Commercial Loans and Fun Blog

I recently read a fascinating book, The Next 100 Years.  The book makes some surprising predictions about the future, some of which are extremely relevant to commercial real estate finance.

The author, George Friedman, predicts that the population of the future will migrate from the suburbs to mega-cities, connected with high-speed rail lines.  The reason why is because future job growth will take place in areas of large population concentration, where ideas for new products and new companies are exchanged more quickly between budding young entrepreneurs, perhaps meeting at the local bar or bistro.

It is interesting to see the CMBS market moving in the same direction.  The commercial mortgage-backed securities market essentially disappeared for two years following the crash in 2007.  Bond buyers had no appetite for bonds backed by commercial real estate.

In the past seven months, however, bond buyers have displayed an increasing appetite for huge CMBS loans, secured by core assets, in primary markets.

A core asset is an essential asset for a business, an asset without which a business cannot carry on its main activity.  For commercial real estate investors, their core assets are those commercial properties that can be relied upon to stay rented and generate cash flow, even in the severest of recessions.  Typically core assets are Class A office buildings, R&D buildings, and retail centers that are leased to very strong tenants.

Okay, so we know that CMBS investors want huge loans - ideally larger than $10 million, but at a minimum larger than $5 million - secured by core assets in primary markets.  But what is a primary market?

As far as commercial real estate finance is concerned, a primary market is a large metropolitan area that consistently generates new enterprises and new jobs.  In plain English, its where commercial real estate investors want to be invested.

The number one, most desireable, primary market today in the United States is unquestionably Washington, DC.  and the surrounding suburbs.  The Federal government is a huge employer, and government employment is growing. 

The next most desirable primary markets are New York City, Boston, Chicago, Los Angeles and San Francisco.  Houston, Atlanta, Dallas-Ft. Worth, and San Diego would also be considered primary markets.

Las Vegas and Phoenix are greatly out-of-favor with commercial real estate investors today.

What is interesting to note is that the mega-cities described in George Friedman's book, The Next 100 Years, are the same ones described as primary markets today by commercial real estate investors.  

If Mr. Friedman is right, the population of the United States will be migrating to, and concentrating in, these primary markets in search of employment.  In a way its counter-intuitive.  One might think that the internet and tele-commuting would allow workers to spread out across the country.  Great minds, however, are convinced that the incubation of ideas, stemming from workers working in close proximity to each other, will lead to a greater concentration of the population of the future in primary markets, living along mass transit routes.

What on Earth is a Family Office?

It sounds like a simple concept, but a lot of commercial mortgage brokers and investors forget it. In order to be a direct commercial lender, you actually need money to lend.

So the next time some clown, who is asking you for a $20,000 application fee, tells you that he is a direct commercial lender, ask yourself this question, "Where is he getting the dough to lend?"

Money to make commercial loans only comes from a small handful of sources. Life companies get their commercial lending dough from the premiums that policy holders pay for their life insurance policies. Banks, savings banks, S&L's, and credit unions get their commercial lending dough from the deposits that they receive from depositors.

Conduits, also known as CMBS lenders, get their commercial lending dough on an interim basis from bank lines of credit. Their commercial loans are eventually sold to a trust, that securitizes the loans into commercial mortgage-backed securities. This source of funds was almost completely dried up for two years following the crash in 2007, but the CMBS market is now showing some signs of life - but only for deals of $5MM or larger.

I think there are only two surviving commercial mortgage REIT's - Avatar and BRT Realty Capital - and they are making loans at hard money rates. (Do you know of any other commercial mortgage REIT's? I'd love to hear about tem. george@blackburne.com.) REIT's get their commercial lending dough from the sale of shares in the real estate investment trust.

The remaining source of commercial lending dough comes from private investors and mortgage funds. In 2006, before the Great Recession, there were about 250 large mortgage funds making commercial loans nationwide. Virtually every one of these funds got crushed during the Great Recession. Commercial real estate fell by 40%, and then commercial lenders flooded the for-sale market with commercial foreclosures. Since "everybody" knows that you can buy commercial foreclosures for 60 cents on the dollar, everybody wants a deal. Nowadays few commercial property buyers will pay more than 60% of 60% of 2006 valuations. Therefore almost every commercial mortgage fund in the country is now in the process of being wound down.

