The investor has some serious down payment money, but who on earth has 38% to put down?  Does this mean that small apartment buildings cannot get financed, even though small apartments are the most desirable type of income property in the whole world?  Please read this again.  The hottest type of real estate - the best and most secure collateral for any real estate loan - is small apartments.

How Your Bank Loan Officer Must Handle This Situation:

First of all, the investor needs to choose a bank loan officer who is willing to go into Loan Committee and fight for the deal.  Then that loan officer must say:

"Boss, listen.  If we make a multifamily loan on a 100-unit apartment building, we could sit on that foreclosed collateral unsold for months, even though the loan had a 1.25 debt service coverage ratio originally. After all, there is not an unlimited demand for, and an unlimited number of buyers of, a 100-unit apartment building."

"In contrast, if we start to foreclose on a small apartment building (5-20 units), our REO department will have buyers lined up before the foreclosure sale even takes place.  You can verify this, Boss.  Just call the REO Department and ask them how many small apartment buildings we have unsold."

"The truth is, Boss, is that small apartment buildings are the single most desirable class of real estate to own.  The prices get bid up so high (in other words, the buyers are willing to accept very low cap rates), that the numbers don't work for a traditional apartment loan."

"If we want the BEST collateral for our loans, we have to show some flexibility on the debt service coverage ratio on small apartment deals.  We have to be willing to accept a 1.0 debt service coverage ratio, as long as the buyer's global income (salary, interest income, other net rental income) will support a few vacancies."

What I have written above is the absolute truth, and the bank loan officer, in Loan Committee, has to keep pounding the drum.  "Do we want fantastic collateral for our loans in real life or just so-so collateral that looks good on paper."  If the loan officer sticks to his guns, Loan Committee will eventually agree.

Here is one more arrow for the bank loan officer's quiver.  Any small apartment building that does pencil is almost assuredly in a slum.  For a small apartment deal to comfortably pencil for a 70% to 75% loan today, it must be selling at an 8% or higher cap rate.  In other words, in order to attract a buyer, the seller has to offer prospective purchasers a higher yield on the property.   The investor is thinking to himself, "The only way I am going to buy a property in this stinky area is if I am getting a huge return on my money."

So the last arrow in your loan officer's quiver is this:  "Boss, if a small apartment building loan ever pencils, I guarantee you that the area is so seedy that you wouldn't want your wife or mother walking around there at night.  The bank should want to make their apartment loans in good areas.  The reason why this deal doesn't pencil perfectly is because its in a good area."

One final point:  Banks, agency lenders (Fannie Mae, Freddie Mac, etc.), and conduits will not allow the seller to carry back a second mortgage behind their new first mortgage loans.  Blackburne & Sons will allow second mortgages!

Commercial loan brokers and borrowers often give up far too easily.  They get a commercial loan application in the door that they think is pretty good.  Then they take the deal to three or four commercial banks, who proceed to criticize the deal to death.  "I don't like the location."  "The borrower isn't strong enough."  "One of the leases expires in just 14 months."  "The borrower doesn't have enough liquidity."

Then the commercial loan broker loses confidence in the deal and quits.  He thinks to himself, "This must not be as good of a commercial loan as I thought it was.  I better go find a better one."  Arghhh!  There is probaly nothing really wrong with the deal.  Let me make something clear:

EVERY COMMERCIAL LOAN EVER CLOSED HAD A FEW BLACK HAIRS.

Read my lips.  Every commercial loan ever closed had a few black hairs.  An intelligent eight-year-old girl (boys are still pretty 'tupid at that age) could pick out flaws in a commercial loan package.  Bankers often think they are a genius when they find a flaw in a commercial loan, and then they tell you to come back when you have a better deal.  Horse pucky!  When you weigh the pro's and the con's of the deal, your commercial loan should probably be made.

So what happened?  You took your deal to a bank or a particular bank loan officer who just didn't feel like lending today.  Because the banker wasn't in the mood, he picked on the first black hair that he could spot and then sent you packing with a pat on the head.  "There's a good little boy.  You come back later with a perfect commercial loan or the broomstick of the Wicked Witch of the West."  Hellooo? There is no such thing as a perfect commercial loan!

Now we get to the point of today's training article:

Commercial loans should close EASILY.  If your banker is using weasel words, move on immediately to another bank!

When your banker uses weasel words like, "Well, I'm not sure," or "I'm worried about the loan-to-value ratio," he is just setting you up to turn you down tomorrow.  Commercial loan packages seldom get prettier overnight.  Banks seldom develop a voracious appetite for commercai loans overnight.  Therefore the instant your bank loan officer starts using weasel words, immediately submit your deal to three more lenders.  

Three is a magic number for me.  I try to make it a rule to always have my commercial loan submitted to at least three different lenders at the same time.  "Oh, my gosh, George, what if two lenders come back and issue me a term sheet at the same time?"  Oh my gosh, what if Michelle Williams and Mila Kunis both asked me out at the same time?  Ha-ha.  Ain't gonna happen in real life.  Always have at least three bankers looking at your deal at the same time.

