Commercial Loans and Fun Blog

Commercial loans on politically-charged properties are difficult to place.  Examples of politically-charged properties include X-rated bookstores, marijuana cultivation facilities, abortion clinics, gambling casinos, gentlemen's clubs, and gay nightclubs or resorts.

Most commercial banks would never make a commercial loan on such a property.  Banks are very sensitive about their image, and they just can't risk an adverse public reaction or some bad press in their local market, just to earn a little extra interest on such a commercial loan.

The issue of commercial loans on politically-charged properties reminds me a lot of the boycott on krugerrands and South African stocks during the 1970's and 1980's over the issue of apartheid.  Many large American mutual funds sold their South African stocks in protest, causing the South African stock market to remain depressed for two decades.

The krugerrand - the one-ounce gold coin minted by South Africa - sold for a $10 to $25 discount to the American Double Eagle or the Canadian Maple Leaf, even though it contained the exact same amount of gold.  Twenty years after the repeal of apartheid, the krugerrand still sells at a small discount to the other gold coins.

Nevertheless, in the 1970's and 1980's many mutual funds chose to ignore the public stigma of South African stocks.  If a South African stock was fundamentally sound and a good value, they would still buy the stock.  A social agenda was not allowed to interfere with a sound investment decision.

At Blackburne & Sons, we do not have the luxury of advancing some social agenda.  Our first loyalty has to be to the safety of our investor's money.  When your rates are 4% to 5% higher than most commercial banks, good commercial loans are hard enough to find as it is.  We simply have to jump all over any good commercial loan that will accept our higher interest rates.

My own private money commercial mortgage company will therefore happily make commercial loans on politically-charged properties, such as gentlemen's clubs and adult bookstores.  In fact, we have financed about 15 gentlemen's clubs over the years, and these commercial loans have paid well.  My view is that an investor can always count on the sun rising and on heterosexual males enjoying the shapely figure of an attractive woman.  We just closed a commercial loan this month on a restaurant with topless waitresses.  I was shocked - shocked I tell you - to observe that this business had been making good money for over 30 years.

Legalized marijuana is a new phenomenon.  Therefore we have yet to make a commercial loan on a marijuana cultivation facility, but we would definitely consider such a commercial loan.  Commercial loans on gay bars, nightclubs, or resorts?  Well, is it making good money?  If so, we would definitely consider making a commercial loan on such a property.

Bottom line:

1. Certain commercial properties are politically-charged, and it is difficult to place a commercial loan on such properties.
2. Examples of politically-charged properties include X-rated bookstores, marijuana cultivation facilities, gentlemen's clubs, abortion clinics, gambling casinos, gay bars, gay nightclubs and gay resorts.
3. Conduits do not make commercial loans on politically-charged properties.
4. Commercial banks don't not make commercial loans on politically-charged properties.
5. Would a credit union make such a commercial loan?  I dunno.  It's worth a few calls.
6. Hard money commercial lenders, like Blackburne & Sons, finance most politically-charged properties.

Most commercial real estate lenders seldom take additional collateral when they make commercial loans.  For example, conduits never make blanket commercial loans.

While banks will occasionally make blanket commercial loans, these blanket commercial loans are usually SBA loans.  Because the loan-to-value ratio on SBA loans is often so high, the bank will sometimes take the borrower's personal residence as additional collateral.

Only rarely will you ever see a commercial bank blanketing additional collateral on a conventional commercial loan.  A conventional commercial loan is a commercial real estate loan that is not guaranteed by either the SBA or USDA.

However, the one class of commercial lender that regularly bankets additional collateral is the hard money commercial lender.  I have an old and valued buddy, Paul Elis, who also owns his own hard money commercial loan shop.  Paul swears by blanket commercial loans.  When push comes to shove, mama is not going to allow papa to lose her castle.  The borrowers are not going to simply walk away from the commercial property because they would also lose their house.

A commercial lender can sometimes get comfortable with a tricky commercial loan by taking additional collateral.  For example, we were looking at a purchase money commercial loan this month where our borrower was buying an REO from the bank.  The problem was that the buyer was not putting a whole lot of cash down.  Normally we would have passed on the deal.

But then the borrower's commercial loan broker did a smart thing.  He offered us additional collateral, which included some land and a separate rental house.  The truth was that I was satisfied with the protective equity in the deal.  Our borrower was buying an REO  from a bank, and the subject commercial property was probably worth more than the purchase price.  If we foreclosed, we would probably get out of the deal without too large of a haircut.

But we didn't want to have to foreclose.  We just wanted reasonable assurances that the buyer would make his payments.  Normally, if a buyer puts down 30% of the purchase price, the size of the downpayment gives him plenty of incentive to make his monthly payments.

Here he was only putting down about 15% of the purchase price.  He lacked skin the game.  He lacked blood money - the blood on the stoop that a lender would see when he entered the property after completing his foreclosure sale.

When his commercial loan broker offered additional collateral, however, he solved my problem.  The borrower would lose both this valuable piece of land and his rental house if he ever defaulted on our commercial loan.

There is one scenario that always makes me chuckle.  Commercial loan brokers will often try to create equity where there is none.  For example, suppose the borrower needed a commercial loan of $200,000.  He offers up as collateral an apartment building, worth $2 million and with a $1.6 million first mortgage.  He also offers up as collateral an office building worth $1 million, but which has a $750,000 first mortgage.

Then the commercial loan broker says, "The apartment building has $400,000 in equity and the office building has $250,000 in equity.  That's $650,000 in equity to secure just $200,000.  Surely you'll make that deal, right?"