This means that today, in early 2011, the only way to fund a hard money commercial loan was for the hard money broker to syndicate a fresh group of private investors. Raising private money is much more difficult in 2011, compared to 2006, because so many private investors got chewed up in commercial real estate and in stocks because of the Great Recession. Large hard money commercial loans - deals larger than $2 million - have become almost impossible to obtain because there are so few mortgage funds remaining, and large syndicates of private investors are extremely hard to assemble.

I did see recently, however, a brand new commercial mortgage fund that raised $100 million in their initial offering. They were able to raise this kind of money because they raised their dough from endowment funds and family offices.

So what is a family office?

A family office is a private company that manages investments and trusts for a single wealthy family. The company's financial capital is the family's own wealth, often accumulated over many family generations.

Traditional family offices provide personal services such as managing household staff and making travel arrangements. Other services typically handled by the traditional family office include property management, day-to-day accounting and payroll activities, and management of legal affairs. Family offices often provide family management services, which includes family governance, financial and investment education, philanthropy coordination, and succession planning. A family office can cost over $1 million to operate, so the family's net worth usually exceeds $100 million. Recently, some family offices have accepted non-family members.

More recently the term "family office" or multi family office is used to refer primarily to financial services for relatively wealthy families.

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A Wise Friend Has Advised Me to Often Get Additional Collateral

A buddy of mine, Paul, owns a hard money commercial mortgage company similar to Blackburne & Sons. He was kind enough to share the following pearls of wisdom:

Paul wrote: "It's been my experience (and I've been around longer than George, although I've been told that I'm younger and better-looking) that when your run-of-the-mill, medium-sized investor gets into trouble, he doesn't sink all at once. He takes a while to drown."

"There's generally some money coming in in dribs and drabs, and the question is, 'What is his motivation to pay us, rather than the other guy? Maybe some money comes in on rents, or maybe he manages to sell one property, etc. It's not just our problem with the debtor. It's just as much us versus the other creditors. The more dear the guaranty or the additional security, the more likely it is that we'll get paid in preference to someone else. AND, I CAN TELL YOU DEFINITIVELY THAT THIS IS THE REALITY, NOT JUST THE THEORY!"

"The vast majority of my deals include either a guaranty and/or additional security (cross-collateralization). Probably half my deals include both. It has saved my (bottom) MANY times. It can be a very effective weapon."

"My convoluted logic: A lender should demand and obtain the type of additional security that provides the borrower with a strong motivation to retain the property. When brokers ask me, "How much additional security do you need?", my answer is, "Enough to make it WALK-PROOF". The borrower cannot walk away from the loan."

"The example I use is - suppose the borrower has $1MM in equity he can pledge in a first mortgage position on something questionable (let's say land in . . . Indiana?), I may or may not be terribly interested. If he could also give me a $750,000 second mortgage on a high-quality apartment building, that could well be more interesting that the $1MM first mortgage on land. And, if he has $500,000 he can put up in third position on his primary residence, he has my undivided attention. Why? Because in a lot of these homes there's a wife with a butcher knife! ... and, she's my best friend. You've just added a whole another element to the motivation factor. We all want to keep our appendages intact.

"(Obtaining a personal guaranty also helps to make a property walk-proof.) The borrower certainly doesn't want his friends and relatives getting a letter from the guarantee holder notifying the guarantor of a default. I could go on and on about guarantys and additional security or both. The laws can differ in different states."

"Just one 'head's-up' that almost all the brokers and the majority of the lawyer's get wrong. Be very careful about additional property being put up by someone who is not the borrower. Don't make them both borrowers by taking the easy way out and having them both sign the note. One is the guarantor, and one is the borrower. Don't make them both borrowers on the note. In California, screwing that up can get you in big trouble. Further, the additional security being put up by the guarantor is not the security for the loan. It's security for the guaranty. One one property, you'll have a note secured by a mortgage. On the other, you'll have a guaranty secured by a mortgage."

