Commercial Loans and Fun Blog

The stock market is down another 600 points today, after being down more than 500 points last Thursday.  What will the future look like?

It's time to wake up, folks. The recession of 2007 to 2009 wasn't just a deep recession.  The approaching follow-up recession probably won't just be a double-dip of the same magnitude.  It will probably be much, much worse.  Historians may someday write that the Second Great Depression started in 2007, and, like the Great Depression that started in 1929, it consisted of at least three consecutive recessions.

Here's what you can expect:

The stock market will probably suffer a long, painful bear market that may last for more than a decade.  Japan's bear market has lasted for 22 years so far.  The Dow Jones Industrial Average may fall below 6,000.

Interest rates will probably stay low.  After all, a great many corporations and credit-worthy borrowers are too frightened now to borrow.  Prices of many goods and services will, by necessity, decline.  Yields on 30-year Treasury bonds may someday fall below 2.0%.  They aren't far off that number already.

Deflation, not inflation, will be the default trend.  Doubt this?  Oil has already dropped below $86 per barrel.  I wouldn't fall off my chair if oil dropped to less than $40 per barrel within a few years.  Remember, cars are becoming MUCH more fuel efficient, and it has been suggested that the world has already reached peak oil CONSUMPTION.  (Note: I did not say production.  I said consumption.)

Residential real estate is toast.  I expect home prices to fall another 40% to 50% from here.  Real wages are declining, and millions of qualified workers cannot find jobs.  Even worse, tens of millions of homeowners are drowning in mortgage debt, and they are upside down on their homes.  What incentive do they have to keep making their payments?

But what about commercial real estate?  Fully-leased commercial real estate will probably NOT plunge in value, if only because competing interest rates are so low.  As John Mauldin, the widely-read economics author, recently wrote, "I am am bullish on income."

That being said, however, the banks are already stuck with several trillion dollars in legacy commercial real estate loans.  They are under intense pressure from the regulators to get these troubled commercial mortgages off their books.  With commercial real estate values likely to deteriorate by at least 3% per year for the forseeable future, it is hard to see many banks making many new commercial real estate loans.

The only commercial lenders making commercial real estate loans for the next seven to ten years will probably be the private money (hard money) lenders.  Therefore, if you are a commercial property owner and you simply must borrow, you should steel yourself to paying 10% to 12% rates. 

If you are a commercial mortgage broker, you should find yourself a reliable hard money commercial lender, like Blackburne & Sons, and start rushing packages to them.  After today, those commercial loans that you had working at the bank are pretty much dead.

Bloomberg just came out with an interesting article listing the 20 healthiest major metropolitan areas in the country.  These metropolitan statistical areas (MSA's) had the lowest rates of unemployment, the highest job growth, and the least troubled housing markets.

Many of these markets included two or three large cities located close together that futurists now call mega-cities.  The presence of one or two large universities in these areas often serves as a floor to the level of economic activity. 

Some of the cities will surprise you, being located in the Rust Belt.  The reason why is because homes in these cities never really appreciated, like those of coastal cities, so the locals are not saddled with immense mortgage debt.

1. Washington, D.C. - Arlington, VA - Alexandria, VA
2. San Antonio, TX
3. Rochester, NY  (Really?  Yup.)
4. Pittsburgh, PA
5. Omaha, NE - Council Bluffs, IA
6. Oklahoma City, OK
7. Nashville-Davidson-Murfeesboro-Franklin, TN
8. McAllen-Edinburg-Mission, TX
9. Madison, WI
10. Little Rock, AR
11. Knoxville, TN
12. Jackson, MS
13. Honolulu, HI
14. El Paso, TX
15. Dallas-Ft. Worth-Arlington, TX
16. Columbus, OH
17. Buffalo-Niagra Falls, NY
18. Boston-Cambridge-Quincy, MA
19. Austin-Round Rock, TX
20. Augusta, GA

Anyone seeking a commercial mortgage located in one of these areas would be wise to point out the area's relative strength to their commercial lender.

A smart commercial lender should arguably never foreclose on a commercial property without first entering into a forbearance agreement with his borrower.  I'll explain why in a second.