Hellooooo? Neither property has a lick of lendable equity.  At 80% loan-to-value, the apartment building is already mortgaged to the hit.  At 75% loan-to-value, the office building is also fully-mortgaged.  You cannot create lendable equity by combining various properties that are individually mortgaged to the maximum.

Now that you know that Blackburne & Sons will buy commercial loan discounted notes, how do you document the file?  If you run across the owner of a commercial loan who needs to discount it, for what documents do you ask?

Below is a Dream List of the documents that a buyer of a discounted commercial loan would love to see.  It is unlikely that you will be able to gather all of the documents listed below, but try to get as many of them as possible.  The better your discounted commercial loan is documented, the smaller the size of the discount.

1. Color photos of the property.
2. Copy of Promissory Note and Mortgage*
3. Original title insurance policy (or fresh prelim)*
4. Something showing the payment history*
5. Closing statement from when note was created*
6. Financial statement on the maker/borrower (when the note was created)
7. Credit report on the maker/borrower (when the note was created)
8. Two years’ tax returns on the maker/borrower (when the note was created)
9. Appraisal - an old one is very helpful and a new one is blissful
10. Rent roll and/or commercial leases (when the note was created)
11. Current financial statement of the Maker, current credit report on the Maker, last two years tax returns on the Maker, current Rent Roll, current commercial leases.  The documents listed in item 11 here are rarely available.

*  Very, very important.  

Find out early who has possession of the original Promissory Note and Mortgage.  It is legally impossible to properly assign a note and mortgage to the assignee (buyer of the discounted commercial loan) without delivering the original promissory note.

In fact, if the assignee (buyer of a discounted commercial loan) fails to take physical delivery of the original promissory note, and if the assignor (the seller of the discounted commercial loan) later files Chapter 7 bankruptcy, the promissory note becomes the asset of the bankruptcy estate!  The intended assignee is completely wiped out.

You are not going to run across discounted commercial loans every day.  Months from now you may need to refer back to this article for the list of documents to gather.  So be smart.  Please bookmark this page right now.

Got a discounted commercial loan right now?  Want to speak to a loan officer?  Please call or email:

BLACKBURNE & SONS REALTY CAPITAL CORPORATION

Alicia Gandy - (916) 338-3232
Desmond Stoll - (916) 338-3232
Tom Blackburne - (574) 210-6686 

My commercial loan, hard money lending company, Blackburne & Sons, competed this week to buy a discounted first mortgage note on an apartment building.  Do you know how to underwrite a discounted note when its a commercial loan?  You will after this blog article.

When underwriting a discounted commercial loan, perhaps the most important issue is the interest rate on the note being sold.  Private mortgage investors, when deciding whether or not to invest in a commercial real estate loan outside of California (yield requirements are 2% to 3% lower in California), usually insist on a yield of between 12%* and 14%*.

*  Gross yield before loan servicing fee.  I've been in the hard money mortgage business for 33 years now.  Show me a hard money lender that doesn't charge a loan servicing fee of at least 1% to 2%, and I'll show you a hard money lender that will not survive the next recession.  I've been preaching this to my fellow owners of hard money shops for years.  During the Great Recession, at least 60% (85%?) of all hard money commercial loan companies failed.  The handful that didn't fail only survived because they went back to their investors and raised their loan servicing fees to at least 2% per year.

Therefore, when underwriting a discounted commercial loan, you must first discount the loan back to present value at a yield that is appealing to a private mortgage investor.  In other words, what is the proper price to pay for this commercial loan for an investor wishing to yield 13%?

When discounting a commercial loan back to present value, much depends on the remaining term of the commercial loan.  For example, let's look at an 8% first mortgage commercial loan secured by an office building.  If there are just two more years remaining on the note, the discount might not have to be too large.

We said that the investor wishing to buy this commercial first mortgage note wants to earn, say, 13%.  Thirteen percent minus 8% equals 5% per year.  Five percent per year times the 2 years remaining on term of this commercial loan gives us a rough discount of only around 10 points.  I'll teach you a more precise way of calculating this discount in a moment.  Right now I want you to focus on the concept that the longer the remaining loan term, usually the larger the discount.

But what if this same 8% commercial loan had 10 more years to run?  Just doing some rough calculations, the discount would have to make up for a shortfall in the interest rate of 5% per year.  A 5% per year interest rate shortfall times 10 years is a whopping 50 (FIFTY) point discount!  Ouch!  A far better option in the above case would be to hypothecate the note - in other words, borrow against it - rather than selling it at a discount.

Below are instructions on how to properly and accurately compute the discount on a commercial loan.  Don't try to slug through them right now.  You can always come back and study this article in detail (bookmark it?) when you have a real deal to underwrite.  Instead, just skip right now to the rest of the article below the instructions.

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HOW TO COMPUTE A DISCOUNT ON A COMMERCIAL LOAN

How do you compute the discount on a commercial loan properly and precisely?  Take out your financial calculator.  You will notice that your financial calculator has a row of five buttons:

1. N (Stands for Number of payments until the loan balloons.)
2. I (Stands for Interest rate.  You may have to convert this to monthly.)
3. PV (Stands for Present Value or the loan balance)
4. PMT (Stands for Payment.  Usually this will be monthly)
5. FV (Stands for Future Value or balloon payment)

As long as you know four of the five values, you can compute the fifth.  In this case, we're trying to figure out how much to pay for this commercial loan.  In other words, we are trying to figure out the PV.  As long as we know the other four values, we can compute the PV.

Therefore, in the N field, insert the number of months until the maturity date.  

In the I field, insert, not the monthly interest rate on the actual commercial loan, but rather 1/12th of the desired yield by your private investors!  In this case, you would insert 1/12th of 13%.