Now remember, the lesson for today is this:  Commercial loans should close easily.  Why?  How?  The answer is that you have to find the right lender for the right deal at the right time.  That's the key.  When you find the right lender at the right time for your deal, you will be amazed at how easily the deal will close.  There will be zero hard-selling on your part, and the "huge" black hairs will appear trivial to the banker.  So if your banker seems like he is fighting you - if it seems like the going is hard - you just haven't found the right lender for your deal.

This leads me to my next point:  Be prepared to take your commercial loan to at least twenty to thirty banks, or other commercial lenders, before closing it.  Using email and Dropbox.com, this is super-easy these days.

Of course, if you take it to a bank, and the banker is drooling all over it, then it sounds like you have found the right bank at the right time.  You certainly should never quit on a deal after presenting it to just ten or fifteen lenders.  Placing commercial loans is a numbers game.  The more commercial lenders to whom you present your deal, the more often you will "get lucky" and find the right bank at the right time.

"But George, where am I going to find all of these banks?"  Finding banks is easy-peasy:

1. C-Loans.com has 750 commercial lenders, and you can actually submit your deal using C-Loans.
   
   
2. CommercialMortgage.com has another 3,500 commercial lenders.
   
   
3. There are 6,799 commercial banks in America.
   
   
4. There are 6,143 credit unions in America.
   
   
5. Go to maps.google.com and enter the address of the subject property.  Then ask Google to plot the nearby banks.  Banks love to lend close to their office.

One final point.  Let's suppose you have a commercial loan in Northeast Boston.  You approach the First National Bank of Northeast Boston, but the white, sixty-year-old, sleepy (lazy) commercial loan officer brushes you off.  Hmmm.  First National Bank should have been perfect for this deal.  The property was right in their sweet spot in terms of loan size and location.  Solution:  Wait 48 hours and then present it to a different loan officer at the same bank.  The new loan officer - Asian woman loan officers are often dynamos - might just love your deal.  I have successfully closed numerous commercial loans using this trick.  The new loan officer might be in the mood to close some deals.

On T.V. and at cocktail parties, you have probably heard all about people making big profits fixing and flipping houses.  The U.S. built only 1.2 million homes last year.  The U.S. must build 1.7 million new homes every year just to keep up with population growth.  How have we been filling that shortfall?  The answer is with fix and flips.   We are returning rundown homes to the housing stock.

When a fix and flipper renovates an older home, he is often providing a near-new home to some young couple, both of who are probably working.  They totally lack the time and experience to do the renovation themselves.  That fix and flipper is truly doing a good thing for that young couple.  The couple will enjoy a near-new home for 20% less than the cost of a new home.

Flipping homes is also great for the environment.  Think of all the trees that are spared because a new home is not constructed.  Lastly, think of the kids.  Older homes usually have much larger yards in which kids can romp and play, compared to new homes.

My point is that you should feel good about the work you are doing as a house flipper.

But How Do You Find a Home to Flip?

Here are some practical tips:

Consider using a wholesaler on your first deal.

Wholesalers are in the business of finding rehab properties, putting them under contract, and then finding a buyer who will execute the house flip.  You take the place of the wholesaler in the contract, paying a fee to the wholesaler for being the middleman.  Make sure the wholesaler doesn’t add a profit margin to himself that is so large that he doesn’t leave any profit for you.   I recently did a Google search, “home wholesalers Indianapolis”, and I found dozens of listings.

Hire an agent who specializes in REO’s. 

REO stands for "Real Estate Owned" and refers to property that is held by a lender as the result of a defaulted loan.  Most of these homes will have gone through an extensive foreclosure, and perhaps an eviction process.  In addition, the prior occupants probably did very little to care and maintain the property during the pendency of the mortgage default, foreclosure and eviction.  As a result, many of these properties are priced lower than the surrounding homes due to their neglected conditions, making them ripe for a house flip.  Many lenders and loan servicers align themselves with a small group of realtors that specialize in selling these types of properties.  The key to finding them for your house flip is to work with a realtor who has the inside track on these real estate listings and new rehab homes on the market.  You can find them by doing specific internet searches for REO real estate agents and brokers within a specific geographic area.  For example, I just did a Google search of “REO specialists Indianapolis” and found lots of listings.

Work with your favorite real estate agent using the MLS.

Have her set up email alerts for new listings based around key words, such as handyman’s special, fixer-upper, fix and flip opportunity, needs work, distress situation, divorce situation, neglected, needs repairs, foreclosure, REO, etc.

Attend foreclosure sales, estate sales, and auctions.

Real estate auctions, conducted at a public place, most often at the courthouse, are the best place to consistently source below-market real estate. The lenders are often times willing to take a discount from the amount owed.  This allows buyers to purchase a property at 60-80% of the market value. The investor can then quickly remodel (if needed) and resell the property for a profit. The downside is that oftentimes you need to pay all-cash for the purchase, and there is no title insurance or inspections on the properties.  Although there is some risk associated with this tip, with proper due diligence and patience you can do this profitably in any market in any area.  In addition, not every foreclosed home finds s a buyer at a foreclosure sale.  By attending foreclosure sales, you will be able to identify those lenders who are stuck with a foreclosed home that they do not want to own.

