Commercial Loans and Fun Blog

Commercial Mortgage Lenders Are Requiring Larger Down Payments

Since the start of the Great Recession, commercial real estate lenders have become more cautious. Before the economic downturn, commercial lenders would regularly make commercial loans to 75% loan-to-value on office buildings, retail centers, and industrial buildings. In fact, in 2006 and early 2007 some conduit commercial lenders were even making commercial mortgage loans as high as 80% loan-to-value.

Today few commercial lenders will make new permanent loans much higher than 60% to 65% loan-to-value. In addition, they will not allow sellers to carry back a second mortgage behind their new first mortgage loans.

This means that real estate investors wishing to purchase commercial buildings must now put down 35% to 40% of the purchase price in cash. No surprisingly, far fewer commercial properties are changing hands.

There is a technique, however, that commercial real estate investors can use to reduce the size of their required down payments.  Instead of carrying back a second mortgage on the commercial property being purchased, the seller can carry back a second mortgage on a different piece of commercial property owned by the buyer.

For example, let's suppose that an investor wants to buy a commercial center owned by a seller. The parties agree on a price of $2 million. Without using this technique, the investor would probably be required by the bank to put 40% down - or $800,000 in this example. That's a lot of dough.

However, the parties might make the following agreement. The investor (buyer) will put down $500,000 in cash, which is still a significant amount. We, in the business, might say that the investor (buyer) has more than enough "skin in the game" to assure that he is motivated to make his new commercial loan payments and maintain the property. The seller - and this is the key - could carry back a second mortgage on an apartment building, a property different from the one being purchased, owned by the investor (buyer). This arrangement would probably pass muster with the vast majority of commercial lenders today.

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Also a A Primer on the Farmer Mac Program

Our hard money mortgage company, Blackburne & Sons, is actively making hard money loans on farm land and cropland nationwide.  Our sweet spot is loans between $100,000 and $1.5 million.

Our farm land loans and cropland loans are typically priced between 9.9% and 12.9%, depending on the risk, with 11.9% being the most common rate. Our typical fee is 2.5 points + $950 to 3 points + $950.

Because we are so bullish on farm land, Blackburne & Sons will lend up to 65% loan-to-value, even if the farmer/operator is losing money or has poor credit. Our hard money farm loans have no prepayment penalty.

The farm land cannot usually have a house on it because the loan could then be classified as a home loan, a type of loan we are not licensed to make. However, if the purpose of the loan is clearly commercial in nature - as opposed to intended for personal, family or household purposes - and the tillable acreage exceeds 30 acres, it may still be possible for the loan to considered commercial in nature. The value of the tillable acreage must clearly exceed the value of the home.

In order to promote Blackburne & Sons' new farm land loan program, I started calling on mortgage brokers who specialize in farm loans. One of them was kind enough to give me a primer on the Farmer Mac program:

Farmer Mac is an acronym for the Federal Agricultural Mortgage Corporation, a government-sponsored enterprise (GSE), similar to Fannie Mae or Freddie Mac. Farmer Mac buys farm loans and ranch loans from banks and correspondents and then sells the loans off as mortgage-backed securities. Farmer Mac never got crazy with their underwriting standards, so they are not suffering from waves of defaults, like Fannie Mae and Freddie Mac.

The underwriting standards of Farmer Mac are very conservative:

Minimum credit score of 680.
The loan cannot exceed 50% of the farmer's total assets.
The farmer's net income must exceed 130% of the proposed payment.
The farmer must have no late payments on prior Farmer Mac or other bank mortgage loans.

Blackburne & Sons' new farm loan program is designed for "near-miss" Farmer Mac borrowers - farmers who fall slightly outside of Farmer Mac's underwriting standards.

Got a farm land deal?  Please call Mike Thurman at 916-338-3232 or email him at thurman@blackburne.com.

Lenders Use Release Clauses So Developers Can Sell Off Lots, Homes or Condo's

Let's suppose a commercial lender - a bank - makes a $2 million commercial loan to a developer on a residential subdivision. The developer uses the proceeds of this commercial loan to obtain an approved subdivision map, to install the horizontal improvements (streets, curbs, gutters, water, sewer, power, etc.) and to market the 100 residential home sites. Now the developer is done, and he is ready to sell off his first residential lot for $40,000.

