Commercial Loans and Fun Blog

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.

The Population of America is Migrating to Mega-Cities Connected By High Speed Rail

The country's most sophisticated real estate investors are all buzzing about primary markets. A primary real estate market is a major metropolitan area that is enjoying significant job growth across a diversified spectrum of industries and a material net inflow of new residents. Examples of primary markets in the United States include Washington, D.C.; New York City, Boston, Chicago, Los Angeles, and the San Francisco Bay Area. If you are going to invest in first trust deeds, you should try to invest in loans secured by real estate located in a primary market.

Why are primary markets so important? Demographers, social scientists, and futurists point out that most new job creation starts in densely populated areas, where workers from different industries meet, mingle, and share ideas. Since most of the new job creation in the United States is occurring in primary markets, the population of the country is destined to migrate there, creating even denser concentrations of people.

According to George Friedman, author of the best-selling book, The Next 100 Years: A Forecast for the 21st Century, high-speed rail will connect two nearby major cities to create mega-cities. The population will live in suburbs along the rail lines.

Bottom line: If you are going to invest in first mortgages, you should try to invest in loans secured by properties located in primary markets.

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 deed investments.

Any Refinance Has to Rely on an Appraisal

All else being equal, a good argument can be made that purchase money first trust deed investments are often less risky than refinances. A purchase money loan is one where the loan is being used to buy the property. In a purchase money deal, the value of the property is usually established in the open market, where knowledgeable buyers and sellers, neither under any undue pressure, negotiate back and forth to arrive at the agreed sales price.

In contrast, any refinance must be based on an appraisal. Unfortunately, real estate appraisers - even the honest ones - are quite often wrong. Appraisers are often wrong for a number of reasons. Sometimes they are just plain incompetent. Fortunately, the states now test and license both residential and commercial appraisers. Commercial real estate appraisers must enjoy the General Certified Appraiser designation, which indicates that they have taken formal classes in commercial real estate appraisal and have passed exhaustive tests. Therefore the competence of the appraiser today is less of an issue than in years past.

However, it has been my observation that appraisers often fall in love with the borrower. Since appraising is a subjective process, there is usually a 20% swing in the valuation that an appraiser can justify either way. The valuation of a $400,000 building might easily be justified as low as $320,000 or as high as $480,000. If the appraiser likes the borrower, he might be tempted to bring in the appraisal at $480,000.

There are other reasons why appraisers are so often wrong. Some charismatic borrowers can make persuasive boasts about the value of the property or the demand for the space. "Tenants are beating down my door to lease this space." Such charismatic borrowers can dramatically influence the opinion of a human and fallible appraiser.

Sometimes good sales and leasing data is either outdated or unavailable. The appraiser then has to take data from different locations and make some sort of subjective adjustment because the subject property is either better or worse. These adjustments are little more than guesses.

Then, of course, there is outright appraisal fraud.

Bottom line: If you are looking at two different first trust deed investments, the purchase money loan may often be the less risky investment because you do not have to reply solely on some appraisal.

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 deed investments.

Sometimes the Best Time to Invest is When Blood is Running in the Streets

Commercial real estate has lost at least 40% of its value since 2006. Banks are reeling from their losses in commercial real estate loans. Of the 100 banks with the largest percentage of commercial loans in their portfolios, 42 of them have already been shut down by the FDIC. Many private investors in commercial first trust deeds made prior to 2007 have suffered painful losses. Now is not the time to be investing in commercial first trust deeds.

Or is it? Consider the following scenario: An office building legitimately appraised for $1 million in 2006. A bank made a $700,000 loan against it. In late 2007 the Great Recession started. Commercial real estate fell by 40%, dropping the value of the building to just $600,000. By early 2008, the tenant defaulted on his lease and moved out. The investor/owner tried to carry the mortgage payment on a vacant building out of his personal savings for several months, only to finally capitulate and default in late 2008. By mid-2009 the bank completed its foreclosure.

The bank finally sells the office building as an REO for $600,000 in early 2011. The buyer is an investor with a 700+ credit score. The buyer is prepared to put 40% cash down, and he is looking for a new commercial first trust deed of just $360,000. The buyer approaches his own bank, and several other banks in town, but no bank will write the loan. They are too nervous to finance commercial real estate right now because of all of the blood that is running in the streets. In addition, the property is vacant.

So the buyer goes to a hard money broker about a hard money loan of $360,000. Is this a reasonable loan? Would it be a wise first trust deed investment for some private investor?