Most hard money lenders just want to get rid of their foreclosures quickly.

They are not interested in becoming landlords or home renovators.  Their loans are often made at low loan-to-value ratios, so there is often sizeable equity in their foreclosures.  If you can find and contact these individuals or companies, you’ll likely get access to some great deals.  I just did a Google search of “hard money lenders Indianapolis” and found dozens of companies listed.

Network-network-network!

Build yourself a network of finders and contacts that - because of their jobs - run across distressed home opportunities.  The next several tips will explain exactly how to do this.

Don’t be shy about offering to pay a finder’s fee for a home that you end up buying.

Folks, I am an attorney, and let me reassure you that finder’s fees are perfectly legal.  Advertise your finder’s fee offer boldly and with confidence.  “A finder is a person whose employment is limited solely to bringing the parties together so that they may negotiate their own contract.”

It is essential that your finder does not try to play real estate broker and negotiate terms.

If your finder negotiates any terms, it is illegal to pay him because he is not a licensed real estate broker.  Therefore limit your finder’s work to setting up an introduction.

How much should you pay?

I recommend a cool $1,000.   Capitalism works, folks.

You need to institutionalize your marketing for homes to buy.

"Institutionalize?  That’s a big, boring, fluffy term.  I’m falling asleep here, George.”

By institutionalize, I mean that you need to develop a repeatable formula that works every time and which requires very little character on your part to implement.  For example, suppose I told you to get on the phone and call 15 people every day?  It’s a formula.  It would probably work; but who has the discipline to make 15 calls every day?  That requires an immense amount of character, so I don’t like it.   But how about this?  Could you develop a list of 70 to 1,000 particular people to whom you could forward a funny or interesting email once a week?  After the joke, you could have a signature block that reads, “I PAY $1,000 REFERRAL FEES FOR HOMES TO FLIP (in big, bold red print).  Please look for homes where someone has died, moved to a care home, or come back in foreclosure.”

 Choose your 70 to 1,000 finders by the nature of their work.

Certain people, because of the nature of their work, see good fix and flip candidates several times per year.   Here are the types of workers who see fix and flip opportunities on a regular basis - real estate agents who specialize in estates, antique dealers, estate sale professionals, clean-out guys, dumpster companies, divorce attorneys, and probate attorneys.

Don’t forget business cards.

You should have two types.  One should read in big, bold type:  “I PAY $1,000 FINDER’S FEES FOR HOMES TO FLIP. “ The other might say, “I’LL BUY YOUR HOME QUICKLY.”

Develop an elevator pitch.

What on earth is an elevator pitch?  An elevator pitch is a short, succinct sales pitch - something that you can deliver in the time it takes an elevator to go up four floors.  Here’s a hypothetical:  “Hello, my name is George Blackburne, and I own Blackburne & Sons.  I am a residential developer, and I specialize in restoring and repurposing run down homes.  I pay a $1,000 finder’s fee to people who find me homes to buy and flip.  May I give you one of my business cards?”

Put a magnetic sign on your car.

“$1,000 Finder’s Fee For Homes To Flip.  574-360-2486.”  You could find a great opportunity while your car is parked at the grocery store.

Get to know the mail carriers in the neighborhoods in which you want to buy.

Mail carriers know who is having financial difficulty, who is behind on their taxes, who is seriously ill, who is moving out, and more.  They know more than Google when it comes to the people on their routes, so get to know them.

Finding homes to flip is a skill that you will refine and improve over time.  Have you developed a great marketing trick of your own?  Would you please share it with me?  Write to me at george@blackburne.com, and please write in the Subject line, “Great Fix and Flip Tip For Old George.”  I would really, really appreciate it!

The following annual Christmas letter went out to all of our 1,300 wealthy private investors this week.  I hope you get a kick out of it too...  

Fortunately, the walkers were held back by a police barricade, but this did not stop them from snarling, gnashing their Zombie-like teeth, and reaching out for our delicate flesh with their angry, outstretched arms.  Was this the Zombie Apocalypse?  No.  These were the Inauguration Day J20 protesters, who so terrified my wife and my 64-year-old cousin, Patti. 

The three of us were walking towards the stands along Pennsylvania Avenue in order to watch my daughter, Jordan, ride her horse, along with the famous Culver Black Horse Troop (100 all black horses) and the Culver Equestriennes (20 lovely young ladies), in review past President Trump and Indiana’s own Vice President Mike Pence in the 2017 Inaugural Parade.  (I rode in President Nixon's Parade in 1971.  George IV rode in W's first parade, and Tom rode in in W's second parade.  A lot of legacy, huh?) 

