Commercial Loans and Fun Blog

This may be the most instructive training article that I have written in several years, so I strongly encourage you to study it.  (Note: This is NOT the subject vet clinic.)

Sometimes in the commercial loan business, you have to value a property based strictly on a capitalization rate ("cap rate").

 

 

 

 

Several years ago, I took on a commercial loan on an owner-occupied veterinary clinic.  The vet had gone through a divorce, and he had been forced to file for bankruptcy three years earlier.  He could therefore not qualify for a SBA loan.

The property was located in a town of over 75,000 people, so he could not qualify for a USDA business and industry loan either.  USDA B&I loans are very similar to SBA loans; but they are designed for rural areas.  Any town with a population of 50,000+ people is not considered sufficiently rural.

The loan had to go to a bank or credit union, so I was forced, absent an appraisal (always let the bank order the appraisal), to somehow create a pro forma operating statement on an owner-occupied veterinary clinic.  Hmmm.  How could I do that without having any idea of the market rent of a vet clinic?  Here is what I came up with, and I must say, it was brilliant.

 

 

 

 

I knew that the vet had bought the facility for $500,000 two years earlier.  To add in some property appreciation over the past two years, I multiplied $500,000 by 103%, which assumed a 3% annual appreciation rate.  To get the second year's value, after more appreciation, I multiplied the result by 103% again, producing a value after two years of $530,450.

Then I pulled a cap rate of 8.5% out of thin air.  Poof.  Remember, I am trying to get my client a commercial loan here, and any commercial broker (a commercial real estate salesman who specializes in selling commercial-investment real estate) will tell you that my cap rate assumption was probably about right.  I might have used 5.5% for a nice apartment building and 6.5% to 7.5% for a retail or industrial property.

You are reminded that a cap rate is just the return on his money that an investor would earn if he paid all cash for the property, assuming you built in a replacement reserve of around 3% of the Effective Gross Income.  The Effective Gross Income is the number you get after taking off 5% for vacancy and collection loss.

 

 

 

 

 

Now please remember where we are going.  We are trying a create a believable pro forma operating statement on an owner-occupied vet clinic, when rental comp's cannot be found.  You could look for a week and not find another vet clinic within 50 miles that was simply rented from some passive investor.  

You will recall that a pro forma operating statement is just an operating budget for the upcoming year, assuming you built in a replacement reserve to eventually replace the roof and the HVAC unit.

Quick Joke:

My wife and I had just finished a meal at one of our local restaurants when I realized I'd left my wallet at home. As the wife headed to the door to retrieve her purse from the car, she told the waitress what had happened, adding, "But don't worry, I'm leaving my husband for collateral." The waitress took one look at me and asked her, "What else you got?"

 

 

If you are not working towards building your own loan servicing
portfolio, get out of the business.  The money is in servicing.

 

 

Back to the Lesson:

Even though we have absolutely no rental rate comparable's, we can now compute the net operating income ("NOI") on the vet clinic.  We simply multiply the value of the building ($530,450) times the cap rate (8.5%) to arrive at the NOI ($45,088).

Confused?

 To value any commercial-investment
property using the income approach, we
simply divide the NOI by the cap rate.  

For example, if an apartment building had a net operating income of $300,000; and we knew that apartment buildings in the area were selling at 5.5% cap rates, we would simply divide $300,000 by 5.5% to arrive at a value of the apartment building of $5.45 million.

To value a commercial property -

Value = Net Operating Income / Cap Rate

 

 

 

 

Now let's get back to our veterinary clinic.  We are trying to build a pro forma operating statement, while hampered by the fact that we have no rental comp's.  

To get a net operating income, we simply move the formula around -

NOI = Value of the Property x Cap Rate

NOI = $530,450 x 8.5%

NOI = $45,088

We're getting there!  But your commercial lender will want to see a Gross Income, a 5% Reserve for Vacancy and Collection Loss, some expenses, including a management fee, and a 3% Reserve for Replacement.

 

 

 

 

The expenses are easy.  We just assume that the property is leased on a triple net basis ("NNN")!  The tenant (our vet) pays the taxes, the insurance, the repairs, the utilities, etc.   Poof.  Suddenly we have no expenses to worry about.  Am I good or what?  Haha!

But your commercial lender will still want to see you taking off 5% for Vacancy & Collection Loss.  He will want to see you taking off 3% for Management and another 3% for Reserves for Replacement.

We know that the NOI is just 94% of the Effective Gross Income, after taking off 3% for Management and 3% for Reserves.  Therefore to get the Effective Gross Income, we simply divide the NOI by 94%.

 

 

 

 

To get the Gross Income, we start by knowing that the Effective Gross Income is 95% of the Gross Income, because we have to take off 5% for Vacancy and Collection Loss.  Therefore we simply divide the Effective Gross Income by 95%.  Voila!  We've done it.

 

PRO FORMA OPERATING STATEMENT

Gross Income:                                         $50,364
Less 5% Reserve for Vacancy:                $ 2,398
Effective Gross Income:                          $47,966

Less 3% For Management:                     $ 1,439
Less 3% Replacement Reserves:           $ 1,439

Net Operating Income:                            $45,088

Take pride in your understanding of today's lesson.

 

 

 

 

Did I lose you?  Remember, I had to create a pro forma operating statement, so the lender could compute the debt service coverage ratio on your commercial loan request.  

The problem was that there were only about twenty veterinary clinics within 50 miles of the subject property, and all of them were owner-occupied.  There were no rental comparable's, so I couldn't just say, "Steve's Vet Clinic is leased for $3.00 sf, so the market rent of the the subject property must be $3.00 sf as well."