Note to self and staff: Get either an outside personal guaranty (not just the owner of the LLC) or additional collateral, or both, on every deal.

Do you need a private money commercial loan? You'll find 150 hard money lenders on C-Loans.com. Is your deal bankable? You'll find 500+ banks on C-Loans.com as well. And C-Loans.com is free!

Interesting Deal Involves Merger of Land Lessor's and Land Lessee's Interests

Our hard money mortgage company, Blackburne & Sons, is competing for a very interesting loan this month. The borrower is the owner of a land lease. He leased the land to a developer for 55 years, and the developer built a large shopping center on the property.

Although the developer is still current on the underlying land lease, the shopping center has largely failed. Most of the retail spaces are vacant. The holder of the chattel mortgage on the developer's leasehold interest, a bank, started foreclosure, so the developer declared Chapter 11. The parties could not agree on a reorganization plan, so the bankruptcy court has ordered the sale of the shopping center's leasehold interest (the shopping center on leased land).

Our borrower owns the land lease. He receives a big land lease payment every month of, say, $15,000. Now he wants to buy the shopping center that sits on his land.

I was surprised to see a deal like this because normally the holder of the land lease would simply sit back and wait for the developer to default on his land lease payments. If the developer were to default, the holder of the land lease would declare him in default and "foreclose" on his land lease (more precisely terminate the developer's interest in shopping center). The holder of the land lease would then own the entire property - both the land and the shopping center that sits on the land - in fee simple (the normal way that people hold title). The land lessor's interest and the land lessee's interest would merge because they are identical parties.

In this case, however, the holder of the land lease is afraid that someone else will buy the shopping center, and he will be stuck with a "lousy" $15,000 per month income for the next 51 years. Fifteen thousand dollars per month sounds like a lot of money until you think of the hyper-inflation suffered by Zimbabwe.

Therefore our borrower is coming to us to help him purchase the land lessee's interest. Once the land lessor's interest merges with the land lessee's interest, he will be able to easily sell the combined interests for far more money than the sum of the two parts. Few investors want to buy real estate on leased land because it brings with it the obligation to make the land lease payments during a recession. In addition, real estate on leased land is sometimes difficult to finance.

Do you need a commercial mortgage loan on real estate on leased land? Simply go to C-Loans.com and apply for a normal first mortgage. Then, in the Special Issues section, please insert the words, "The property is on leased land with 49 years remaining on the lease. The monthly land lease payments are $4,600 per month." Be sure to apply to banks. Banks are the type of commercial real estate lenders who make commercial real estate loans on leased land.

Investment Banker Announces Closing of $20.6 Million Deal

There are so few large commercial construction loans that are closing nowadays that a recent closing of a $20.6 million apartment construction loan actually warrants a mention in our blog.

The loan was closed by a large regional bank. The project was a planned 125-unit apartment complex in Studio City, California. The project will be a mix of one-, two- and three-bedroom market rate apartments. Onsite amenities include a swimming pool and sun deck, tennis courts, and a clubhouse.

The construction loan, which represents 72 percent of the total development cost carries an interest rate of Libor + 2.75% with no floor, so the current interest rate is approximately 3.0%.

The mortgage banker that originated this loan sent an announcement of the closing to thousands of real estate brokers and finance executives. Such a closing announcement is called a tombstone. The typical tombstone will contain the contact information of the mortgage company originating the deal, in hopes of generating more leads.

Do you need a commercial construction loan right now? You can submit your mini-app to 750 different commercial lenders in just four minutes using C-Loans.com. And C-Loans is free!

Fannie Mae and Freddie Mac Will Not Lend on Apartments with Tuck-Under Parking

The conduits are making are making CMBS loans again, and the most preferred product is multifamily loans. The problem is that the agencies - Fannie Mae and Freddie Mac - have better rates and terms for apartment loans than the conduits. The agencies will also go higher in terms of loan-to-value.

The conduits are therefore looking for scratch and dent apartment loans that don't quite qualify for the agencies. One reason an apartment building might not qualify is that it cannot satisfy the 90/90 Rule. Fannie and Freddie will not finance an apartment building that has not been at least 90% occupied for ninety days.