There was a reason why the stands were so empty.  Police barricades were required to keep back the Zombies.  No, that’s unfair to the Zombies.  Even Zombies don’t behave this badly.  One of the protesters, a skinhead, targeted his rage at poor Cisca and Patti, shouting obscenities in their faces for absolutely no reason.  For all he knew, these two grandmothers might have voted for Hillary.  

With a daughter scheduled to ride in the parade, we were not to be dissuaded.  We eventually had to walk several miles to circle around the Zombie barriers, but finally we got to the stands.  We learned afterwards that most of the other Culver parents gave up trying to reach the stands.  Later, the press made great hay over the fact that the stands were so empty.  Helloooo? Would you want to be eaten by Zombies?  Plucking off your little toes.  Eating them like French fries.  Ketchup? 

In the stands, we were within 30 feet of the President as he walked down the parade route.  Melania Trump was stunning, of course, but I was most impressed by the lovely Ivanka Trump, wearing a tasteful, but close-fitting, cream dress and very high heels.  When one of her little boys, around four years in age, started acting like a little boy-onster (half boy, half monster), she scooped him up, threw him on her hip, and continued walking and waving without missing a step.  Talk about the modern woman.  Wow. There is a special place in the corner for any little boy-onster who acts up during his grandfather’s big parade.

As the Culver horses rode past the reviewing box, Jordi was on the left side, closest to the President.  One television news network (CNN?) zoomed right in on Jordi, who rocked 20 million Americans with her radiant smile.  I paid a lot of orthodontist bills for that smile, but it was worth it!  If you are ever suffering from insomnia, be sure to ask Cisca to show you pictures, including her 4-second video clip of Jordi dazzling the world.  Very nice, Cisca… zzzz... head bounce...   

The J20 Zombies are on trial right now for smashing windows, trashing cars, and eating human flesh on Inauguration Day.  According to the legal arguments being advanced by the Federal prosecutor, if you are part of a Zombie horde, and even one Zombie rips off a human arm and begins munching, you are guilty of mayhem, even if you are a vegan Zombie.  Hmmm.  That’s a pretty dangerous argument for the future of free speech and non-violent protests.  I mean, c’mon, how are you going to keep every single Zombie from grabbing a quick snack.  Even I have to admit that my Cisca’s lovely ear lobes are irresistibly delicious.  Oh, my gosh, am I a Zombie?

This is Christmas time, and I should be spouting sweet nothings and warm wishes of love… but I simply must say that 2017 was a pretty lousy year for America.  The Zombies and the Nazis can no longer talk to each other.  A Republican friend of mine admitted that he has no more liberal friends.  I was part of an email string that contained a pretty funny, but politically insensitive, joke.  A liberal mortgage broker in the string of 20 brokers objected to the insensitivity of the joke, and my buddy wrote to him, “You are no longer my friend.”  Huh?  That broker had brought business to my lender-friend for 10 years!  What?  That’s it?  In the words of the great Rodney King, that world-renown humanitarian, “Can’t we all just get along?” 

And before any Zombies jump all over my Nazi friend, I must say, in all candor, that many Zombies no longer allow Nazis to even speak.  Apparently believing in free markets and self-help makes all Republicans to be fascists, nationalists, white supremacists, misogynists, or some other form of “ist”.  In the 1960’s, bras were first burned and the Vietnam War was famously protested at the University of California at Berkeley.  Berkeley was the epicenter of free speech… but apparently Ann Coulter, the conservative commentator, is not allowed to speak there.  Apparently she’s a misogynist.  No, that’s not it.  Must be some other form of –ist.  Security concerns?  Hmmm. 

And if you think I am over-blowing this whole speech thingee, just watch any “news” show today.  Apparently both the Zombies and the Nazis have forgotten all about common courtesy.  They constantly interrupt each other while the other is speaking.  Let’s play a game.  Turn on Fox News or CNN and set your timer for one minute.  I’ll bet that the speaker will be interrupted at least three times in a minute.  My dear mother would have smacked me upside the head.  [Smack!] 

Okay, so my daughter, Jordi, had graduated from Culver Girls Academy. Culver was incredibly expensive - far more expensive than most colleges. I’m not bragging… okay, I’m bragging… but Jordi won First Team, All State, starting goalie for high school lacrosse in Indiana.  Fortunately for my wallet, she had been recruited to play lacrosse for Earlham College, an hour east of Indy, and she had received an “academic” scholarship.  Phew!  My personal future was now clear.  I had done my duty.  Now it was finally golf time with my 300 buddies at Pretty Lake Golf Club.

But then I got the call.  “Dad, your only granddaughter, Reagan, hardly knows you.  You have to move to Indy.”  So we loaded up the truck and moved to Beverly… er, Indianapolis.  We found a pretty little brick house in a gorgeous subdivision, just two houses away from the prestigious Geist Reservoir.  All I want for Christmas, Santa, is to squeeze my little house between two of those 8,000 square foot “cottages” ($$$) on the lake.  