By assuming a reasonable and believable cap rate, we were able to work backwards to create a reasonable pro forma operating statement.

By the way, this commercial loan successfully (and easily) closed with a credit union, despite the recent bankruptcy.  Hoorah!

 

 

 

 

This is the perfect time to talk about the "quality" of income.  Real estate crashes seem to strike about every ten to fourteen years, and it has been thirteen years since the Great Recession.  If we were to have another commercial real estate crash, would you rather own a building leased to Betty's Gift Shop or one leased to Amazon.com?

 

 

 

 

The quality of income refers to the likelihood that you are going to receive it.  All money is green, whether it comes from the headquarters of the Catholic Church in America or from Boom-Boom's Place, LLC, a chain of gentlemen's clubs in southern Louisiana.

But is it likely that Boom-Boom's Place may have a little trouble making its rent payments or its mortgage loan payments if the economy completely tanks?  Guys are less likely to be drinking five beers a night and spending $30 on tips to the dancers if they are out of work.

Okay, obviously, we would rather be on the receiving end of $7,000 per month from Amazon.com than from Betty's Gift Shop; but in order to win that deal, we have to make some sacrifices.

 

 

 

 

Amazon.com, Inc. signs a lease for a small industrial building, perhaps used to repair its delivery trucks.  Upon the execution (signing) of the lease, the owners of the little industrial building offers the property for sale.

Now normal industrial buildings in Portland are selling at, say, 6.5% cap rates.  In other words, if an investor paid all cash for a garden-vareity industrial building in Portland, he could expect to earn, after paying all expenses and setting aside a little money every year to eventually replace the roof and the HVAC system in 12 years, a return on his money of around 6.5%.

A cap rate is just the return on your money if you paid all cash for a commercial building.

 

 

Wake up, folks!  The money
in this industry is in loan servicing fees!

 

 

Before computing that return on your money, always remember that you need to set aside a little money every year to replace the roof and the HVAC system.  This is called the replacement reserve.

Okay, so the seller has a building leased to Amazon.com for $7,000 per month.  Your accountant tells you that you need to set aside $850 per month to eventually replace the roof, repave the parking lot, and replace the HVAC system.  So the investment is scheduled to yield $6,150 per month.

Since industrial buildings in Portland typically sell at a 6.5% cap rate, you compute the value as follows:  Six-thousand-one-hundred-fifty dollars per month times twelve months suggests an annual net operating income ("NOI") of $73,800.

 

 

 

 

If you divide the annual net operating income (NOI) by the proper cap rate (expressed as a decimal), you get its value.

Okay, so $73,800 divided by .065 (6.5% expressed as decimal) equals a value $1.14 million.  Therefore you submit your offer of $1.14 million.  The selling broker falls out of his chair laughing.  What the heck?

"George," he says, "Betty's Gift Shop might sell for $1.14 million (a 6.5% cap rate), but this is Amazon.com!  The world could be in complete chaos, yet a buyer could absolutely depend on Amazon making its rent payments.  There are investors out there who need the security of predictable payments, and they will pay far extra to buy that stream of predictable payments."

 

 

 

 

"George, I have offers on this building of $1.5 million, $1.72 million, and finally $1.85 million.  That works out to a 4% cap rate."

When a real estate and stock market crash is coming, it's all about the quality of the income.

 

 

 

 

 

 

Wow.  If you walked into the executive offices of some savings and loan associations in the early 1980's, the wealth and opulence would have amazed you - walls paneled with expensive oak, glistening marble floors imported from Italy, and genuine crystal chandeliers hanging from the ceiling.  On the walls you would often find wildly-expensive oil pantings created by the great masters.

If invited, you might dine in the executive dining room, where highly-paid chefs would treat you to a masterpiece of culinary delight.  The President of the S&L might even fly in on the corporate jet to meet you.  And hence came the famous expression...

When the president gets a jet, sell the stock.

 

 

 

 

In other words, if the president of a publicly-traded S&L started spending money like a drunken sailor, dump your stock.  The orgy of excess spending all came crashing down just a few years later, when this lavish spending and some reckless underwriting caught up to the S&L's.  But how did we get here?

From the year 1933, which represented the bottom of the Great Depression, until the year 1986, Federal Reserve Regulation Q limited the interest rate that banks and S&L's could pay on time deposits (CD's).

In other words, suppose you owned a bank, and your bank desperately needed more deposits.  The other banks in town were paying just 2.0% on C.D.'s, but you were willing to pay 2.5% interest to your depositors.

 

 

 

 

 

Guess what?  You couldn't do it.  Regulation Q limited you to just 2.0%.  Your bank was not legally allowed to offer 2.5%.  In order to compete, banks offered free toasters or free transistor radios in order to attract depositors.

Then in 1986, Federal regulators relaxed Regulation Q.  As long as your bank was healthy, you could offer whatever interest rate you wanted in order to attract new deposits.

Suddenly, wealthy real estate developers were opening their own banks and S&L's.  Hot money was quickly being moved from bank to bank, as certificates of deposit matured.  Whichever bank or S&L in the entire country was offering the highest interest rate would get these fast-moving deposits.  After all, the deposits were insured by the Federal government.  It didn't matter which bank a depositor chose.

 

 

 

 

But as interest rates on bank certificates of deposit increased, it became increasingly difficult for a bank or an S&L to make a profit.  There was a practical limit as to how high of an interest rate an S&L could charge for a mortgage loan.