In the PMT field, insert the monthly payment.  On some financial calculators, you may have to change the sign of the monthly payments from positive to negative, or vice versa.  Be careful not to forget the final month's payment.  Is it included in the ballon payment?  Don't double count, but also don't forget the last monthly payment either.

In the FV field, insert the ballon payment.  On some financial calculators, you may have to change the sign from positive to negative, or vice versa.  Is the last monthly payment included in the balloon payment?  Don't forget it ... but don't double-count it either.

We are now ready to compute the size of the discount.  Ask your financial calculator to compute the PV - what you should pay for the commercial loan if you want to yield 13%.

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Let's suppose you are trying to buy a $100,000 commercial loan, and you compute the discount to be $17,000.  Does this mean that you should pay $83,000 for the commercial loan?  No.  You have forgotten about the loan fee being charged by your lender and your own loan brokerage fee.

Let's suppose that Blackburne & Sons is charging 4 points, and you are charging a loan brokerage fee of 2 points.  Therefore you should subtract from the purchase price of the commercial loan the combined loan fee of 6 points, or in this case, $6,000.

We're still not quite done.  There will be closing costs - attorney's fees, title insurance, and recording fees.  A good rule of thumb for these costs is 2.5 points for commercial loans with a face value of less than $500,000 and 1.5 points for commercial loans with a face value larger than $500,000.

Therefore we have a $100,000 face value commercial loan, minus a discount of $17,000 to make the yield attractive, minus $6,000 in combined loan brokerage fees, minus $2,500 in closing costs - for a net to the seller of $74,500.

Why would a seller take just $74,500 for his commercial loan?  (1) He needs money; and (2) he no longer wants to take the risk that the borrower won't pay.

We are not done yet underwriting the deal.  You need to look at the loan-to-value ratio.  The end private investor, in our example, is paying $83,000 for the commercial loan ($100,000 minus the $17,000 discount to bring the yield up to 13%).  Is this a reasonable loan-to-value ratio?  Divide $83,000 by the current value of the property to make sure that it does not exceed 70% LTV.

What is the payment history of the underlying borrower on the commercial loan?  The above discussion assumes that the underlying borrower has been paying essentially perfectly.  If not, the discount may be significantly larger.

What is the credit of the underlying borrower?  Did the original owner of the commercial loan pull a credit report on him?  Does the loan package include old tax returns, showing that the underlying borrower was making money, at least when the commercial loan was originally made?  Is the property owner-occupied?  Does the maker's (the underlying borrower's) business look like it is thriving?  Is this a rental property?  If so, does it look fully-occupied?

If the answer to all of these questions is yes, the private investor buying the commercial loan may only require an 11% yield, rather than a 13% yield.

One the other hand, if the answers are not so appealing, the discount may have to be larger.  That being said, this is a capitalistic world.  There is some discount that is large enough to make almost any first mortgage commercial loan worth buying.

Today you are going to learn a ton today about business financing.  By business financing, I mean commercial loans NOT secured by real estate.

As you know, I already own a very successful commercial mortgage portal named C-Loans.com.  C-Loans has now closed over 1,000 commercial real estate loans totaling over $1 billion.  But it wasn't easy to build this portal.  It took us six, long, painful, heart-breaking years to reach profitability.

We are now in the process of building a business financing portal.  Our plan is to use all of the lessons and much of the software that we used to build C-Loans to build a portal for business owners who need financing - accounts receivable financing, factoring, equipment leases, equipment financing, lines of credit, and about a dozen other forms of specialized business loans.  We have purchased the wonderful domains, CommercialLoans.com and CommercialLoan.com, to use for this new venture.

Okay, so I interviewed today a good friend, named Scott Jordan, of All Credit Lending Solutions.  Scott's business is almost the exact opposite of mine.  While I make all of my dough in commercial real estate finance, Scott makes almost 100% of his dough in business finance.

I took careful notes during my interview with Scott, and today's blog post is largely a data dump of everything Scott taught me.  I learned a ton, and I promise that so will you.  This is not a primer on the entire subject of business financing.  It's more a short collection of topics upon which he tutored me.

Business Lines of Credit:

Prior to the Great Recession, many commercial banks used to regularly make these loans - up to about $50,000 ($100,000).  The size of the line of credit was often based on the amount of the company's monthly sales, and sometimes the line of credit was even unsecured.

Since the crash, the appetite of commercial banks for such loans has greatly diminished.

Collateral Based Loans:

Collateral based loans are when the lender takes physical possession of the asset and lends you some modest percentage of its value.  There are lots of different names for collateral based loans - Pawn Loans, Car Title Loans, Asset Based Loans, and perhaps a layman would understand the term, Hard Goods Loans.

Examples of hard goods that could be serve as collateral for small commercial loans are car titles, truck titles, heavy equipment titles, boats, artwork, jewelry, gold, rings, and household goods worth at least $10,000.

Collateral based loans are very expensive, typically between 3% to 5% per month.  They are intended only to be short-term loans.

There are even a number of online collateral based lenders, the largest being PawnGo.com.  You send them the asset, they inspect it, and then they make you an offer.

Cash Advance Commercial Loans (Cash Advances):

Cash advance lenders are a newer breed of business lender that makes commercial loans to companies that make lots of regular daily sales.  They will examine your company bank statements or merchant account statements, and then they will lend you a certain percentage (65%?) of your average monthly balance.

A merchant account is a type of bank account that allows businesses to accept payments by payment cards, typically debit or credit cards.  A merchant account is an agreement made between the business/seller, the bank where the merchant account is held, and the payment processor to settle all transactions made by debit and credit cards. The fees associated with these accounts are usually in the following categories: monthly, discount rate and transaction. The rate that a business is charged for debit and credit card services provided by its merchant account is called a merchant discount rate.