Another fatal flaw for Fannie and Freddie is tuck-under parking. Tuck-under parking is basically carports underneath the building. The concern is that the building could collapse in an earthquake. Below is a picture of tuck-under parking.

Although the agencies won't finance properties with tuck-under parking, CMBS lenders will gladly make these loans. If your apartment building is also struggling to maintain 90% occupancy, you should consider a conduit loan.

Do you need a conduit loan right now? You can apply to several dozen conduit lenders in just four minutes using C-Loans.com. And C-Loans is free!

You can also write to me, George Blackburne, at george@blackburne.com. Simply insert the words, Conduit Apartment Loan Request, in the subject line of your email.

Commercial Real Estate Investors Are Close to Capitulation, Which is a Bullish Sign

I work as the Controller of Blackburne & Sons Realty Capital Corporation, one of the oldest private money (hard money) commercial lenders in the country.

Daily, trust deed investors call our office to inquire about the status of one of their particular investments, to question the amount of a disbursement, or to simply check-in on their overall portfolio. A couple years ago, the substance of the calls consisted of simple accounting questions or a request for a brief update.

For the past three years, given the deteriorated condition of the commercial real estate market, unfortunately many of the calls received today entail a scared or panicked investor, wondering how their investment(s) will survive. While each investor’s concern is voiced differently, the underlying emotions associated with those concerns tend be to be similar relevant to market conditions. I’ve facilitated investor calls five days a week, eight hours a day for the past 4 ½ years; but only after a seminar with Tony Woods, author of “The Commercial Real Estate Tsunami”, was I able to identify the investor emotions exposed in those conversations.

A chart provided in Woods’ book, courtesy of Westcore Funds of Denver, Colorado entitled “The Cycle of Market Emotions,” is a fabulous tool to understand the underlying emotional cycle. Examples of emotions are euphoria (the best feeling possible), down to fear, panic, capitulation and finally despondency.

Present day, I believe the majority of investors’ emotions seem to be in the area of panic or capitulation, based on the substance of calls and reactions to updates.  However, just recently more and more investors are becoming submissive (i.e. despondency). These particular investors still call for updates, but the information provided is no longer a shock or disappointment; rather considered par for the current market conditions.

It’s always darkest before dawn… so I remain optimistic for our loyal trust deed investors that again (hopefully sooner than later) the feeling of hope and relief in trust deed investing will be restored.

Angela Gimenez is the Vice President and Controller of Blackburne & Sons Realty Capital Corporation. The opinions expressed are her own.  She can be reached at 916-338-3232.

The More Commercial Mortgages a Bank Has in Its Portfolio, the Higher Its Chances of Being Closed By the Feds

I read today a terrifying statistic about commercial real estate loans. Of the 100 commercial banks with the highest percentage of commercial real estate loans in their portfolios, 42 of them have already failed. In the eyes of the regulators, commercial real estate exposure has become a frighteningly accurate predictor of bank health.

No wonder its so hard to get a commercial loan from a bank these days!

So what should a borrower or a commercial mortgage broker do?  He will probably have to submit his commercial loan request to scores and scores of banks before finding a commercial lender willing to make the loan.

The easiest way to submit a single commercial loan application to scores of banks is to use C-Loans.com. C-Loans is a commercial mortgage portal with 750 participating commercial lenders. The user simply completes a four-minute mini-app and then asks the system to display suitable commercial lenders.

He then puts a check mark next to six banks and presses, "Submit." Within minutes bankers will be calling him or emailing him offers.  And C-Loans.com is free!

Blackburne & Sons Makes Private Money Loans on Farms, Farmland, and Cropland

Let's suppose you own farmland, and you need to borrow some money. Perhaps you need to pay some delinquent real estate taxes or buy seed and fertilizer for this year's planting.

Normally you could just apply to a Farmer Mac mortgage company to refinance your property; however, what would happen if you were late paying your mortgage a couple of times last year? What if your tax returns did not show that you made enough money last year to make the new mortgage payments? In this case, you would not qualify for a loan from Farmer Mac.

Blackburne & Sons is a private money lender that specializes in making loans on cropland, even if the borrower's credit is poor or showed a loss last year on their tax returns.