To make matters worse, the bleeding heart California Supreme Court, in an infamous decision known as Wallenkamp v. Bank of America, had ruled in 1980 that a due-on-sale clause in a mortgage was unenforceable.  Other states soon followed suit.

Prior to this boneheaded decision, a bank could make a 30-year home mortgage at a fixed rate of, say, 3.5%, knowing that the vast majority of homeowners would move and sell their house every seven years.  When they sold their homes, the mortgage would have to be paid off.  If interest rates crept up to 4.25%, it was not the end of the world for the bank because the loan would almost certainly be paid off in just a few years.

 

 

 

 

 

After the Wallenkamp decision, however, banks and S&L's became forced to allow new buyers to assume their low-rate, 30-year mortgages.

As interest rates on both C.D.'s and mortgages marched upwards due to raging inflation, banks and S&L's soon found themselves actually losing money on the older fixed-rate mortgages in their portfolio.  They might be forced by inflation and competition to pay 6% on deposits, while earning just 3.5% on a mortgage loan that potentially could stay on the books for the next 30 more years!

Banks did not suffer as badly as savings and loan associations.  Banks always wrote fewer mortgage loans than S&L's.  Banks, in those days, also priced many of their business loans at 2% over prime.  As the prime rate marched ever upwards, so did the interest rate charged to their borrowers.

 

 

 

 

But S&L were only allowed by charter at the time to make mortgage loans, not business loans.  These mortgage loans were almost universally fixed rate loans.  The fixed rate on the mortgages in the portfolio of an S&L soon became too low for most S&L's to make a profit.  Remember, the prime rate reached 21.5% in 1981, as inflation approached 16% annually.

The Explosion of Construction Lending:

Savings and loan associations therefore became desperate to earn more income.  They found this additional income in the form of construction loans.  

Construction loans, assuming the project goes well, are very profitable for a bank or an S&L.  The bank gets to earn its two-point loan origination fee (competition has since forced this typical loan origination fee down to just one modernly) on the entire loan amount, but in the early months, the bank has only a tiny fraction of the loan outstanding.   Cha-ching.  This works out to a huge yield for the bank.

 

 

 

 

In addition, construction loans are short term.  Banks greatly prefer short term loans because they can get their money back and then go into turtle mode if they see a recession coming.  

Therefore, in the early 1980's, commercial construction lending went wild.  The skylines of every football team city in the country were lined with huge construction cranes, as huge office towers and hotel towers climbed towards the heavens.

The Savings and Loan Crisis:

Then the government changed the tax law.  No longer could depreciation losses be used to shelter the incomes of the rich and of high-income earners, like physicians.  They began to dump, and even walk away from, their commercial real estate holdings.  Prices plummeted by 45%.

 

 

 

 

At the same time, the price of oil also plummeted.  Oil-producing regions like Texas and Colorado saw their incomes shrivel and their office buildings soon emptied.  The era of see-through buildings had arrived.

A see-through building was typically an office tower with no tenants and no tenant improvements.  Because the building was just an empty shell, you could literally look in one window and see the seagulls flying outside of the far windows.  

The S&L's Crisis rolled across the country, starting in the East first, reaching Texas 18- months later, and finally reaching California 18-months after that.  The crisis came to a head and resulted in the failure of 1,043 out of 3,234 savings and loan associations in the United States between 1986 and 1995.

The rest is history.

 

 

 

 

 

 

The date was around 50 years before the birth of Christ.  The Roman Republic had wonderfully prospered under a truly republican form of government for almost 400 years.  At the time, there were no kings, no emperors, no dictators, or no Caesars in Rome.  The Senate alone ruled the city-state.

In 49 B.C., Julius Caesar was then the governor of Gaul.  Gaul consisted about a dozen smaller kingdoms, which combined would eventually become France.  Caesar had conquered each kingdom and province in turn.  As he moved from province to province, he sold the captured people of Gaul into slavery.  Caesar made an immense amount of money in the process.

 

 

 

 

In terms of relative wealth, Caesar was the Bill Gates of his era.  He was not the single richest man in Rome, but he was definitely one of the top three or four.  

Caesar had also raised and paid for EIGHT of his own legions, and he did so without the Senate's permission.  "Aye, there's the rub."  (Hamlet, Act 3, Scene 1.)  Eight legions were a lot in those days.  The Senate had only given its quasi-permission to raise one legion.  The Senate controlled only 12 or 13 legions, and they were scattered all over the Roman Empire.  The Senators of Rome were genuinely scared.

Two more bits of background before Caesar crosses the Rubicon.  First of all, the Roman judicial system was totally and completely corrupt.  The judges all took bribes, and sometimes they even had the parties bid against each to see who would pay the largest bribe.  Justice in Rome could not be found in the courts.  The ruling of the Judge was already decided before most trials even started.

 

 

 

 

Now the last bit of background.  Rome had already suffered several bloody civil wars, so the Senate had passed an inviolate law.  Any Roman general who brought a legion across the Rubicon River in northeastern Italy was immediately declared an outlaw and an enemy of the state.  It became the duty of every Roman citizen to kill him.

Okay, so Caesar is in Gaul, putting down the occasional uprising, collecting even more slaves, and getting even richer in the process.  But Caesar had enemies in Rome.  Many rich and powerful political families had their own gang of thugs, including Caesar.  These gangs would all use clubs to crush the skulls of any political enemies caught walking the streets of Rome.  Swords were strictly forbidden.  To carry a sword in the city limits was an automatic death sentence.