The interesting thing about a cash advance commercial loan is that the commercial lender will suck out a small, regular, loan payment from your business account every business day!

Asset-Based Line of Credit (ABL Loan):

An ABL lender will secure his commercial loan, and base the size of his commercial loan, by the amount of your company's accounts receivables, plus a certain percentage of the value of your inventory (35%?), plus a certain percentage of the value of your fixed equipment (35%?).

An ABL loan is often better than factoring your receivables because you don't have to pay as large of a monthly discount if you are not using the money.  You only pay interest when you have borrowed money on the line of credit.

ABL loans are not cheap.  The very best borrower will pay at least Prime + 4%, and interest rates of Prime + 10% are far more common.  Nevertheless, an ABL loan is cheaper than factoring, and you may be able to borrow more money.

Crowdfunding:

Crowdfunding is the collective effort of individuals, who network and pool their money, usually via the Internet, to support efforts initiated by other people or organizations.  Crowdfunding is used in support of a wide variety of activities, including disaster relief, citizen journalism, support of artists by fans, political campaigns, startup company funding, motion picture promotion, free software development, inventions development, scientific research, and civic projects.

Crowdfunding can also refer to the funding of a company by selling small amounts of equity to many investors. This form of crowdfunding has recently received attention from policymakers in the United States, with direct mention in the JOBS Act - legislation that allows for a wider pool of small investors with fewer restrictions.  (In my opinion, the JOBS Act is the single most beneficial piece of Federal legislation passed in the past 50 years.  The positive effect on innovation and job creation in the U.S. is going to be huge.)

Peer-to-Peer Lending:

Peer-to-peer lending is the practice of lending money to unrelated individuals, or "peers", without going through a traditional financial intermediary such as a bank or other traditional financial institution. This lending takes place online on peer-to-peer lending companies' websites using various different lending platforms and credit checking tools.

Using various P2P lending websites - such as Prosper.com and LendingClub.com - wealthy, accredited, private investors are making personal loans directly to borrowers, with either a dozen or more individuals investing together in a single loan or with a single private investor making the entire loan.  Typical loans are 9.9% to 13.9%, fully-amortized over a three to five year term.

So what's the difference between crowdfunding and peer-to-peer lending?  Crowdfunding raises equity, while P2P lending creates debt.

Using Linked-In:

So I asked my buddy, Scott, where he got his leads.  Do you get most of your business financing deals from brokers.  "No," he replied, "brokers only account for about 25% of my business.  Seventy-five percent of my business comes from business borrowers directly - word of mouth, my website, referrals, and Linked-In.  Linked-In is huge for me."

So how do you get business from Linked-In?  I don't personally participate on Linked-In, but Alicia Gandy in our Sacramento office - we call her The Loan Goddess because she is our biggest producer - gets a ton of business from Linked-In.

Scott replied, "I join lots of groups.  Also, if I see someone with a successful business in the newspaper, I'll send him an invitation to link with me on Linked-In.  Seventy-five percent of the people that I invite agree to link to me."

Great advice, Scott!  Great lessons.  Thank you.

Do you need a business loan not secured by real estate?  Please call my buddy:

Scott Jordan
All Credit Lending Solutions
303-887-2570
sjordan@allcreditls.com

Important reminder:

Sooner or later you are going to be working on a conventional commercial first mortgage, and the bank is only going to be willing to lend up to 63% loan-to-value.  Your borrower needs 75% loan-to-value financing.  Our new Preferred Equity Loan program will solve your problem.

A purchase money commercial loan is a commercial loan that is used to buy a commercial property and which is secured by the same property.  For example, if you refinanced your free-and-clear apartment building to buy a strip center, the new loan on the apartment building would NOT be considered a purchase money loan, even though the proceeeds were used to buy a commercial property.

Most purchase money commercial loans these days are SBA loans.  If an established and profitable business wants to buy a larger facility, in order to expand and hire more workers, the SBA will guarantee a large portion of that loan.  The buyer would only have to put down 10% of the purchase price (the new commercial loan would be 90% loan-to-value).

The opposite of an SBA loan is a conventional commercial mortgage loan.  A conventional commercial mortgage loan is a commercial loan made with no government guarantee.  By the way, the SBA is not the only Federal governmental agency that guarantees commercial loans.  Don't forget that the USDA also guarantees commercial loans using its Business and Industry loan program.  A USDA Business and Industry Loan is a commercial real estate loan, guaranteed by the USDA up to 90% LTV, and made in a rural, lowly-populated area, that will create more jobs in the rural area.

So a conventional commercial mortgage loan is a commercial mortgage loan that is not guaranteed by the SBA or the USDA.  Most conventional commercial mortgage loans are made by either commercial banks or conduits.  A commercial bank is just a garden variety bank, as opposed to an investment bank or a merchant bank.  The word "commercial" is just a fancy word for "business" and signifies that the bank is in business to make a profit.

An investment bank is a company that sells stocks and bonds and occasionally takes companies public.  A merchant bank is usually a small group of very wealthy investors - guys who often own a bank or life insurance company together - who use their excess profits to make equity investments in risky, potentially high-yielding investments.  There are probably fewer than 200 merchant banking companies in the whole country, and you'll probably never get to meet one.  If you ever meet a so-called "merchant banker" at some commercial lending conference, the chances are 20:1 that he is a con man, an advance fee scammer, and/or a huge slinger of bull-pucky.  Mortals like you and me don't get to meet real merchant bankers.