Cisca and I love it here.  Indianapolis has two pro sports teams, Uber, and even food delivery.  Have you tried Uber Eats?  Works great.  We get to babysit Reagan three or four nights per month, and she even has her own bedroom.  I used to chase her up the stairs, pretending to pinch her little bottom.  “Make your run, Reagan.”  And she would squeal in delight.  But then she turned on me.  “Make your run, Gramp,” and she pinched my fat fanny all of the way up the stairs.  Smarty pants.  Actually she is.  She scored in the 99th percentile in math and 98 percentile in reading. 

Cisca is thriving here in Indy.  She found a Zumba Gold dancing class, and she is making lots of friends.  Then she got adopted by our homeowner’s association
representative, a warm, charming, and effervescent lady who lives just six houses down the street.  There are close to 1,800 homes in our homeowner’s association!  This wonderful lady actually came to greet us when we moved in, and she has convinced Cisca to volunteer on the home quality committee.  Cisca came home laughing one day.  One of the homeowners had painted, without permission, their gorgeous brick home “Pepto Bismal pink”.  The Gestapo whisked them away in the night, never to be seen again. 

George IV is absolutely killing it at work.  He will close $1.4 million in hard money loans this month.  Because I am George III and he is George IV, I get numerous calls for him by accident.  These brokers keep telling me what a great guy he is.  Makes a papa proud.  Sadly George IV recently broke up with his long-time love, but fortunately he has already met someone new.  Both of them are joining us for Christmas too, which makes me do dog-flips.  One big dog pile of love. 

Every workday, our second son, Tom (aka “M”, the neglected Middle child), comes over to my house, just nine minutes away, and we work together out of my walk-out basement.  (I have owned Blackburne & Sons now for 37 years.  Our big office with all of the bodies and machines is in Sacramento, California; but Cisca and I were financially blessed and able to move to Indiana to send our children to the fabulous Culver Academies 18 years ago.)  I now get to see my son every day.  Is this a great country or what?  Tom is working very hard these days.  He sounds great selling, and he is finally starting to produce some loans.  The renovation of his starter home is almost done.  Tom and his lovely girlfriend, Alex, take care of Reagan, our granddaughter, exactly half the time - one week on and one week off.  And then there is Bernie, their 70-pound, lovable, goofy, energetic, bouncing, flopping, playful, and absolutely adorable golden retriever puppy. 

Jordi is enjoying Earlham College, and because I am so close, I get to go to every game.  In soccer she started at center forward, as a freshman, until she severely twisted her ankle.  She still scored a lot of goals, including a last-minute game-winner (4-3) in the final game of the season.  I stood there quietly on the sidelines and barely cracked a smile.  Not!  I went crazy… crazy for loving you. 

As for me, I have a heart rhythm problem, where my heart doesn’t beat fast enough to pump out all of the fluids; but I am scheduled for another jump start right after Christmas.  I’ll still probably die at age 95, when Cisca catches me again not putting the dirty dishes in the dishwasher.  [Smack!]

What did I learn this year?  Frighteningly, I got a brief glance of just how easy it would be for this country to turn into a fascist state.  The Zombies played an important role in exposing the danger, but can’t we all just learn to fight a little nicer?  Just sayin’.  Merry Christmas, everyone!

Tom Goodfather was worried about his kids.  His beloved wife, Susan, had died last year of breast cancer, leaving Tom as the sole guardian of their three children, ages 9 and 7 (the last two were twins).  Ten days ago Tom's doctor delivered even more bad news.  Tom's thyroid cancer, which had been in remission for six years, was back.  The doctor had tried to be optimistic, but Tom understood his underlying message.  "Make your final arrangements."

The only good news is that Susan had died with $1 million in insurance, and Tom had not needed to touch any of it.  Another positive was the fact that Tom's burgeoning real estate empire of 147 apartment units was performing well.  The lack of new construction had left apartment rents climbing.

So Tom make an appointment with a trust officer at Bank of America and arrived there today to set up a trust for his three kids.  Have you ever noticed the NTSA at the end of Bank of America's name - Bank of America NTSA?  NTSA stands for National Trust and Savings Association.  This tell you that Bank of America has a trust department, as do many commercial banks.

Investopedia defines a trust company as follows:  A trust company is a legal entity that acts as a fiduciary, agent or trustee on behalf of a person or business entity for the purpose of administration, management and the eventual transfer of assets to a beneficial party.

Huh? What?  Sorry, I nodded off.  How about a definition in English, George?  A trust company is a company that is super-honest and reliable.  It is also a company that follows written instructions to the letter.  A rich person, known as the trustor or settlor, hands over cash, stocks, bonds, real estate and other assets to the trusteeeeee (trustee) who receeeeeeives (receives) the assets.  The trustee then follows the written instructions in the trust agreement for the benefit of the beneficiary, in this case the kids.  The total of all of the cash, stocks, bonds, and real estate handed over to the trust is called the corpus (body) of a trust.

Tom instructs the trustee, Bank of America's trust department, upon his death, to deliver to Tom's sister-in-law, Mary, $4,000 per month to pay for the three kid's care and welfare.  Tom also instructs the trust company to invest $2 million in S&P-listed stocks and investment grade bonds in order to pay for their college.  Finally, upon the last child reaching the age of 25, the trust is to dissolve and divide the assets between the three kids.