As the body count grew, lawsuits were filed against Caesar.  The suits weren't just about money.  Many of these lawsuits were quasi-criminal in nature, and if Caesar was ever brought to trial, he could expect to be murdered in jail on his very first night.

 

 

 

 

The good news was that Caesar was immune from civil litigation as long as he was the Governor of Gaul.  The bad news was that Caesar's (five year?) term as Governor was about to expire.  The Roman Senate ordered him back to Rome to stand trial. Remember, the trials were all fixed, and the order from the Senate was effectively a death sentence.

So what does a general with EIGHT legions do?  Caesar marched his most loyal legion across the Rubicon (really just a large stream) and headed for Rome.  Oops.  The Senate looked around and realized that the forces they had to face the most brilliant general since Alexander the Great were pathetic.

The Senate and the Roman Army therefore fled Rome to Greece, and the Roman Civil War ensued.  The Senate eventually raised seven legions in Greece to Caesar's four, but in the big showdown - a fierce battle in Greece that pitted Roman versus Roman - Caesar pulled off a brilliant battlefield move.  Together with the fact that his troops absolutely adored him and the fact that his troops were all seasoned veterans, Caesar's forces routed the young, inexperienced troops of the Senate.

 

 

 

 

The Roman Republic was dead.  Never again in history was the Roman Senate anything more than just a figurehead.  The real power always rested thereafter in whoever was Caesar.

Let me put this differently.  The Roman Senate brought a bull-pucky legal suit against Caesar, and they lost the Republic.

Have you figured out yet why I am writing about Caesar and the Rubicon today?  The undeniably blue State of New York brought criminal charges this week against the Trump Organization, citing a scheme to defraud, conspiracy, grand larceny and falsifying business records. 

 

 

 

 

Now folks, I am not saying that an army of Trump supporters is going to descend from the hills and overthrow the American Republic.  C'mon, guys, get real.  

But I do believe it is historically ignorant for the State of New York to set the insanely dangerous precedent that any American president who loses power will be instantly exposed to, and assailed with, charges from the states controlled by the opposite party.  Think about President Duarte in the Philippines, who instructed his army, the police, and his own hit squads to instantly shoot 6,000 (20,000?) drug dealers.  Why would I bet that Duarte will declare marshal law and extend his own term?

Let me be clear and not beat around the bush.  Those New York State prosecutors are so historically ignorant that they should not be allowed to have children.  (Don't hold back, George, tell us what you really think.  Hahahaha!)  C'mon, you New York prosecutors.  You are attorneys.  You all studied history.  You should know better than to set such a dangerous precedent.

 

 

 

 

For God's sake, the single most important thing about America is that political leaders and parties can change power in America peacefully.  If you make an outgoing President or a political party fear for their freedom or their own physical safety when they step down from power, how long will it be before America is no longer a republic?

Imagine the following scenario:  Admiral Smith anticipates a Chinese invasion of Taiwan, and through the use of a distributed defense, where missile launchers are spread out over 50 different islands, ships scattered in the South China Sea, and 60 rusting old trawlers pressed into service as missile ships, we sink the entire invading Chinese fleet.

Admiral Smith retires from the Navy, greatly adored by servicemen from all five  branches of the service.  Don't forget that we now have the Space Force, who surely played a huge role in the First Chinese War.

 

 

 

 

Admiral Smith runs for President, and he wins in a landslide.  But a great many Americans grow to hate him.  He has raised taxes, and he used the additional income to build more underground missile plants and to build new American shipyards in Mexico and Canada.

The American economy has been on a war footing for too long, and it has suffered.  Inflation stands at 12% annually, and good-paying, non-military jobs are scare.  Millions of Americans come to hate Admiral Smith, even though he keeps warning them that China will soon attack again.

The State of Utah then files criminal charges against Admiral Smith for having only two wives.  C'mon, guys, I am just having some fun here; but my point is that the State of Utah files some bull-pucky charges that carry a life sentence.  Yikes.

 

 

 

 

So Admiral Smith appeals to the military, who absolutely love him and agrees with all of his warnings and preparations for the next Chinese war.  Congress is "temporarily" closed, as Admiral Smith declares marshal law and extends his own term.  "I have no choice but to protect America from China."

So to the prosecutors in New York, I call you historically ignorant.  You have set an insanely dangerous precedent, and you may have just cost us the American Republic.

"Those who cannot remember the past are condemned to repeat it." -- George Santayana

 

 

 

 

 

Some of the cheapest commercial mortgage money in the whole world comes from trusts.  There are trillions and trillions of dollars currently invested in trusts.

 

 

 

For example, a wealthy dad might create a trust for his two minor children, where they receive a monthly income and the payment of their education for twenty-five years, until they reach the age of, say, 30 years old.

But here's the thing.  The trust documents will often say that the trustee is only allowed to invest in bonds with a certain credit rating; e.g., BBB or better.

 

 

Click here to view the video lesson.

 

Therefore, in order to invest in commercial real estate loans, those commercial loans - more precisely, the bonds backed by those commercial loans - must be rated by a bond rating agency, such as Standard & Poor's Global Ratings, Moody's, and Fitch Ratings.

The process of taking around 80 large commercial real estate loans - totaling, say $1.5 billion to $3 billion - and turning them into bonds that can be rated by a bond rating company is called securitization.

 

 

 

 

The bonds themselves are called commercial mortgage-backed securities ("CMBS").  The CMBS industry is huge, and it helps to provide permanent commercial loans, with rates not much higher than those offered by life insurance companies ("life companies").  Life companies offer the lowest interest rates in commercial real estate finance ("CREF") and get the safest, most desirable commercial loans.