Purchase money commercial loans are often used to buy commercial investment properties.  Examples of commercial investment properties include apartment buildings, office buildings, shopping centers, strip centers, mobile home parks, and self storage facilities.  They are properties where the income comes - not from running a business, like a restaurant or a bowling alley - but rather from plain-vanilla monthly rent.  Commercial investment properties are purchased by real estate investors, rather than business owners.

Now we are finally getting to the point of this article.  If a real estate investor wants to purchase a commercial investment property, like a multi-tenant office building, right now, the typical bank is going to require a huge downpayment.  Why?  Because commercial banks are too scared to lend higher than 58% to 62% loan-to-value on commercial investment properties.

To make matters worse, commercial banks will not let the seller carry back a second mortgage.  Why?  They don't want to over-burden the property with debt.  They are afraid that if a tenant or two moves out and the cash flow dwindles, the commercial property owner might be tempted to use the cash flow earmarked for repairs and maintenance to make the payments on the second mortgage.  Soon the property becomes dilapidated.

This means that buyers of commercial investment properties today have to put between 38% to 42% down in cash!  Who has this kind of cash?

Now if the purchase price is huge, say $15 million or higher, the buyer will probably use a conduit loan (aka: CMBS loan).  Behind the conduit loan, the buyer will often take out a mezzanine loan of $3 million to $5 million.  Then the buyer will put just 25% down in cash.  The mezzanine loan fills the gap in the capital stack between 65% LTV (the maximum exposure of a CMBS loan) and 75% loan-to-value.

A mezzanine loan is not a second mortgage.  Instead, its a personal property loan against the membership interests of the LLC that owns one of these big, trophy commercial properties.  Remember, a share of stock is personal property, not real property.  A membership interest in an LLC is also personal property, not real property.  Seizures (foreclosures) of personal property can be completed in less than six weeks.  Real estate foreclosures can take 18 to 24 months in New York and many other states.  This why these junior lenders make mezzanine loans, rather than second mortgages.

Therefore, if your investor is buying some huge, trophy commercial investment property for more than $15 million, he can probably get away with putting down as little as 25% of the purchase price, by using a CMBS loan, capped off by a mezzanine loan.

Unfortunately, mezzanine loans are legally very complicated.  The legal fees alone can exceed $60,0000.  As a result, few mezzanine lenders will make mezzanine loans of less $5 million (maybe $3 million).

Therefore, if a buyer of a commercial investment property is paying less $10 million to $15 million, he has a real problem.  A commercial banks will only lend up to 58% to 62% LTV.  This means he has to put down 38% to 42% of the purchase price.  Not surprisingly, few smaller commercial investment properties are changing hands.

Until now.

Blackburne & Sons has just come out with an earth-shattering new commercial capital program.  Our hard money mortgage company is now making Preferred Equity "Loans" from $100,000 to $600,000 nationwide.

Preferred Equity is actually not a loan.  It's an equity investment.  Legally we become part owners of the property; but we are only entitled to a Preferred Return that looks almost identical to garden-variety interest.  Banks will allow Preferred Equity in "second position" because our payments are NOT required.  If the property doesn't generate enough cash flow some month to make the Preferred Equity payments, the payments do NOT have to be made.  

Don't worry about it if you are largely lost.  At the end of this article, I'm going to give you a link to brand new white paper that explains Preferred Equity in layman's language.

Here's what you need to know:  Commercial investment real estate is about to explode.  There has been virtually no new commercial construction for six years.  In the meantime, the U.S. has become the world's largest producer of oil.  We have so much natural gas, and its so stinking cheap, that our heavy manufacturers have an enormous competitive advantage over every other country in the world.  The U.S. economy - but for this miserable winter - should be exploding in production and hiring.  It will happen this Spring.

Folks, I am the guy who warned you for a decade that a deflationary depression was coming.  It came, but the Great Recession is over now.  Commercial real estate is poised, after a 45% decline during the Great Recession, to march upwards for a decade.

Commercial real estate values are going to appreciate, and lots of investors are going to want to buy some.  You won't be able to close any purchase money deals unless you find some company who can close the gap in the capital stack between 60% and 75%.  This what our new Preferred Equity program does.

Folks, our new tiny Preferred Equity Program is the most important development in real estate finance since the second mortgage.  You must - you absolutely MUST - download this free white paper and become more comfortable with Preferred Equity.  It is the only way you will close purchase money commercial investment loans for the next five years.

A Special Use Property (aka: Single-Purpose Property) is a property whose design, construction, and use precludes uses other than that for which it was built.

When underwriting commercial loans on these types of properties, it is most important to understand there is never a defined list of Special Use Properties.  Instead the underwriter must be able to recognize the characteristics of the property, which make it Special Use.

For example:

• The property is not easily converted, in terms of costs, to another use.
• The zoning restricts the use.
• The property and repayment could be affected by trends, operation, equipment or cash flow.

Once you recognize that the property is Special Use, approach the valuation carefully.  You need to find an expert in the area for that type of property with proven competency. Know what kind of value you are looking for - Real Estate Only or Going-Concern Value.  Will the FF&E’s have any value?  You may need to research conversion costs.

It's important to know the operator of the property.  Who is the key person?  What is their experience?  What education or specialization is necessary?

What is the history of the company?  Have they always been in that location?  Is there a history? Is it a good story or well-grounded?

Sometimes its important to know the supplies used, the raw materials, and the suppliers.

Anticipate disasters, such as a ski resort with a no-snow year, a vineyard with a drought, or E-Coli at a restaurant.  Look at the company's track record.  Do they have the cash reserves to survive?