But wait. The lot buyer isn't going to fork over his $40,000 unless the developer is prepared to hand over the lot free and clear of any mortgages. The bank has a $2 million loan against the lot (and admittedly the other 99 lots). How do we get rid of the $2 million bank loan with the proceeds of just a $40,000 lot sale?

The sale will be accomplished using a partial release clause in the loan documents. A partial release clause is an agreement between the commercial lender and the borrower whereby a mortgage that blankets two or more parcels will be released from a particular parcel upon the payment to the commercial lender of a previously-agreed amount of money. For example, "The commercial lender agrees to release its mortgage against residential lot number 17 upon the payment $20,000." The bank gets $20,000 from the sales proceeds of lot number 17 (a nice culs-de-sac lot), and the developer gets to pocket the remaining $20,000 as his profit.

But be careful here. What if this new residential subdivision has just 15 culs-de-sac lots and 10 nice lots with views? What if the rest of the lots are stinky? Suppose the developer is able to sell all 25 premium lots for $40,000 each and gives the bank half the proceeds. That's $500,000 for the bank and $500,000 for the developer. Now the bank is owed $1.5 million, and its loan is secured by the 75 remaining lots.

What happens if the non-premium lots cannot be sold for any more than $18,000 each? If the initial release price per lot was set at $20,000 the problem soon becomes apparent. The developer cannot sell any of the remaining lots. Even if the bank cooperated and let him sell the lots for $18,000 each, this would only bring in another $1,125,000. The developer would still end up owing the bank $375,000, and all of the collateral would be gone!

Okay, obviously the bank needs to do something in order to protect itself. One way the bank will protect itself is that it will ask the appraiser to assign an anticipated sales price per lot. The release price per lot will no longer be a uniform $20,000 per lot. Instead, the premium lots might have a release price of $30,000 each and the non-premium lots might have a release price of $17,000 per lot.

But what if some of the lots cannot be sold for any reasonable price? What if consumers pick over the subdivision and leave 35 non-premium lots unsold? The developer would still owe the bank almost $600,000 and the bank would only have as collateral a bunch of undesirable lots.

To make sure that the bank does not end up with a bunch of unsalable lots (or condo's), the typical partial release clause will have a provision whereby the developer must pay down the construction loan or land development loan by 115% to 125% of the release price before the bank will release a unit. Therefore, in our example, the developer will have to pay down the land development loan by 120% of $30,000 ($36,000) in order to get a premium lot (culs-de-sac or view lot) released. This way a developer does not get to keep a lot of the profit and leave the construction lender with a bunch of crumby, unsellable lots or units.

Large Commercial Loans Today Are Being Written as Floaters with Collars

The days of long-term, fixed rate commercial loans are gone for awhile. Sure, a few life companies will still make commercial real estate loans between $5 million to $25 million at a long term, fixed rate; but commercial loans from life insurance companies seldom exceed 55% LTV today.

Most large, commercial loans getting funded these days are floaters - adjustable rate mortgage loans - on standing properties. Very few large commercial construction loans are getting funded these days, unless the loan is an apartment construction loan from the FHA.

Large land loans (over $2 million) are essentially impossible today too. No one is making them. In the years leading up to The Great Recession, large land loans were usually made by hard money lenders with large commercial mortgage pools. Unfortunately, almost every large commercial mortgage pool in the country is now either in bankruptcy or winding down.

The only large commercial loans being made today are loans on standing and almost fully-leased commercial properties.

When these loans are made, they are using being made by the money center banks as floaters. Floaters are adjustable mortgage loans with a term of usually only five years. They are usually readjusted monthly according to changes in one-month LIBOR. A typical margin is 300 to 400 basis points.

The borrower will usually want some sort of interest rate ceiling or cap. The lender will usually want some of floor on the loan. These interest rate caps cost money - usually an extra point or two. Sometimes a borrower can "pay" for his cap by agreeing to a floor. For example, a borrower can pay two extra points for a 4% ceiling; but if he agrees to a floor equal to the start rate, the lender might waive the two-point cap fee.