I just returned from Las Vegas, where I spoke at Leonard Rosen's 26th National Hard Money Lending Conference.  Leonard always brings in top attorneys to speak on how to become a hard money lender.  Even though I have personally owned a hard money lending company, Blackburne & Sons, for more than three decades, I find that I always learn important new things at these conferences.  The wise technique that I will now describe was suggested by one of Leonard's veteran attorney-speakers.

Suppose a commercial borrower falls behind in his payments.  He has personally guaranteed the commercial real estate loan, and his wife is terrified that they may soon lose the family home.  Husband and wife are losing sleep.

The borrower contacts his commercial lender and begs for help.  The unwise lender brushes him off and files a lawsuit to foreclose.  The borrower countersues!  He claims that the bank's loan officer promised to increase the borrower's loan from $1 million to $1.2 million.  The borrower, the lawsuit claims, detrimentally relied on the loan officer's promise, and he just spent $100,000 - the last of his cash reserves - ordering new raw materials for his widget-manufacturing business.

Now the bank has a problem.  The countersuit will drag out the foreclosure for at least another 2.5 years, during which time the building is being neglected.  After all, why should a borrower keep the building in good repair when he is poised to lose it in foreclosure?  The roof starts to leak.  The mold starts to grow ...

This was a huge mistake that could easily cost the bank hundreds of thousands of dollars, assuming the building does not have to be completely demolished after the bank completes the foreclosure.

Here is what the bank should have done:  The bank should have executed a Forbearance Agreement with the borrower, offering the borrower lower payments for, say, six months, in return for ... a waiver of all prior claims against the bank!

This would almost certainly have cut off any effective countersuit by the borrower and allowed the bank to complete its foreclosure, if necessary, without opposition.  What a terrific technique!

Our hard money commercial mortgage company, Blackburne & Sons, has continuously been in the market to make new commercial mortgage loans for more than 25 straight years.  In other words, we're always in the mood to make commercial loans.  This is not just some advertising plug.  I have an important point to make in just a moment, and my point will be made in red.  It will surprise you.

In contrast to the "always ready" hard money brokers, a great many banks are constantly in and out of the commercial mortgage market every few years.  For two years a bank might be hot-to-trot to make commercial real estate loans.  Then, for the next three years, the bank might turn down all but the most perfect commercial mortgage loans (about as common as unicorns).  It's fair to say that 99% of the banks in the country today are only making commercial real estate loans to unicorns asking for perfect commercial loans.

So why are hard money brokers always in the market to make commercial real estate loans?  Hard money brokers are just market-makers.  They just have to lower the loan-to-value ratio and raise the rate until they reach a point where some private investor will invest in the loan. 

For example, let's suppose the stock market is tumbling 500 points a day.  Unemployed Americans are marching in the streets, and the demonstrations are becoming more and more violent every day.  Already dozens of cars have been burned, and the police have been forced to fire over the heads of the protestors in order to quell the violence and vandalism.  (I actually foresee this for America within two to three years.)

Now suppose a retired real estate investor owns a very nice office building in one of the more desirable areas of town.  He owns it free and clear.  Suddenly the retired investor gets nervous.  He wants to have more cash in hand, so he applies to a hard money broker for a quick commercial loan.  At the first the broker offers his private investors a loan of 70% loan-to-value at 12%.  No one invests in the mortgage loan.  The investors are too frightened to invest in a first mortgage.  The true unemployment rate is over 20%, and there is far too much violence in the streets.

Therefore, the broker might cut the loan to 60% loan-to-value and re-offer the loan at 14%.  If there are still no takers, he might eventually cut the commercial loan all of the way down to 45% LTV and offer the loan at a whopping 18% interest.  Finally, the investors will probably start buying, and the loan will finally sell out.  You could say that the loan has finally cleared the market.  The hard money broker finally found that combination of low loan-to-value ratio and high yield that would prove irresistable to wealthy mortgage investors.

Therefore, for most modern and desirable commercial properties, there is some combination of loan-to-value ratio and yield that will allow a hard money mortgage broker to arrange a commercial loan.

Ah, but here's the rub!  Here is the whole point of this article.  Sometimes, because private mortgage investors are nervous, the interest rate on a hard money commercial loan has to be so high that the borrower cannot afford the monthly payments!  And everyone loses if a hard money mortgage broker is ever forced to foreclose.