Today's three-minute video lesson attempts to quickly explain the concept of a tranche.    A tranche is a division or portion of a pool or whole.  Think of a tranche as one of the pancakes in a tall stack of flapjacks.

 

 

 

 

Specifically, a tranche is an issue of bonds derived from a pooling of like obligations (such as securitized mortgage debt) that is differentiated from other issues, especially by maturity, rate of return, or risk.

Confused?  This short video training lesson should help.

 

 

 

 

 

 

So you own an office building, with a $6 million commercial loan from a conduit.  All is going well, until you add on in the back of your office building a $4 million self storage project.

But it's all good, right?  That vacant space was being wasted.

The self storage addition is a huge success.  You quickly begin to fill it, and the value of your commercial lender's collateral soars from $11 million to a whopping $16 million.  Your lender's commercial loan is now just 37.5% loan-to-value.

 

 

Click here to view video.

 

You paid cash to construct the self storage addition, and the net cash flow on the property has increased by $14,000 per month.  How could any commercial lender not be thrilled?

But then the loan servicing agent for your conduit commercial lender gets the annual tax bill, and the tax bill is materially higher.  They write to you for an explanation.

 

 

 

 

"No problem, guys.  At my own cost, I just added 122 self storage units  on the unused land in the rear of our office building.  The value of your collateral has just increased by $5 million.  You're welcome."

And then the poop storm begins...  Click here to view the video and to watch in horror as the downpour from hell drenches this unfortunate commercial property owner.

 

 

 

 

 

 

This four-minute video training lesson will help you become better at underwriting commercial real estate loans

 

 

 

 

Historically commercial lenders and commercial construction lenders have required that a borrower's or a developer's net worth be at least as large as the commercial loan or construction loan that he is requesting.

In a perfect world, if the developer is applying for a $5 million construction loan, he should have a net worth of at least $5 million.

Fortunately commercial construction money is so plentiful today that many construction lenders are relaxing this requirement.

 

 

 

 

The test that commercial construction lenders apply is the Net-Worth-to-Loan-Size Ratio.  Simply divide the net worth of the developer by the loan size.  This result should be greater than 1.0.  During recessions, banks will often require this ratio to be as high as 1.5.

What if there are several members of the development company with a decent net worth, but none of them alone satisfies this test?  Answer:  You can combine the net worth of the developers.

 

 

You need to work every day towards building your
own loan servicing portfolio.  Is where the money is.

 

 

Commercial mortgage money and commercial construction money is immensely plentiful today, so lenders are relaxing the Net-Worth-to-Loan-Size Ratio.  How low will they go?  Nothing is written in stone, but some commercial construction lenders may consider a Net-Worth-to-Loan-Size Ratio as low as 0.75.

But if the developer's net worth is not even 75% of the commercial construction loan that he is requesting, then the loan request is seriously flawed.

 

 

 

 

 

 

It has been my observation over the past 41 years that the real estate market tends crash about every ten to fourteen years.  It has been 13 years since the Great Recession, so we are about due.

Normally real estate crashes are the result of some malinvestments.  “Mal” is Latin for bad, like in the word “malpractice.”  A malinvestment is an unusually bad investment, normally implying some immensely large losses on a nationwide (or worldwide) scale.

 

 

 

 

Countless over-built, vacant, and see-through office buildings in 1986 led to the Savings and Loan Crisis and a 45% decline in real estate values.  The Dot-Com Bubble in 2000 was another example of malinvestments leading to a 45% real estate crash.  The Subprime Mortgage Crisis in 2008 lead to the most recent 45% decline in real estate values.

Anybody out there notice that each of these crashes was exactly 45.000%?  About 18 months into the next real estate crash of 35%, my sons are likely to invite you to join in a syndicate to buy up some distressed real estate.  If you are accredited, join! Invest!  Make a fortune!  It’s going to be scary to invest during a bad recession.  Get over it.  You know in advance that the crash and the eventual bounce are coming.

Thirty-five percent, George?  I thought you said that real estate crashes by exactly 45.000%?  You will never-ever catch the absolute bottom of a real estate crash.  Real estate values bounce off their nadir (lowest point in a cycle) and then begin to soar in about one nanosecond.  Bounce, skyrocket.  You are likely to almost double your money in three years, so don’t hesitate... and don’t get greedy and try to catch the absolute bottom.  An 80% to 90% increase in value in just three years is plenty.

 

 

 

 

Okay, so what will be the next big malinvestment?  My bet is on cryptocurrencies; but possibly not until after a huge bubble - far larger than the current one - has grown and popped.

After the pop, speculators are going to realize that they don’t even own a vacant office building, a dot-com company (while Pets.com crashed and burned, Priceline.com actually survived), or even an over-valued home.  They are going to realize that they only own some worthless entries in some untouchable blockchain that they can never spend.

Here’s the problem with cryptocurrencies - pretty girls.  Huh?  What?  Life is actually simple to understand.  Boys will do anything to kiss a pretty girl.  It’s why they wear their pants around their ankles and their baseball caps sideways.  They think it attracts girls.  I used to get really angry when some young man would drive around my neighborhood, blasting the bass on his car stereo.  I felt it was a personal challenge to come out and fight.  He wasn’t challenging me to come out and fight.  He was just trying to attract a pretty girl.

 

 

The real money in commercial real estate finance
is in loan servicing fees.  It's easy!