A loan with both a cap and a floor is said to have a collar.

If you need a large commercial loan today on a standing property, please write to me, George Blackburne, at george@blackburne.com or call me at 574-360-2486.

Is Extend and Pretend Finally Over?

It is very rare for a commercial lender to make a fully-amortized commercial loan. Most commercial real estate loans are amortized over 20 to 25 years, and they have a large balloon payment due after either five or ten years.

When Lehman Brothers collapsed in September of 2008, the market for commercial mortgage-backed securities (CMBS) also collapsed. At its peak, over half of all commercial real estate loans (by dollar volume) were originated by conduits to enter the pipeline to become commercial mortgage-backed securities. Then, without warning, "Boom!" (as John Madden might say) the entire CMBS industry suddenly disappeared.

Not surprisingly, since September of 2008, it has become far, far more difficult for borrowers to refinance their ballooning commercial mortgage loans. Rather than force their borrowers into foreclosure and bankruptcy, the securitization trusts and commercial banks, which own most of these maturing commercial real estate loans, have been either extending their loans or patiently forbearing from filing foreclosure.

This industry-wide practice has become know as extend and pretend or delay and pray.

The "pretend" part of that phrase acknowledges the reality that a vast number, if not a majority, of all commercial real estate loans are greatly over-leveraged. Suppose a five-year commercial real estate loan was written in late 2004 at 75% loan-to-value. Commercial property values since 2004 have probably fallen in the neighborhood of 35%. This ballooning loan has therefore probably soared from 75% LTV to around 113% loan-to-value.

As long as the borrower keeps making his monthly payments, however, commercial real estate lenders across the country have been extending their loans and pretending as if these loans were still adequately secured.

Is this a crazy strategy for the commercial banks? No. This is a perfectly rational decision. The same thing happened to Blackburne & Brown, our hard money commercial lending company, during the commercial real estate smash-up in California in 1991. For years we had made first mortgages on commercial real estate up to 65% loan-to-value. When commercial real estate values in California fell by 45%, two-thirds of our commercial loan portfolio was upside down. Our borrowers owed more on the property than the commercial real estate was worth.

Nevertheless, most of our commercial real estate borrowers just continued to make their payments. By 1994 commercial real estate values had recovered, and our most of our commercial loans were back to being right-side up. No one should find this terribly surprising. Poor people don't own commercial real estate. Rich people do. And most of these wealthy commercial borrowers could afford to just keep making the payments. Therefore I have no disagreement with those securitization trusts and commercial banks who have elected to extend and pretend or delay and pray.

However, the commercial loan officers at Blackburne & Brown are starting to report that more and more banks are finally demanding that their commercial real estate borrowers pay off their ballooning commercial real estate loans. They will extend and pretend no longer.

Suppose one of your commercial borrowers has a ballooning commercial real estate loan of $750,000 but he can only qualify for a $600,000 refinance.  Blackburne & Brown Equity Preservation Fund may be able to help. The Fund will invest $150,000 in your borrower's property and pay down his ballooning loan from $750,000 to $600,000. In return, the fund will take a share of the ownership of the property. Your borrower will still run the property.

Got a commercial real estate deal where you need equity? Please email E.J. Ridings at ejridings@gmail.com.

It Has Never Has It Been Harder to Close a Commercial Loan

A buddy of mine recently sent me an interesting email that says it all about placing commercial loans today.

George,

... The markets have been turned upside down. There is a real disconnect today with what the borrowers want and think they can get and what they can realistically can get from the lending community.

We just funded a $6.5 million loan for a self-storage project at a 6.95% rate for ten years. The borrower wanted a NON-recourse loan. While there were several hundred lenders in that market for that product 18 months ago, today there are none. The exception, the life companies, are at 55% LTV. Our deal was 61% LTV without 12 months of stabilized income. The life companies would not even take a hard look at the deal. The borrower was VERY well qualified, with lots of cash and a great financial statement.

We went to over 120 lenders who would make a loan on this property type in So Cal and found only ONE who would do the deal. The deal closed, and the lender has now eliminated self-storage as a product they will lend on.