This is why Blackburne & Sons has recently developed the participation mortgage.  A participation mortgage has a very low interest rate - say, 7.9% in a market where most hard money investors are demanding a yield of at least 14%.  The missing yield is recaptured as an income kicker and and an equity kicker.  In other words, the hard money mortgage investor takes a piece of any future increases in the property's gross monthly income and in the property's fair market value.  In effect, the current owner of a commercial property gives up future income and appreciation, in return for a much lower monthly payment today.

Blackburne & Sons is rolling out a revolutionary new product for commercial loans called a participation mortgage.  Rather than make a new hard money commercial mortgage at 13.9%, we might now make the same loan at just 7.9%.  The loan, however, would have an income kicker and an equity kicker.

An income kicker is a share of any increase in the gross monthly income of the property.  For example, let’s suppose the gross scheduled income at the time the loan was originated was $10,000 per month.  If the gross monthly income goes to $16,000; then Blackburne & Sons would take a percentage of that $6,000 per month increase.  The typical income kicker would be between 15% and 50%.

An equity kicker is a share of any increase in the value of the property.  For example, let’s suppose a commercial building is worth $1 million at the time we originate a loan.  The borrower renovates the property and then leases it out.  Suddenly the property is worth $1.8 million.  Blackburne & Sons would take a certain percentage of that $800,000 increase in the value of the property, but only when the property eventually sells or our loan is either refinanced or paid off.  A typical equity kicker would be between 15% and 50%.

Why not just make the loan at 13.9% and forget all of this nonsense about income kickers and equity kickers?  The problem is that the monthly payments on a $1 million loan at 13.9% will break the financial back of many borrowers.  Hard money investors want their big yields, so it’s simply not possible to make a hard money loan at 7.9%, absent some sort of additional financial incentive, like these two kickers.

Very few commercial construction loans are being made these days.  I always figured that it was because the banks were just too darned scared to make new commercial construction loans.  After all, commercial real estate has fallen by 40%, and many commercial banks have suffered immense losses on commercial construction lending.

But not every company in America is losing money.  There are a great many companies tied to agriculture here in the Midwest that are making money hand over fist.  Why aren't they expanding their manufacturing facilities?

A developer buddy explained the problem to me.  A great many companies have enough dough to cover 20% of the construction cost of their new buildings.  Since these companies are also making money, the bank even tentatively approves their commercial construction loan - subject to the appraisal and other third party reports.

The vast majority of new commercial construction loan applications are falling out at the appraisal stage.  Many, if not most, commercial real estate appraisals are coming in at less than 75% of the actual construction cost. 

In order to be financially feasible, a new project should be worth 15% to 20% more than the cost of construction.  That difference is the developer's profit.

The Profit Ratio is the anticipated profit divided by the total cost to build the new building.  Bankers typically require this ratio to be at least 15% to 20%.  If the potential profit is too small, the developer will have little incentive to complete the project if he runs into any sort of cost overrun.  The last thing a bank needs is another half-completed project.

Modernly, not only are banks finding that the deals have no profit in them, but - even worse - the projects are worth, upon completion,  less than 75% of their construction cost.  Not surprisingly, you will see very few commercial construction loans getting funded.

There are still a few commercial banks willing to make new commercial construction loans.  You can submit your commercial loan to 750 hungry commercial lenders using C-Loans.com.

Four months ago I accepted an invitation from Leonard Rosen to be a panelist at his hard money lender seminar in Las Vegas. Folks, I was immensely impressed. Leonard Rosen is a warm, generous man; and more importantly, his Become a Hard Money Lender training course is the real deal. If you have ever dreamed of becoming a hard money lender yourself, you simply must attend.

You should come and meet me personally on July 28th at the Monte Carlo Resort and Casino at Leonard Rosen's next 8-hour seminar. At this conference, you'll learn how to become a hard money lender and earn residual income, in addition to just loan orrigination fees. You'll learn how to become the banker and to finally have control over your deals. You'll learn the hidden secrets of the hard money industry.

For more information, please click here.

A silent second mortgage is a second mortgage with no monthly payments.  The best way to understand how a silent second mortgage can be used is to see an example.