 

 

Okay, now back to cryptocurrencies and malinvestments.  The way new bitcoins are created is when immense server farms solve these incredibly difficult algorithms.  This allows the number of bitcoins to grow, but at a very controlled pace.  The problem with solving these incredibly difficult math algorithms is that it takes an immense amount of electrical power to run these computers and to cool them.  There are coal-fired power plants in central and western China that are cranking out unconscionable amounts of greenhouse gasses to power these server farms.

And this is where the pretty girls come in - the "hippie chicks" of today.  Sooner or later these beautiful and desirable women are going figure out - as Elon Musk recently did - that cryptocurrencies are destroying the planet.

 

 

 

 

The largest ice shelf in history just calved off Antarctica yesterday.  These pretty girls are going to start to protest against cryptocurrencies.  Want to kiss a pretty girl?  You better be against cryptocurrencies.  Soon - say, in about a year - it will become politically impossible for any public company to accept Bitcoin in payment… and then the cryptocurrencies will fall towards worthlessness.

The possible winner?  Silly little Dogecoins.  New Dogecoins are created automatically by the blockchain on a regular schedule, and there is absolutely no mining involved.  There are no huge algorithms to solve.  Want to win the love of some pretty girl?  It might not hurt to publicly curse Bitcoins and to own some Dogecoins.

 

 

 

 

 

 

This really happened:  The other day I went to a medical laboratory for a blood draw.  As I sat down, I jokingly told the phlebotomist, "I need to warn you.  I'm a screamer."  She immediately quipped back, "That's okay, I'm a muzzler."  Oh, to have a wit that fast again.

 

Kinda cool:  Actual gold confiscation order from 1933.

 

 

CREF Training Lesson For the Day:

When trying to obtain a loan on a hotel, it makes a huge difference to most commercial lenders whether a hotel has interior corridors.  

Interior corridor hotels provide guests with access to all of the rooms from within the building.  All hotel room doors are located within an interior hallway.  Most rooms are designed with the bathroom at the entrance and a window at the opposite end of the room.

Why are interior corridors are so important?  Protection from rain and snow falling sideways is obviously an issue.  But the most important reason is security.  

Arguably, a hotel with exterior corridors is functionally obsolete; in other words, it has a feature so expensive to fix that the hotel is unable to be used to adequately perform the function for which it was intended.

 

 

 

 

The Motel 6 chain, for example, was having a real problem with bad guys watching their victims go to their rooms from the parking lot.  When the right victim was identified, the bad guys would simply kick in the door and then rape and/or rob the victim.  The police would often take seemingly three weeks to arrive, and by then the bad guys would be long gone.

If you are having trouble placing a loan on a motel or hotel with exterior corridors, you might apply to Blackburne & Sons.  We once even made a loan on the World Largest Female Mud Wrestling Palace.  The loan paid perfectly, but the owner made so much money that he paid us off early.  [Sob.]  And then there was the time when we (unknowingly) made a loan on a bar engaged in dwarf-throwing contests...  Haha!

Deadly Feasts and Prions:

Back in 1997, an author by the name of Richard Rhodes published fascinating book, Deadly Feasts: Tracking the Secrets of a Terrifying New Plague. 

 

 

Once again, the whole purpose of being in finance is to 
build a loan servicing portfolio.  That's where the money is!

 

 

In this brilliant and gripping non-fiction medical detective story, the author follows virus hunters on three continents as they tracked the emergence of a deadly new brain disease that first kills cannibals in New Guinea, then cattle and young people in Britain and France - and then is traced to food animals in the United States.

Virus hunters?  The truth is that a prion - the incredibly dangerous vector that they were chasing - is not a virus.  It is not alive.  It was never alive.  You can even torch it with one of Elon Musk's Not a Flamethrower (its a flamethrower, folks), but the evil pathogen cannot be destroyed.  If it gets in your food, you will die a blithering idiot.  It is the human form of Mad Cow Disease.

So what is a prion?  A prion is a protein that twists itself the wrong way.  Think of it as a Twizzler which twists to the left, instead of to the right.  The result is that the infected human cell always dies.

 

Free Kisses.

 

 

But that's not even the bad news.  If the protein twists "to the left", the proteins in the adjoining cell go, "Hey, the protein over there gets to twist to the left.  I wanna twist to the left too!"  So they also twist to the left, which kills their host cell, but not before badly influencing all the proteins around them.

The other piece of bad news us that prions migrate to the brain.  Yikes.  Mad Cow Disease is called bovine (cow) spongiform (looks like a sponge) encephalopathy (brain disease).  When you look at the brain of an infected cow under a microscope, it has so many holes in it, it looks like a sponge.  The cow gets so stupid that it forgets how to stand and eventually even how to breathe.

Okay, so back to the Deadly Feasts.  The children of the cannibals of Papua New Guinea were all dying.  Modern cannibals no longer slaughter innocent explorers and eat them.  Joke:  Cannibals capture two missionaries and throw them in the stew pot.  Suddenly, one of them suddenly starts to giggle.  "What could possibly be funny at a time like this?" asks one astounded missionary.  The other missionary replies, "I just peed in the soup!"  Haha!

 

Doggy Style Pet Grooming.
Heavens, I love good marketing.

 

 

But the cannibals of Papua New Guineas did have one strange, but compassionate, practice.  They would eat the flesh of a deceased loved one or respected member of the tribe.  Researchers discovered that prion disease had gotten into the cannibal population, and by eating this flesh, many more of the tribe's members contracted prion disease - what the natives called kuru.