What is your exit strategy?  Have this in place.   Your exit strategy should be different from your borrower's exit strategy.  Is long term funding needed for the deal to work?  Can it be short term?

To mitigate risk follow the Big 5:

1. Reduce the LTV
2. Take additional security
3. Obtain solid guarantees
4. Include good operating covenants
5. Don’t make the loan 

Here are some other important considerations:

1. Who will come to OUR rescue?
2. Is there a dumber lender?
3. Will the guarantors really make a difference?

When making a commercial loan on a Special Use Property, you should include loan covenants, such as operating ratios, “no dark” provisions, periodic inspections and reports.  For example, if you have a storage facility request, you may want to obtain bi-annual reports of tenant names and information.  On properties with septic tanks and wells, require periodic inspections.

And last, but arguably most important, what is the mortgage history of the borrower?  Were his last two loans private money loans?  Did he take cash out each time?  What was his payment history?  You have to look at it as the borrower is not operating well if he needs to keep getting private loans.  Why?  Is he not making money?  Is he not good with his finances?

If you have a balloon payment coming due on your commercial property, or if you are trying to buy an investment property, and you don't have a whopping 42% of the purchase price to put down in cash, this article is super-important to you.

Preferred equity is a wonderful form of commercial real estate capital that can save your bacon, whether you're a commercial loan broker or a commercial real estate investor.  Some examples will hammer home this critical concept.

Let's suppose that you're a commercial real estate investor.  You make your living buying and leasing out office buildings and shopping centers.  In 2004, you paid $2.6 million for a strip center in Los Angeles.  You put down $650,000 (25%) and took out a $1,950,000 new first mortgage from Ruby Bank.  This new commercial first mortgage had a 10-year term.

It's now the year 2014.  Your $1,950,000 first mortgage is ballooning, and you realize that you have a problem.  During the trough of the Great Recession, your $2.6 million strip center had fallen in value to just $2 million.  Fortunately, with the recovery, your strip center is now worth $2.5 million; but that's not enough.

The problem is that few commercial banks will make commercial real estate loans in excess of 58% to 63% loan-to-value today.  Even if you could convince a bank to make you a loan of $1,575,000 (63% of $2.5 million), the proceeds of the loan won't be enough to pay off your $1,950,000 existing first mortgage.  Yikes!

Even forgetting about points and closing costs, you will be short a whopping $375,000.  The bank will expect you to bring the shortfall to the closing; but you don't have $375,000 in cash!  You barely survived the Great Recession without losing any property.  To make matters worse, you personally guaranteed the loan from Ruby Bank.  You're in deep trouble.  Your dog could leave you, and your wife could bite you.

You sit down with your banker, and you ask him, "What if I could find a hard money lender to make a $375,000 second mortgage?"  The banker replies, "Commercial banks won't allow second mortgages behind their commercial first mortgages these days.  They don't want the propety overburdened with debt.  The danger is that if the owner's cash flow gets tight, he might be tempted to use the money earmarked for repairs and maintenance to make the payments on the second mortgage.  The property will fall into disrepair, the tenants will move out, and the bank will end up foreclosing on a run-down, vacant strip center with a leaking roof and mold all over it."

"What am I going to do?" you ask the banker.  The banker replies, "You need to find a partner to contribute $375,000 in cash to the deal, in return for a partial ownership of the building."  So you go to your brother-in-law, begging for cash, only to find out that he is as impoverished as you are.

Fortunately you find Blackburne & Sons, the only realty capital provider in the country making small preferred equity investments (its easier to think of them as preferred equity loans), from $100,000 to $600,000.  Most preferred equity providers won't even look at deals smaller than $3 million.

Blackburne & Sons agrees to invest $300,000 in preferred equity into your property, bringing the preferred equity capital stack (the sum of the first mortgage plus the preferred equity) up to 75% of value.  This means that you, the owner, still have to bring to the closing table $75,000 in cash, but this smaller amount is far more manageable.  It sure beats defaulting on your balloon payment and getting sued for the deficiency.

Here's another example of how preferred equity can save your bacon:

You're a commercial loan broker.  You have a wealthy commecial real estate investor who wants to buy an office building in Pleasanton, California for $3 million.  Your customer is insisting on a new permanent loan of 75% loan-to-value, but of the 13 banks that you have approached, none of them would lend more than 63% of the purchase price.  Your buyer refuses to put down more than $750,000, but the bank won't lend more than $1,890,000.  You are short $360,000, but the bank won't even allow the seller to carry back a second mortgage.  You're at loggerheads.

A $360,000 preferred equity investment from Blackburne & Sons can save this deal, along with your $22,750 commission (1 point).

Why would the bank allow a $360,000 preferred equity investment, but not a $360,000 second mortgage from the seller?  Preferred equity is NOT a loan.  If the buyer doesn't have the cash flow to make the preferred equity yield payments, he doesn't have to make them.  They simply accrue and defer.  The buyer doesn't have to neglect the needed repairs on the property in order to make the payments.  This is the critical distinction between a second mortgage loan and a preferred equity investment.

Preferred equity is not cheap.  It will cost the borrower between 16% and 22% annually, plus an 8 point investment banking fee to raise the capital.  The investment term is five years.  If the buyer does not pay us off at that time, the property will be sold to pay off the preferred equity investment.  Any remaining profit goes to the buyer.

Why is preferred equity so expensive?  Preferred equity competes against private money first mortgage investments, which can yield up to 12% to 14%.  Clearly a $300,000 preferred equity investment behind a $2.5 million first mortgage from the bank is far-far more risky than a $300,000 hard money first mortgage investment.  Suppose the tenants move out?  The monthly payments on the underlying first mortgage from the bank could be $14,000 per month.  Imagine making $14,000 monthly payments, month after month, as you deperately try to find new tenants.