To apply, please call Warren More at 916-338-3232 or email him at wmore@blackburne.com

This New Financial Ratio Has Replaced the Debt Service Coverage Ratio

For over 50 years commercial real estate lenders determined the maximum size of their commercial mortgage loans using the debt service coverage ratio. For example, a commercial lender might insist that the Net Operating Income (NOI) of the property be at least 125% of the proposed annual debt service (loan payments).

But then, in the mid-2000's, a problem started to develop. Bonds investors were ravenous for commercial mortgage-backed securities, driving yields way down. As a result, commercial property owners could regularly obtain long-term, fixed rate conduit loans in the range of 6% to 6.75%.

At the same time, dozens of conduits were locked in a bitter battle to win conduit loan business. Each promised to advance more dollars than the other. Loan-to-value ratio's crept up from 70% to 75% and then to 80% and then up to 82%! Commercial property investors could achieve a historically huge amount of leverage, while locking in a long-term, fixed-rate loan at a very attractive rate.

Not surprisingly, the demand for standard commercial real estate (the four basic food groups - multifamily, office, retail, industrial) soared. Cap rates plummeted, and prices bubbled-up to sky-high levels.

When the bubble popped, conduit lenders found that many of their loans were significantly upside down. The borrowers owed far more than the properties were worth.The lenders swore to never let this happen again. The CMBS industry therefore adopted a new financial ratio - the Debt Yield Ratio - to determine the maximum size of their commercial real estate loans.

The Debt Yield Ratio is defined as the Net Operating Income (NOI) divided by the first mortgage debt (loan) amount, times 100%. For example, let's say that a commercial property has a NOI of $437,000 per year, and some conduit lender has been asked to make a new first mortgage loan in the amount of $6,000,000. Four-hundred thirty-seven thousand dollars divided by $6,000,000 is .073. Multiplied by 100% produces a Debt Yield Ratio of 7.3%. What this means is that the conduit lender would enjoy a 7.3% cash-on-cash return on its money if it foreclosed on the commercial property on Day One.

Please notice that this ratio does not even look at the cap rate used to value the property. It does not consider the interest rate on the commercial lender's loan, nor does it factor in the amortization of the lender's loan; e.g., 20 years versus 25 years. The only factor that the Debt Yield Ratio considers is how large of a loan the commercial lender is advancing compared to the property's NOI. This is intentional. Commercial lenders and CMBS investors want to make sure that low interest rates, low caps rates, and high leverage never again push real estate valuations to sky-high levels.

So what is an acceptable Debt Yield Ratio? Ten percent - this is the lowest number that most conduit lenders are using to determine the maximum size of their advances. In our example above, the subject commercial property generated a NOI of $437,000. Four-hundred thirty-seven dollars divided by 0.10 (10% expressed as a decimal) would suggest a maximum loan amount of $4,370,000.

Typically a Debt Yield Ratio of 10% produces a loan-to-value ratio between 63% and 70%, the maximum level of leverage that the current CMBS B-piece buyers are requiring.

It is the money center banks and investment banks originating fixed-rate, conduit-style commercial loans that are using the new Debt Yield Ratio. Commercial banks, lending for their own portfolio, and most other commercial lenders have not yet adopted the Debt Yield Ratio.

You will notice in my definition of the Debt Yield Ratio that I used as the "debt" just the first mortgage debt. The reason why I threw in the words first mortgage is because more and more new conduit deals involve a mezzanine loan at the time of origination. The existence of a sizable mezzanine loan behind the first mortgage does NOT affect the size of the conduit's new first mortgage, at least as far as this ratio is concerned.

Will conduit's ever accept a Debt Yield ratio of less than 10.0%? Yes, if the property is very attractive, and it is located in a primary market, like Washington, DC; New York; Boston; or Los Angeles - an area where cap rates are exceedingly low (4.5% to 5%) - a conduit lender might consider a Debt Yield as low as 9.0%.

Need a commercial mortgage loan right now? You can apply to 750 commercial lenders - including several dozen conduit lenders - in just four minutes using C-Loans.com And C-Loans is free!