So why were the cannibal children dying, but not the older members of the tribe?  (The elders died too, but it was much later, and their deaths looked like Alzheimer's.)  The brains of the children were grow more rapidly.  There is far more brain cell division in children, a time when prion disease spreads from cell to cell.  The brains of these children would develop huge holes, and eventually their brains would become so impaired that the children would die.

There is no cure for prion disease - known in humans as Creutzfeldt-Jakob Disease (CJD).  Medical instruments even coming into contact with any such diseased tissue have to disposed of entirely because no amount of heat will ever destroy the vector.  You could heat your meat in an industrial blast furnace, and it wouldn't help.  You can't kill something that was never alive.

 

 

 

 

 

Okay, so why is crazy George talking about prion disease?  An article came out in a medical journal this month suggesting some connection between some COVID vaccines and prion disease.  Be careful here.  Critics of the article have pointed out that the author of the article once opposed the influenza vaccine, and the medical journal that published the article is a, gasp, for-profit magazine.

I was just going to ignore the article in the medical journal and continue to get the younger children in my clan vaccinated, until I read an incredibly stupid article in USA Today trying to debunk the article.  The gist of the USA Today article was that none of the test subjects got Creutzfeldt-Jakob disease (CJD).   Uh, huh.  Hello, USA Today???  CJD often doesn't show up for years, especially in adult test subjects.

The only way to confirm a diagnosis of CJD is to examine the brain tissue by carrying out a brain biopsy or, more commonly, after death in a post-mortem examination of the brain.  The USA Today article, debunking the connection between two of the vaccines and prion disease, was so poorly reasoned that now I don't know what to think.

 

 

 

Now I am thinking to myself, "Oh, crap.  Oh, crap.  Did I just kill half my family by encouraging vaccinations?"  Folks, be careful here.  There may be a far-far greater risk from COVID than from some trillion-to-one risk of prion disease.  Just be aware of the issue.  Despite being vaccinated myself, I confess that I may discourage my son against vaccinating our grandchildren.

 

 

Forget any other course that I sell.
This is the course that 90% of you should take.

Update on the Coming War Against China:

Why do I insist on scaring the poop out of you with these reports about the coming war with China?  Answer:  Because I am praying that some "expert" will contact me privately and reassure me that America has the ability to instantly shoot down all of China's satellites, thereby blinding all of their carrier-killer (DF-21) missiles and Guam-killer (DF-26) missiles.  

Sadly, no one ever so reassures me.  Instead, the wisest of my friends are all out there getting dual citizenships, so they can quickly flee America.  We are so screwed.

 

 

 

 

1. I learned recently that China can only invade Taiwan during certain months of the year because of the weather in the South China Sea; otherwise, the seas get impossibly choppy.  When is the next window?  I dunno, but it's at least not for several months.
   
   
2. China will have to amass huge quantities of shipping, armor, troops, and supplies on their Eastern coast before they can invade, and our spy satellites should easily be able to spot this buildup.  The surprise missile barrage that will take out our carriers and our landing fields on Guam and Okinawa shouldn't therefore come as a complete surprise.
   
   
3. But if you think 'ole George is a complete whack job because of his worry about the coming war with China, consider what the Australian Minister of Defense (the equivalent to our Secretary of Defense) said this week, "The drums of war are beating and a war with China over Taiwan should not be discounted."
   
   
4. Do you remember when I warned you about that crazy dictator of the Philippines?  President Duarte is the guy who has had his police and army simply shoot drug dealers on the spot.  He has executed tens of thousands of them.  I warned you six weeks ago that Duarte was just crazy enough to attack the Chinese fishing fleet off the Spratlys Islands.  Well, his Secretary of State told the Chinese this week to get the f*ck out of there.  Hahahaha!  The Secretary of State is the chief diplomat for any country.  He is supposed to be the most tactful guy in his whole country.  "Get the f*ck out of there."  Ha!  I can see it as plain as day.  President Duarte is going to send his warships to the Spratlys and start shooting, and World War III will start.  Remember, folks, you heard it here first.
   
   
5. Please keep watching the price of gold!  If you ever see it soar $150 or more per ounce in a single day (please contact me!), buy some extra groceries, buy one or two more boxes of ammunition (they may be used someday as currency*), and definitely consider getting out of the market.  Live near a missile manufacturing plant, especially on the West Coast?  Move!  Sadly, we may lose this war.  With their long-range missiles, they are the school-yard bully, and we are the 98-lb. weakling who cannot reach.  *I once read about a spontaneous swap meet that sprang up after a horrible earthquake.  The only currency that most of the dozen vendors wanted was ammunition.
   
   
6. But what about America's vast and wildly expensive air force?  The range of our jets is so short that a senior U.S. Air Force general said this month that our mighty F35a's were not even worth including in any high-end war game.  Oh, crap, oh, crap.  

 

 

 

 

 

 

On May 10, 1940, the Germans invaded France.  By June 21st - just six weeks later - France had surrendered.  It kind of reminds of the old joke about how Euro Disney in Paris had to discontinue their nightly fireworks displays.  The local army garrison kept surrendering.  Haha!

What would have happened if you were a French investor, and you had bought French government bonds in January of 1940?  These bonds were probably marketed to you as war bonds.  

 

 

 

 

When the French government fell, did your war bonds suddenly become worthless?  I couldn't find the answer on Google; but if these French war bonds retained any value whatsoever, they were probably worth only a small fraction of their original face value.

Did the really smart French investors dump their war bonds before the invasion?  Almost certainly they did.