Pop quiz:  What is an investment grade bond?  An investment grade bond is one that is rated BBB or better by Standard & Poors or Moody's.  Investment quality bonds are usually from large, old, and established companies.

The reason this whole subject came up this week is because we recently added a new bank to C-Loans that does not even have the word "Bank" in their name - U.S. Trust.  Remember, folks, the majority of all banks have trust departments, so you will see banks names such as First Bank & Trust and Guaranty Bank & Trust.  Now you know what the word, "Trust", means.

There is another hot term sweeping through the secondary market for hard money loans - "buy-to- rent".  Buy-to-rent loans are loans made to real estate investors who buy up single family homes and just rent them out for the long term.

This all started around 2009, when the Blackstone Group, the huge private equity firm, realized that it could buy up REO's, fix them up slightly, rent them out, and earn cash-on-cash yields in the range of 6% to 9%.  Initially this financial sector was known as the REO-to-rental industry.

Cash-on-cash yields of 6% to 9% were huge, considering that CD's were paying less than 1% and ten-year Treasuries, curiously known as the long bond, were paying less than 2.75%.  We have all heard of stories of New York investment bankers, flying out to the suburbs of football team cities, driving around for five hours, and then buying 30 to 50 homes in a single day.  These were the Blackstone guys, and this brilliant move by the Blackstone Group marked the bottom of the Great Recession.

Want to know just how brilliant?  Many of these rental homes went on to appreciate 25% or more, on top of the 6% to 9% cash-on-cash returns. This is capitalism in its most admirable form.  "Greedy capitalists" played a major and very beneficial role in ending of the Great Recession.  They created a floor on housing prices, when housing prices were in a free fall.  They replaced fear with greed.

By the way, REO stands for Real Estate Owned.  It is a term used by banks to record on their books properties upon which they have foreclosed.  There is a huge accounting penalty imposed upon commercial banks for maintaining REO's on the books.  This is why commercial banks are desperate to dump their REO's as soon as possible, even though it means the bank has to take a painful haircut (a painful loss of part of its initial investment). 

A cash-on-cash return is your cash return on your downpayment or on your purchase price, if you pay all cash.  The Blackstone boys paid all cash; hence their very handsome cash-on-cash returns.

Example:

Herb Black buys a rental home for $100,000, putting down $40,000 in cash and obtaining a $60,000 first mortgage from a bank.  He rents the house out for $1,100 per month.  His real estate taxes, insurance, repairs, and other expenses amount to $300 per month.  His mortgage payments are $400 per month.  He therefore has a positive cash flow of $400 per month or $4,800 per year.  His cash-on-cash return is therefore 12% ($4,800 divided by $40,000 times 100%).

Today the number of bank foreclosures is way-way down.  Gone are the days when millions of homes were in foreclosure, and houses could be purchased for a fraction of their replacement cost.  The REO-to-rental industry to winding down to just a memory.

However, bond yields remain at very low levels.  Certificates of deposit are still paying less than 1%, and the long bond is still yielding less than 2.75%.  It therefore still makes sense for an investor in search of yield to buy homes and rent them out.  An investor can still earn a handsome 5% to 7% return on his money.

Just as fix and flip loans are all the rage right now, Wall Street is gearing up to buy billions of dollars in buy-to-rent loans.  Wall Street is becoming the secondary market for private money loans.  A secondary is where mortgage loans that have already been originated are bought and sold. Be sure to grasp the concept that the loans have already been made.  Title has closed.  The borrower and the seller already have their dough.  Only then are these loans bought and sold in the secondary market.

The secondary market for buy-to-rent loans is starting to blossom.  Wall Street is salivating, so you will now hear the term, buy-to-rent loans, everywhere.  I urge you to get ahead of this tidal wave.  Blackburne & Sons is looking to make buy-to-rent loans almost nationwide.

To succeed in commercial real estate sales and/or commercial real estate finance (CREF), you need to know the lingo.  Here's a new one for you - adaptive re-use.  Here's what Wikipedia has to say on the subject:

Adaptive reuse refers to the process of reusing an old site or building for a purpose other than which it was built or designed for.  Here's another definition that I stole from a fine article on the subject:  

Adaptive reuse, or adaptive re-use architecture, is the process of re-purposing buildings — old buildings that have outlived their original purposes — for different uses or functions while at the same time retaining their historic features... A closed school may be converted into condominiums. An old factory may become a museum...  A rundown church finds new life as a restaurant — or a restaurant may become a church.

Adaptive Reuse is a way to save a neglected building that might otherwise be demolished. The practice can also benefit the environment by conserving natural resources and minimizing the need for new materials.

A buddy of mine owns a mortgage REIT and proudly announced recently the closing of a $4.6 million bridge loan to convert a former K-Mart building to a self-storage facility in Indianapolis.  This is a good example of an adaptive re-use.  