But there is good news.  Blackburne & Sons can be bought out at any time for what is "owed"; i.e., its original investment, any advances, interest on the advances, plus a 17% per annum preferred equity yield on the original investment.  If our deal were a loan, you would say that our loan had no prepayment penalty.

An example will make this more clear.  Let's suppose that Robert Buyer teams up with Blackburne & Sons to buy for $1 million a small row retail building in downtown Palo Alto, California.  Mr. Buyer puts up $250,000 and Blackburne & Sons puts up $120,000 in a preferred equity position.  The bank makes a new commercial loan of $630,000.  The agreed-upon preferred equity return is 17%.

Just weeks after we buy the property, Apple Computer decides to buy this entire block in Palo Alto as part of their campus.  Apple agrees to pay a ridiculous sum, a whopping $2 million.  The all-cash deal closes just 10 days later.  The equity holders get to split a cool $1 million profit.  But who gets what?

The profit distribution plan of an equity venture is called a waterfall.  In this case, the first equity investor to be repaid its $120,000 principal investment is Blackburne & Sons.  Is there any more left over?  Yup, there's TONS of money left over.  Okay, so Robert Buyer gets back his $250,000 principal investment.  Is there any money left over?  Yes.

Therefore, Blackburne & Sons earns its preferred return of 17% annually (prorated for 37 days), so we earn a whopping $397.  The balance of the $1 million profit ($999,603) goes to Robert Buyer!

Preferred equity capital is expensive.  Therefore the wise borrower will repay Blackburne & Sons at the fastest possible pace.

Are you a commercial mortgage banker?  If so, you would be wise to heed my words here.  This is a brand new program, and no one in the marketplace knows about it.  Using our preferred equity, you can give your buyers and borrowers more leverage that any other mortgage banker in the country.  This gives you a HUGE marketing advantage.  In commercial real estate finance, the commercial mortgage banker who wins the deal and earns the fee is often NOT the guy with the lowest rate, but rather the guy who offers his borrowers the most dollars.

So be smart here.  Promote the heck out of this program!

Commercial loans are still quite hard to close these days.  Here are ten practical tips that will help you qualify for a commercial loan:

1. Instead of calling random commercial mortgage companies for your commercial real estate loan, focus your phone calls on commercial banks.  Commercial banks make the most number of commercial loans these days.  You can also save yourself countless phone calls by simply using C-Loans.com.
    
2. Don't forget about credit unions.  Credit unions, who historically never made commercial loans, have come out of nowhere to seize 5% of the commercial real estate lending market over the past two years.
    
3. Use local lenders.  Many commercial mortgage borrowers are under the mistaken belief that some mystical nationwide commercial lender offers lower rates than a local bank.  This is simply untrue.  You'll get your best commercial mortgage deal from a commercial lender located close to the subject property.
    
4. You can find all of the banks and credit unions located close to your commercial property by merely plotting your property on maps.google.com.  In the left column you'll see a photo.  Click the hyperplink underneath the photo that says, "Search Nearby."  Simply enter "banks" and hit return.
    
5. If you are trying to buy a commercial property, and you don't qualify for an SBA loan, you are about to discover that you have a problem.  Most commercial banks will not make conventional (non-SBA) commercial mortgage loans in excess of 58% to 63% loan-to-value these days.  This means that you have to put 37% to 42% down.  Yikes!  Who has that kind of money?
    
6. You can solve this problem by using preferred equity investments from Blackburne & Sons.
    
7. What if you have a $2 million balloon payment coming due on your commercial property, but the bank will only lend you $1.6 million?  A $400,000 preferred equity loan from Blackburne & Sons might save your property.  (Technically our $400,000 is not a loan but rather an equity investment; but its easier to think of it as a tiny mezzanine loan.)
    
8. If you are in the commercial loan business, make sure you are building your list of referral contacts every day.  I am a huge fan of list advertising.  The cold weather has greatly slowed commercial loan demand this winter, but my own commercial mortgage company, Blackburne & Sons, was able to respond by doubling the number of email newsletters and fax newsletters that we send out every day.  I am pleased to report that we did this, and my loan officers are once again deliciously buried with commercial loans.
    
9. Don't give up on your commercial mortgage newsletters too soon.  Your first five newsletters may not generate a single lead, but if you send out a fun, folksy, unprofessional commercial loan newsletter every 10 to 21 days religiously, your sixth newsletter will be a hit.  I  promise you!  Why?  It takes a while for The Newsletter Effect to kick in, but once it does, it is a powerful force.  This is what happened to my own son, Tom.  "Dad, these stupid newsletters aren't working.  No one is calling."  Then his sixth newsletter hit.  Bam!  His phone have been ringing like crazy ever since.  I've got to tell you, it felt good to be vindicated in front of my own son.  Need more help with your commercial mortgage marketing?
    
10. You could easily be closing three times more commercial loans than you are today, but you keep making 67 different mistakes.  I recently finished my training masterpiece, my Commercial Mortgage Broker Practice Course.  The course contains 67 different, very practical lessons on commercial mortgage brokerage, including the very first thing to say to a commercial lender when you call him to run a deal by him and including the single most important lesson in all of commercial real estate finance.  It's a five-hour audio course, designed to be listened to in your car on long drives.  Ideally you should listen to it at least five times, but if you listen to it just three times, I promise you will triple your income as a commercial mortgage broker.  "But George, I'm as poor as a church mouse right now.  I can't afford $199."  No problemo.  Simply submit two commercial loans using C-Loans.com and earn $100 Blackburne Bucks for each submission.  Then you can buy this amazing course without it costing you one penny out of pocket.  Folks, it will change your life!