My hard money commercial mortgage company, Blackburne & Sons, was recently asked to refinance a balloon payment on a nice apartment building.  The problem was not the loan-to-value ratio.  That was fine. 

The problem was that the deal didn't cash flow.  The property was owned by a 401(k) plan, and the beneficiary of the 401(k) plan was not allowed to contribute money to the property to help cover the negative cash flow.  That would be an illegal 401(k) contribution.

We solved the problem using a silent second mortgage.  We convinced the private lender whose loan had ballooned to accept a partial payoff.  He was paid everything that he was owed, except for $75,000.

We had the original private lender then carry back his remaining $75,000 in the form of a second mortgage.  The loan carried an interest rate of ten percent, but there were no payments on this second mortgage!  The second mortgage had a term of three years, at which time the $75,000 in principal and the accrued interest would be due.

Volia!  Because our loan was $75,000 smaller, it now cash-flowed perfectly.  The private lender got most of his dough now, without the need to foreclose.  The 401(k) plan could now handle the monthly payments to Blackburne & Sons without the need of monthly, illegal contributions.  This was a nice win-win-win.

Don't Count on the Second Mortgage Holder to Bring You Current

Let's suppose you are considering a first mortgage investment of $100,000 on the purchase of a $200,000 little office building. The buyer is putting $40,000 down (20% of the purchase price), and the seller is carrying back a second mortgage of $60,000 (30% of the purchase price). A first mortgage loan of only 50% loan-to-value sounds attractive; but keep in mind that if the deal goes bad, second mortgage holders rarely bring first mortgages current, and if they do, they almost never keep up the payments for long.

You will recall that if the borrower defaults, the second mortgage holder will (almost always) be wiped out if the first mortgage goes to foreclosure. This is true even when there is a lot of equity in the property. Why? Because (almost) no one ever bids at foreclosure sales. Therefore, the only way for the second mortgage holder to protect himself is to bring the first mortgage current and to keep the first mortgage current while the second mortgage forecloses.

In real life, this almost never happens. In fact, I have owned Blackburne & Sons, a hard money lender, for over 30 years, and I can think of very few cases where a second mortgage holder actually brought our first mortgage current. More importantly, there has not been one case in over 30 years where a second mortgage holder has kept our loan current while he foreclosed himself. Not one.

The wise first mortgage investor will therefore never rely on a second mortgage holder to bring his loan current.

This is not an offer to sell first mortgage investments. An offer is made only through an Offering Circular. Investing in first trust deeds and first mortgages involves substantial risk. Please be sure to carefully review the Risk Factors section of the Offering Circular before investing. A substantial and prolonged decline in real estate value is possible.

Please click here for more information on first mortgage investments.

Keep This in Mind When You Invest in Trust Deeds

When a trustee holds a Trustee's Sale (foreclosure sale) or when a sheriff holds a Sheriff's Sale, the reality is that almost no one ever bids at these sales. Even if a lender is entering a credit bid of just $600,000 on a property clearly worth $1 million, 95% of the time no one else will bid more than $600,000. I have been the owner of Blackburne & Sons, a hard money lender, for over 30 years, and I think we have been outbid at just two foreclosure sales.

So why doesn't anyone bid at these sales? The biggest reason is that bidders have to bid all-cash. In other words, a bidder would have to bring a cashier's check to the foreclosure sale of $600,000. Who has that kind of cash?

Another reason is that the bidder takes the risk that there may be some title issues or easement issues. In a normal sale, the buyer gets title insurance to indemnify himself against these risks.

Lastly, a great many foreclosure sales get delayed at the last moment. After painstakingly investigating title and after raising a whopping $600,000 in cash (cashier's check), the bidder will frequently have to wait around for a sale that gets postponed time and time again. It's so discouraging that most potential bidders just give up.

There is an exception to this general rule. If the property being foreclosed is an inexpensive home - a deal where the bidder would only have to raise $50,000 to $100,000 in cash - it would not be surprising to see one or two bidders competing to buy the property.

This is not an offer to sell first mortgage investments. An offer is made only through an Offering Circular. Investing in first trust deeds and first mortgages involves substantial risk. Please be sure to carefully review the Risk Factors section of the Offering Circular before investing. A substantial and prolonged decline in real estate value is possible.

Please click here for more information on first trust deeds.