I sent my buddy an email congratulating him on the closing and his use of the interesting term, adaptive re-use.  "Hey Bill, helluva term, adaptive re-use!"  He replied, "Yeah. Buy a vacant K-Mart for $40 per square foot. Fill it with self storage racks. Sell it for $100 per foot."

By the way, a magazine advertisement or big email blast boasting of a nice commercial loan closing is called a tombstone.  Tombstones are an unusually effective manner to advertise for new commercial loans.  Seriously guys, you should blast out a tombstone every time you close a commercial loan.  They really produce results.

You should always pay attention when other commercial lenders blast out tombstones too.  Tombstones reveal the areas of comfort and preference for the lender.  Commercial lenders tend to carve out niches.  For example, my hard money shop, Blackburne & Sons, is getting more and more comfortable making commercial loans on cannabis facilities.  We're doing four cannabis deals this month.

My wife and I just got back from a short cruise to Cuba.  What a poorly-run country!  Under the communists, the average citizen makes just $50 per month.  Fifty dollars!  Havana was filled with beautiful, French colonial homes... that haven't seen a penny of repair since 1959.  The masonry walls were literally crumbling.  The Cuban people, though, were pretty warm and friendly towards Americans, and we as tourists felt very safe.

Trump and the Republican Party want the Cuban votes in South Florida, so President Trump just reversed many of President Obama's executive orders designed to improve relations and to open trade with Cuba.  The Cubans of South Florida want their country back, so they want to keep the pressure on the communists.  Its hard to argue with the proposition that the communists have grossly mismanaged the country.

You will recall that a fix and flip loan is a loan used to acquire a run-down home and to renovate it in anticipation of a quick sale.  When a fix and flip lender orders the appraisal, he will ask the appraiser for two values - the current "as is" value of the property and the after repair value ("ARV").

The after repair value is the value of the home after the renovation has been completed.  This number is also the single most important number in the whole underwriting process.  If a fix and flip deal passes the after repair loan-to-value ratio test, a lot of flaws in the deal can be overlooked.

Okay, so what must the loan-to-value be based on the after repair value?  For most fix and flip lenders, this ratio must be 70.0% or lower.  Many fix and flip lenders will not exceed 65% of the after repair value.

Ultimately the after repair loan-to-value test is a measure of the profit in the deal and of the wisdom of even doing the deal at all.  At a recent conference, several fix and flip lenders reported that they had had investor-flippers actually thank them for turning down their deals because the projects lacked profitability.  The appraiser and the lender had caught a big mistake that the investor-flipper was about to make.  In several cases, the investor-flipper was able to go back to the seller, show him the numbers, and convince the seller to lower his asking price!

I hinted earlier that some flaws might be overlooked if there was a enough potential profit in the deal.  For example, normally a fix and flip lender will require that the investor-flipper contribute (put down) 20% of the purchase price of the run-down home.  If the after repair loan-to-value ratio was less than, say, 65% then the investor-flipper might be able to convince his fix and flip lender to allow him to put down just 15% of the purchase price of the run-down home.

If the project has lots of potential profit, in other words, the after repair loan-to-value ratio is less than 65%, the investor-flipper might get approved with a credit score of less than 600 or with better credit but with no experience.  No matter the size of the potential profit, it is unlikely that the investor-flipper would be approved if he both lacked experience and had poor credit.  Potential profit can only do so much to help.

I just finished an extended article on fix and flip loans, and I encourage you to read it.  The guys making the big money in finance these days are the ones either using fix and flip loans or originating them.  Fix and flip financing is a target of hot money on Wall Street.

One of the most important questions asked by fix and flip borrowers is, "How much cash do I have to bring to the closing table?"  The good news is that fix and flip loan borrowers ("renovators") need far less cash than home builders or commercial real estate developers.  In fact, I promise you that you will be thrilled and pleased with how little cash a renovator has to bring to the table. Hooray!  Just be patient.

Before we get into exactly how much cash a renovator needs to qualify for a fix and flip loan, let's use this opportunity to review commercial construction loans and the Loan-to-Cost Ratio.

The Total Cost of a commercial construction project is calculated as follows:

Land Cost plus
Hard Costs (brick and mortar) plus
Soft Costs (governmental fees, interest reserve, etc.) plus
Contingency Reserve (5% of hard and soft costs) equals
_______________________________________________

Total Cost

When underwriting commercial construction loans, banks usually require that the Loan-to-Cost Ratio not exceed 75%.  In other words, if the total cost of the project is $1 million, the developer must contribute at least $250,000 in cash to the project.  Ouch.

Prior to the Great Recesssion, when banks got killed on their commercial construction loan portfolios, most banks would happily lend up to 80% loan-to-cost.  In other words, the developer only had to come up with 20% of the Total Cost of the project.  Some banks were even going 90% loan-to-cost.  After commercial real estate collapsed by 45%, Dr. Phil might have asked the banks, "How did that work out for you?"  Ha-ha!  