A good argument can be made that now is a fine time to be investing in commercial first trust deeds. A loan of $360,000 is just 36% of the property's value in 2006. The buyer is putting 40% cash down. This means he has a lot of skin the game. He is not likely to just walk away from a $240,000 down payment. The buyer has excellent credit. Most important of all, the loan is based on an actual, arm's length purchase. We have finally found a price at which the property can clear the market; i.e., find an all-cash buyer.

It's terrifying to make new commercial real estate loans in the midst of a bloodbath; but sometimes the best time to invest is when blood is running in the streets. At no other time in the past 12 years could a trust deed investor regularly expect to be able to make a 12% commercial real estate loan to a wealthy investor with excellent credit on a standing commercial property at such a low loan-to-replacement cost ratio. Most other times some bank would have snatched up such a deal and offered the borrower a loan at less than 8% interest.

The deal described above is just a hypothetical deal. It's sole purpose is to stimulate your thinking and to open your mind to the idea that there may be some interesting commercial first trust deed investment opportunities out there right now.

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.

These Are All Important Terms in the CMBS Industry

You will recall that the term, "CMBS", is short for commercial mortgage-backed securities. CMBS loans are large commercial real estate loans that are originated by banks and conduits according to very strict, published guidelines. CMBS loans are usually secured by loans on the four basic food groups - multifamily buildings, office buildings, retail buildings, and industrial buildings.

When about $1 billion of new CMBS loans can be assembled, the loans are assigned to a trust. The trust then issues bonds (securities), backed by the commercial loans in the trust. These bonds are then sold by investment bankers, like Goldman Sachs or Morgan Stanley, to investors - like insurance companies, pension plans, and wealthy trusts. The banks and conduits, which originated the CMBS loans, get their money back, and the whole process starts all over.

The CMBS industry competes against life insurance companies for the largest and nicest commercial real estate loans in America. If you pick out any nice skyscraper or huge shopping center in America, you can bet that the property is financed by either a life insurance company or a CMBS loan.

The life insurance companies almost always win. Think of it this way. Jennifer Aniston was a lovely lady, but when Angelina Jolie set her sights on Brad Pitt, well ... Angelina got the man she wanted. It's the same thing in commercial real estate finance. CMBS loans have terrific terms, but if MetLife wants the loan on a particular power center, well ... MetLife will get the loan. Fortunately for the CMBS industry, life companies only have a limited appetite. They simply don't have enough dough to make every large commercial real estate loan in the country.

But wait a minute. Suppose a 30-year-old office tower in New York City has a $300 million balloon payment coming due. What if none of the large life companies wants to do the deal?  Could the CMBS industry handle a $300 million loan? After all, the typical CMBS offering is only on the order of $1.3 billion. That means a single loan could represent almost 25% of the entire CMBS offering. Yikes! Then think about an act of terrorism. Suppose terrorists blew up the building. The investors in that pool of CMBS loans would take an immense loss - far too large to be tolerable.

This is how the investment bankers handle big loans. First they started by taking a $70 million loan and splitting it into a $50 million "A-piece" and a $20 million "B-piece". The A-piece would obviously get paid before the B-piece. Only the $50 million A-piece would be added to the $1.3 billion CMBS offering, making that one large loan only around 4% of the total offering.  The $20 million B-piece would be sold to a private buyer. This kind of structure was called an A/B Note.

The problem with the A/B Note structure, however, was two-fold. First, it only worked on loans up to around $100 million. After that, the A-piece was simply too large to put into a single CMBS offering. Secondly, the B-piece was often hard or expensive to sell.

Therefore the investment banks came up with the concept of pari passu notes. Pari passu is Latin for "on equal footing." Issuers of commercial mortgage-backed securities began to split large loans into a series of smaller notes, each note being equally entitled to a pro rata share of any payments received. For example, a $200 million loan might be split into 5 pari passu notes of $40 million each, with each note going into a different CMBS offering. This worked well until the number of new CMBS offerings slowed dramatically after 2008.

Most CMBS offerings today are fusion deals. A fusion deal is a CMBS offering with one very large pari passu note - perhaps as high as $120 million - and forty or so smaller deals of $5 million to $20 million.

Do you need a conduit loan? You can apply to scores of conduits with one simple mini-app using C-Loans.com.

Are you an accredited investor? If so, what are you doing with your IRA? Accredited investors are earning 11% to 13% in first trust deeds.

Read our blog on trust deed investing.

Are you a mortgage broker? Download our free Commercial Loan Placement Kit, that includes a list of 200 hungry commercial lenders, a Commercial Loan Placement Checklist, our wonderful whitepaper, How to Place a Commercial Loan When Banks Are Too Terrified to Lend, and our webinar on Structured Finance.

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