If you are a conventional buyer of commercial real estate, or if you are a commercial broker, this article is VERY important to you.  The reason is because you are about to discover a BIG problem with your next commercial real estate loan.

It is very hard these days for a buyer or a commercial broker to put together a conventional purchase of an investment property, like an office building or a shopping center.  Banks today will only make commercial mortgage loans up to around 58% to 63% loan-to-value.  This means the buyer of a commercial property - assuming he can't get an SBA loan - has to put 37% to 42% down in cash.  Who has that kind of money?

The good news is that Blackburne & Sons has a wonderful new commercial loan product - more precisely a preferred equity investment - that will solve this problem for you.

Why are the banks so conservative when underwriting commercial real estate loans today?  Many commercial banks lost a ton of money in commercial real estate loans during the Great Recession.  These banks watched in horror as commercial real estate fell in value by 45%.  In addition, the portfolios of many commercial banks are too heavily invested in commercial loans today.  Why?  They can't get these legacy loans (loans written before the Great Recession) off the books.  Although the vast majority of these legacy loans are current, a great many of them are past maturity, and they exceed 85% loan-to-value, based on today's lower values.  Yikes!

To make matter worse, not only will few banks make commercial loans that exceed 58% to 63% loan-to-value, these banks will NOT allow junior financing (a second mortgage).  In other words, the seller cannot carry back a second mortgage.  The banks don't want to see these commercial properties over-burdened with debt.

"Okay, George, you promised me the cure for this problem.  Let's hear it."

Blackburne & Sons will add its dough to the buyer's downpayment to come up with the 37% to 42% required by the bank.  Typically the buyer will come up with the first 20% to 25%, and we'll come up with the rest.  In return, Blackburne & Sons will take a preferred equity investment in the property.

A preferred equity investment is NOT a second mortgage or even a mezzanine loan.  It's an equity investment.  The buyer of the property is not promising to pay any interest rate to the preferred equity investor, nor is he promising to even repay the preferred equity investor's original investment.  Repayment is dependent on the success of the real estate venture.

If the real estate venture is successful, however, the first equity investor to be repaid is the preferred equity investor.  He's special (said in the voice of the Church Lady from Saturday Night Live).  The original buyer of the property - who owns what is known as the common equity - only gets paid any profit after the preferred equity investor gets repaid his original investment, plus the agreed-upon preferred return.

An example will make this more clear.  Let's suppose that Robert Buyer teams up with Blackburne & Sons to buy for $1 million a small row retail building in downtown Palo Alto, California.  Mr. Buyer puts up $250,000 and Blackburne & Sons puts up $120,000 in a preferred equity position.  The bank makes a new commercial loan of $630,000.  The agreed-upon preferred equity return is 17%.

Just weeks after we buy the property, Apple Computer decides to buy this entire block in Palo Alto as part of their campus.  Apple agrees to pay a ridiculous sum, a whopping $2 million.  The all-cash deal closes just 30 days later.  The equity holders get to split a cool $1 million profit.  But who gets what?

The profit distribution plan of an equity venture is called a waterfall.  In this case, the first equity investor to be repaid its $120,000 principal investment is Blackburne & Sons.  Is there any more left over?  Yup, there's TONS of money left over.  Okay, so Robert Buyer gets back his $250,000 principal investment.  Is there any money left over?  Yes.

Therefore, Blackburne & Sons earns its preferred return of 17% annually (prorated for 37 days), so we earn a whopping $397.  The balance of the $1 million profit ($999,603) goes to Robert Buyer!

An important and very favorable point to notice here is that Blackburne & Sons can be bought out at any time for our original principal, plus its preferred return (17% annually in this example) since inception, compounded, with no prepayment penalty!

Let's look at another example.  Let's suppose we buy together a multi-tenant office building.  Unfortunately two of the seven tenants move out.  Therefore the property is not bringing in the kind of income that we projected.  Fortunately the property is making enough money to service the first mortgage, plus there is enough to pay the preferred equity investors a 5% return, but not the agreed 17% preferred return.

What happens?  Can Blackburne & Sons sue Robert Buyer?  No!  Remember, Mr. Buyer never promised Blackburne & Sons any sort of return, not even a return of its $120,000 principal investment.  All Blackburne & Sons can do legally is fire Mr. Buyer and bring in a more competent property manager.

What happens to the unpaid preferred return?  It accrues, defers, and compounds at 17%.  When the property sells, any profit will first be applied towards these arrearages.

"Okay, George, what you're describing is pretty garden-variety preferred equity.  What's so special about your program?"

The unique thing about Blackburne & Sons' Preferred Equity Program is that we will make TINY deals.  Most preferred equity providers have a $3 million minimum.  Blackburne & Sons will only make preferred equity investments of between $100,000 and $600,000.

"How much does your equity cost?"

Each deal is individually priced, so a lot depends on the deal.  Deals in California are much cheaper.  Attractive properties are cheaper.  In these equity investment deals, the CV (curriculum vitae or the business resume) of the buyer matters a lot.

That being said, most deals will cost between 16% and 22% annually and eight origination points.  Keep in mind that these preferred equity investments are tiny-tiny amounts, especially when compared to the bank's new first mortgage.  If he can borrow $630,000 at only 4.75% and $120,000 at 17%, the buyer's weighted average cost of funds is dirt cheap (6.71%).   Also remember that the buyer can buy out Blackburne & Sons at any time.

"How do we get started?

Just call your Blackburne & Sons loan officer or call Angela Vannucci, Vice President and Equity Division Manager, at 916-338-3232.