Since 1945, the U.S. dollar has reigned supreme.  U.S. Treasury bonds were considered the safest investment on earth.  From a pure safety point of view, America was militarily unassailable.  America was protected by two giant oceans, and the U.S. Navy was the most powerful navy on Earth.  No one could touch it.  Until today.

 

 

 

 

I have warned you that a war against China is coming soon, and we have the wrong weapons.  Our horse cavalry will be attacking enemy machine gun nests.  Because of an unfortunate intermediate range missile treaty with Russia, we stopped building such intermediate range missiles for ten years.  

In the meantime, China, Iran, and North Korea were experimenting on, and building, intermediate range, conventionally-armed missiles like crazy.  Now that everyone has nuclear missiles, no country will ever use them, just like no one will ever again use mustard gas.  The upcoming war will be fought with conventionally armed missiles.

For example, over the past 12 months, China has increased its arsenal of mobile DF-26 missiles from 200 to a whopping 350.  These aren't the infamous carrier-killer missiles.  These larger missiles have an even longer range.  The Chinese are calling their DF-26 missiles their Guam killers.  America has a huge Air Force and Navy presence on Guam.

 

 

 

 

 

Guam is where our fabulously expensive F-35A fighter-bombers take off, refuel, and rearm.  This week, a high-ranking Air Force general said that our F-35's are too useless to even be considered in war game scenarios.  Their range is so short that can't reach China's missile launchers, and when they try to return, their airfields will have been demolished.  Most of our advanced jets will be annihilated in the opening Chinese missile salvo, and the few that get off the ground and conduct a sortie will never be able to return.

And you can also bet that Chinese subs off the West Coast of America will be simultaneously launching conventional missiles to take out our Naval shipbuilding yards in California and Washington state.  

Yes, we will still be able to build ships on our East Coast, but the Chinese will also be attacking the Panama Canal.  It will probably be closed for the duration in the opening hours of the war.

 

 

Mortgage bankers who earn loan servicing fees make
ten times more than mortgage brokers.  Servicing is not that hard.

 

 

In the opening minutes of the War for Taiwan (in truth, the War For America's Living Space), we will likely to lose some, if not most, of our carriers and capital ships to Chinese DF-21 carrier killer missiles.  

"Thank goodness the Chinese have no plans to invade the U.S."  Heavens, I wish that was true.  I recommend that you do NOT read this 2003 speech by a retiring Chinese Defense Minister.  

They want our land, and the Defense Minister said it would only be humane to warn Americans to leave the country first.  In his speech, the Defense Minster estimated that 100 million to 200 million Americans would have to be killed.  He even used the Nazi term, Lebensraum - living space.

 

 

 

 

"...In answering the question, 'Will you shoot at women, children and prisoners of war,' more than 80 percent of the respondents answered in the affirmative, exceeding by far our expectations… If these future soldiers do not hesitate to kill even non-combatants, they’ll naturally be doubly ready and ruthless in killing combatants."

Do not read this speech.  It will absolutely ruin your  day.  I only included it so you will not simply dismiss my warnings today as the rantings of a quack.

Today's Big Economic Issue:

But today's article is not about the coming war with China.  It's about a sudden 35% collapse in the U.S. dollar.  Hear what Stephen Roach has to say about the risk.

 

 

 

 

Who is Stephen Roach?  Stephen S. Roach, former chairman of Morgan Stanley Asia and once the firm's chief economist, is a senior fellow at Yale University's Jackson Institute of Global Affairs and a senior lecturer at Yale's School of Management.  

When I was growing up, the national business news would convey predictions and comments from Mr. Roach as often as it conveys today those of Jamie Dimon, the current Chairman of JPMorgan Chase.  Stephen Roach is one of the most respected economic scholars in the country.  

CNBC wrote last night:

Roach warns the increased U.S.-China tensions exacerbate his dollar crash call.  Late last spring, he predicted the greenback would drop 35% against other major currencies over the next year or two.

 

 

 

 

“The dollar moved down sharply in the second half of 2020.  It reversed course in the first quarter of this year (George:  Pandemic flight to quality), and now it’s under downward pressure again,” Roach said.  “It reflects my concerns over the current account deficit in the United States, the unwillingness of the Fed to tighten interest rates for the conceivable future, and then the possibility that Europe may end up having a stronger commitment to fiscal policy than any of us, myself included, thought.”

He’s also concerned the current backdrop with China could exacerbate the danger.

“You add to that pressures on America’s role as a global leader that may be brought into play by frictions with China and there’s still, in my view, considerable downside left for the U.S. dollar,” Roach said.  “You’ve got a real problem here, and it’s one that worries me a lot, and I think the markets are completely ignoring.”

 

 

 

 

The Point of Today's Article:

Apparently I am not the only one worried about China.  

Some Jews were smart enough and/or lucky enough to get out of Germany before the Holocaust.  Some French investors were able to dump their French government war bonds before the Germans marched into Paris.  

Do you really want to own Treasury bonds if the U.S. is clearly losing the war with China.  It reminds of that scene in Gone With the Wind, where Scarlett O'Hara's father revealed that he had lost everything in bonds issued by the Confederacy.

The smart money may now be looking at how woefully unprepared America is for the upcoming missile war and is starting to sell some of their dollars.  You can be sure that a 35% decline in the dollar would do the U.S. stock market very little good.

It's mind blowing to start to view Treasuries as potentially risky investments, but there you have it.  If foreign investors ever began to doubt the ability of the American Navy to defend the Pacific Ocean, the Fed would have to buy up all of the Treasuries that they would dump.  To protect the dollar, the Fed would have to sharply increase interest rates.  The U.S. economy would get absolutely hammered.