Borrowers in most cases are still not realistic about what they will accept vs. the market. There is no 100% financing. The borrower must have 25% to 35% equity in the deals today. For refi's the borrower must have a DSCR of at least !.25:1, and even Fannie Mae wants 1.20:1 for apartments. And FNMA has a new requirement that they want you to own at least four multi-family projects, or have owned that total (in the past), if they are to consider you for a loan ...

R. H. Adams

This mortgage broker had to submit his commercial loan to 120 different commercial lenders before finding the one commercial lender who would do the deal. He didn't quit. To his credit, he pushed on and on until he found a home for the deal. You will probably have to do the same with your own commercial loans.

I have often said, "Sometimes placing a commercial loan is as difficult as finding a wife for your best friend. You can set him up with a lovely girl that is the right age, the right size, the right level of beauty, and the right religion ... and still there is just no chemistry or fireworks. All you can do is keep setting your friend up with new ladies. It becomes a numbers game."

So if you are trying to place a commercial loan with a bank or a life insurance company today, you may have to submit your commercial loan to 50 to 100 commercial lenders ... until you find just the right chemistry.

A Hypothecation is a Loan Against a Commercial Loan

Suppose a wealthy commercial real estate investor owns a commercial building free and clear. A potential buyer makes a good offer on the commercial building, subject to obtaining a new commercial mortgage loan at 7% from his bank for 75% of the purchase price. The wealthy commercial property owner accepts the offer.

Unfortunately the commercial lending world is in turmoil right now. Banks are afraid to make new commercial loans for more than around 62% loan-to-value. The bank turns down our borrower's 75% LTV commercial loan application, and the deal looks like it is going to fall apart.

Then the commercial real estate broker has an idea. He convinces the wealthy owner to carry back a commercial loan for 75% of the purchase price at 7% interest. After all, the wealthy investor owns the commercial building free and clear. The buyer puts down 25% of the purchase price in cash, and the deal closes.

Now let's scroll forward four years. The stock market has tanked, and the wealthy investor is not so wealthy anymore. He has lost 70% of his stock investments, and now he desperately needs cash to fix up an empty office building that he owns.

He takes his $750,000 first mortgage note that he owns to a number of commercial mortgage companies that specialize in discounting commercial notes. (By the way, if you ever want to sell a commercial note at a discount, please call me, George Blackburne, at 574-360-2486.)

Because his commercial loan has a 27-year remaining term and the note rate is only 7%, he learns that he will have to discount it by close to 28 points in order to sell it. He would have to give up over $200,000 if he tried to sell his note at a discount; and he really only needs the money for about 18 months. He is going to use the money to pay for the tenant improvements on his vacant office building. Once the new tenants move in, he'll be able to easily refinance the building and pull out lots of dough.

The investor therefore calls his clever commercial real estate broker, and the broker tells him to just hypothecate his first mortgage note. A hypothecation is a loan secured by a mortgage receivable. It's a loan secured by a loan.  In this case, the investor will be pledging his $750,000 first mortgage note as security for a new hypothecation loan of $500,000.

The advantage of hypothecation loan, compared to selling a mortgage receivable at a discount, is that the investor won't have to discount his perfectly performing first mortgage note by over $200,000. He'll just pay a modest 3 point loan fee on the new, smaller $500,000 loan. The interest rate on the hypothecation, typically around 12%, is admittedly higher than what a bank would charge for a new commercial loan, but banks are not really lending right now. In addition, our investor really only needs to borrow the money for about 18 months, until his new tenants move into his vacant office building and he refinances the building. It's far better to pay 12% on $500,000 for 18 months than to suffer a $200,000+ discount if he tries to sell his commercial loan.

If you own a commercial first mortgage note that you would like to either hypothecate or sell, please call me, George Blackburne, at 574-360-2486.

Here Are Some Quick Valuation Methods Used By Commercial Real Estate Brokers and Appraisers

Suppose you are a commercial loan broker or commercial mortgage banker. A commercial borrower comes to you and applies for a multifamily loan on his 32-unit apartment building. He absolutely needs $3 million in apartment financing. Is his commercial loan request reasonable, or is he wasting your time?

