Commercial Loans Blog

Why Commercial Second Mortgages Are So Rare - Part I

Posted by George Blackburne on Tue, Aug 13, 2013

Later in the week I will share with you the ratio known as the Old-Money-to-New-Money Ratio.  Today, however, I will explain why very few commercial lenders make commercial second mortgages.

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Perhaps the the most important reason why so few commercial second mortgages are getting made is because virtually all of the largest commercial second mortgage lenders were wiped out in the commercial real estate recession of 1987 to 1991.

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Prior to 1987, high-income-earners, like doctors, could shelter much of their employment income by using passsive losses (depreciation) from commercial real estate.  In late 1986, Congress completed a major tax overhaul that eliminated the advantages of passive losses from commercial real estate.

Suddenly commercial real estate lost much of its appeal, and commercial real estate values plummeted by a whopping 45%.  (Note to my sons:  That number - 45% - is an important historical number.  Commercial real estate tends to fall no more than 45%, even in the absolute worst of recessions / slumps.  The next time commercial real estate falls more than 38%, syndicate our investors and start buying back into the commercial real estate market.)

The commercial real estate recession (heck, it was a depression) lasted for five long years.  Wonderful, old commercial hard money lenders took painful losses in second mortgages.  In most cases the second mortgage holders were completely wiped out, as they ran out of money with which to keep the first mortgage current.  A great many commercial second mortgage companies - companies run by honest, competent men that had been in business for decades - simply went out of business.

The commercial second mortgage industry never recovered.  It's been well over 25 years since more than one commercial lender out of hundreds would consier a commercial second mortgage.  Commercial second mortgages are so rare today that its easier to think of them as if they no longer existed.

Tomorrow I will write about some serious legal problems facing commercial second mortgage lenders - things like the due-on-encumbrance clauses and prohibitions against alienating title in any way; e.g. mezzanine loans and preferred equity.

But for now you can simplify your understanding by remembering that the reason why commercial second mortgages are so rare is that all of the commercial second mortgage lenders got wiped out between 1987 and 1991.  The commercial second mortgage industry never recovered.

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Topics: commercial second mortgages