Having learned their lesson painfully, banks now require that commercial real estate developers contribute at least 25% to 35% of the Total Cost of the project.  But you and I don't care!  Our fix and flip loans are residential loans, not commercial loans, and the secondary market is absolutely ravenous for fix and flip loans.  You or your renovator will NOT need to contribute 25% to 35% of the Total Cost of the project.  No-no-no.

So how much cash will a renovator need to contribute to qualify for a fix and flip loan?  Well, the first wonderful thing to appreciate is that fix and flip lenders do not even use the Loan-To-Cost Ratio.

To qualify for a fix and flip loan, the renovator only has to come up with
 20% of the price of the dilapidated house being purchased!

Please note that we are NOT talking about 20% of the Total Cost of the project.  We are only talking about 20% of the property purchase price.

Example:

John Renny is buying a rundown house in a nice area for $100,000.  He will need another $60,000 to renovate the property.  John only has to come to the closing with $20,000 - 20% of the purchase price of the rundown house!  His fix and flip lender will loan him 100% of the dough to effect the repairs and upgrades.  Wow.  Is this a great country or what?

Just for fun, let's compute the Loan-to-Cost Ratio of John Renny deal above - a fairly typical residential fix and flip deal.

House Purchase Price (in a dilapidated condition) plus
Hard Costs (of renovation) plus
Soft Costs (closing costs, report fees, 4 mo's interest reserve) plus
Contingency Reserve (5% of hard and soft costs) equals
______________________________________________________

Total Cost

Now let's plug in the numbers.  C'mon, guys, don't zone out on me here.  This is fourth grade math.  Maybe third grade math.

House Purchase Price = $100,000
Hard Costs = $60,000
Soft Costs = $16,000
Contingency Reserve = $3,800
__________________________

Total Cost = $179,800

In our example, John Renny is bringing only $20,000 in cash to the closing table, which is the magical 20% of the cost of the dilapidated house.  Therefore his fix and flip lender will make him a loan for the difference - $179,800 minus the $20,000 downpayment equals $159,800.

Okay, so what is the Loan-to-Cost Ratio of John Renny's imaginary fix and flip loan?

$159,800 / $179,800 x 100% = 88.9% Loan-to-Cost!!!

Wow.  Nowhere else in the civilized world can a real estate developer get this kind of leverage.  This is why successful fix and flippers are making incredible retuns on their money.

I met a nice lady from Alaska a few years ago who lives in Anchorage.  Every year several people in Alaska are stomped to death by a moose, so finding one in your swimming pool is not really a laughing matter.  A college classmate (interestingly she is white) of my daughter is from Swaziland, and she is crashing with us over the Thanksgiving holiday because its too far to travel back to Africa.  When I asked her about wild lions and tigers and bears, she said that the hippo's are the big killers in Africa.  Huh.  Who would have thunk it.  Such friendly looking animals.  And don't even get me started on the dangers of Porky Pig...  :-)

My son, Tom, and I just returned for the 5th Annual American Association of Private Lenders Conference in Las Vegas.  At the conference, fix and flip loans were all the rage.  Everyone was talking about them.  Several of the break-out sessions were about fix and flip financing.  There were even hedge fund managers and Wall Street investment bankers prowling the conference floor in search of hard money shops (private money mortgage brokers) to sell them more fix and flip loans.

There is a lesson to be learned here:  Give the investment community what it is seeking.  If you are not already active in fix and flip financing, you need to start focusing your efforts there.

There are a number of reasons why the investment community is so hot-to-trot to make fix and flip loans:

1. Debt buyers are desperate for yield.  Treasuries, corporate bonds, and even junk bonds offer only very low yields.
   
   
2.  Fix and flip loans are secured by real estate.  In start contrast, corporate and junk bonds do not offer this kind of collateral.
   
   
3. Wall Street has learned that a portfolio of rental homes provides an excellent source of cash flow and potential appreciation.  Its is far from the end of the world if an investor has to foreclose on  a home.
   
   
4. Homeownership rates have plummeted to levels not seen since the 1960's, thereby creating a huge demand for rental homes.  Once again, if a fix and flip lender forecloses on a newly-renovated rental home, it is far from the end of the world.
   
   
5. New home construction is far below the levels of the early 2000's, so home buyers are attracted to newly-renovated properties.

The typical fix and flip loan is a first mortgage loan to a renovator to buy and renovate a one-to-four residence and then to quickly sell it for a profit.  The typical fix and flip loan is a 12-month, interest-only loan, and it has no prepayment penalty.

Virtually all hard money lenders making fix and flip loans will require that the renovator cover at least 15% of the acquisition price of the unrenovated house.  Then most hard money lenders will lend to the renovator 100% of the funds needed to renovate the property.

Example:

John Renny plans to buy a $100,000 house and then to spend another $60,000 in renovations.  The hard money lender will require that he put down at least $15,000 on the home purchase.  The hard money lender will then lend him $85,000 of the acquisition price plus the $60,000 cost of renovation plus the loan points and sometimes even plus a four-month interest reserve.