If you knew approximately how much his apartment building was worth, you could quickly check the loan-to-value ratio to make sure that it didn't exceed 75%. Few multifamily lenders, other than Fannie Mae, Freddie Mac and the FHA, will make apartment loans in excess of 75% LTV today.

One quick technique is the Gross Rent Multiplier. Take the annual rent of the apartment project and multiply it by the typical multiplier for your area. For example, suppose the annual gross rents for this project are $500,000 (about $1,300 per month per unit). If apartment buildings in this area are selling for a Gross Rent Multiplier of between 7 and 9 and the project is just of average quality, you might multiply $500,000 by 8 to give you a rough estimate of value of $4 million. A loan request of $3 million versus a $4 million value (75% LTV) is about the maximum loan amount that the borrower could hope to get.

Another technique is a market approach to valuation called the Price Per Unit. Suppose comparable apartment projects in this area are selling for $90,000 to $130,000 per unit. Because the subject apartment building is average and it is located in an average area of town, you might choose to use $110,000 per unit.  Thirty-two units times $110,000 per unit gives you an estimated value of around $3.52 million. Gee, a $3 million loan against a $3.52 million property isn't looking too promising. If you're busy, maybe you don't take on this loan, especially if the borrower absolutely must get $3 million.

"But, George, my office is located in Billings, Montana. I don't have a clue how much apartment buildings are selling for per unit in Atlanta, Georgia."

Here's a trick. The commercial brokerage firm of Marcus & Millichap (marcusmillichap.com) is well-known for refusing to take listings on over-valued multifamily properties. In other words, if the market value of an apartment building is $3 million, they won't list the building for $4 million.  So go to their web site, find some nearby and comparable apartment buildings, and determine the listing price per unit. Then you should probably reduce the price per unit by 7% to 10% to get a rough estimate of the market.  You can do the same thing using LoopNet.com.

Another commercial property valuation technique, the Capitalization Method, could be used to value the multifamily property. Suppose the borrower hands you a fact sheet containing a reasonable looking pro forma operating statement. If you knew that apartment buildings were selling in that area for 5.75% to 6.75% cap rates, you could merely divide the NOI by the cap rate to arrive at a rough estimate of the value of the building. For example, suppose the borrower provides you with a reasonable-looking pro forma perating statement. According to his own numbers, his NOI is just $220,000 per year. If you divide $220,000 in net operating income by an estimated market cap rate of 6.25%, you'll get around $3.5 million.

This borrower is probably hosed. He has a $3 million ballooning loan, and yet the building is only worth around $3.5 million. Unless this guy can bring another $400,000 in equity to the closing table, he may end up losing the apartment building in foreclosure. His best bet is to plead with the lender for an extension or a loan modification. By quickly valuing the property, you may have saved yourself a lot of wasted effort.

If you need a loan on apartment building, you can apply to 750 commercial lenders in just four minutes using C-Loans.com.

Comments at a Recent Banking Conference

“Last week, I hosted a meeting of mortgage lenders,” continued last night’s emcee. “They got together all the mortgage lenders in Britain who are still in business. I felt sorry for the guy. All alone…

“Today, a guy goes into a bank and he says… ‘I’d like to talk to you about a loan…’ and the banker says to him, ‘Great…how much can you lend us?’

Interesting Report from National Mortgage News Online

No one can be terribly surprised that the other shoe has finally fallen.  According to a June 22nd report from National Mortgage News Online:

Commercial Real Estate Prices Fall 8.6% in April

Commercial real estate prices as measured by Moody's/REAL Commercial Property Price Indices decreased 8.6% in April, leaving the index at 25.3% below its level a year ago and 29.5% below the peak in prices measured in October 2007.

According to Moody's, the large negative return for April likely reflects that deals closed during that month were negotiated at the end of 2008 and in the first quarter of 2009, when securities markets and overall sentiment were plunging. "The size of April's decline, following a 5.5% decline in January, also suggests that sellers are beginning to capitulate to the realities of commercial real estate markets," says Moody's managing director Nick Levidy.

The South has been the worst performing region over the last year, with an annual decline of more than 20%. Commercial real estate has performed worse in Southern California than in the Western region as a whole. In Southern California, the office market has been the worst performer, with prices dropping 22.2% in the last year.