Commercial Loans and Fun Blog

We have all heard the old saying, "The harder I work, the luckier I get."  This is especially true during tax time in the commercial loan business, from mid-March to late April.  Commercial loan demand is almost non-existent.  Here is a reminder why.

If you blast out newsletters during tax time, your results are going to be crumby... but you will still somehow find a few deals.  

The deal that lands on your plate will apparently have nothing to do with with your newsletter or your social media post.  The borrower will have never met nor spoken with any of the recipients of your newsletters, nor with any of your social media subscribers.  Nevertheless this borrower will somehow find you.

It all boils down to the size of cosmic pillow.  WTFudge, George, this sounds stupid.  Just watch.  You scoff now, but fifteen years from now you will will be sharing the Cosmic Pillow Theory with your own staff and kids.  [Chuckle]

The Cosmic Pillow Theory suggests that the cosmos is like one giant feather pillow.  This pillow is stuffed to the gills with feathers, and if you try to stuff even one more little feather into that pillow, a different feather is going to pop out of a bursting seam somewhere else on that pillow.  The cosmos just can't handle even one more feather.

So when you market (newsletters, social media posts, trade shows, etc.), you are trying to stuff one more feather into that cosmic pillow.  The feather from your marketing will appear to squeeze into the pillow, but somewhere else, along a bursting seam in a far corner, an unrelated feather - a lead- will be squeezed out.

This explains why if you send out a newsletter to your Oregon commercial real estate investors how you will somehow stumble across a sweet, do-able New Mexico strip center loan.  Remember, this borrower doesn't know a soul in Oregon; yet somehow he will find you.

Folks, I am not making this stuff up.  I share with you my experiences over my forty-four years in the commercial loan business.  This bizarre reality has happened to me sooo many times during tax season that I actually had to invent the silly Cosmic Pillow Theory.  A theory is only theory if it actually has been proven - if it actually works.  Folks, the Cosmic Pillow Theory is no mere hypothesis.  It works.  

So here's my lesson:  Don't stop advertising and marketing during tax time.  Yes, your results will be crumby, but you will still pick up a few commercial loan requests.

Now the Wonderful News:

if you bring a commercial loan to a bank in the next few months, that bank is going to jump all over the deal.  The bank has virtually no other commercial loan demand, so the bank is effectively wearing beer goggles.  Hahahaha!  Your deal will suddenly look like a supermodel.

More Good News:

When interest rates on commercial loans start going up, borrowers get motivated to borrow now, rather than six months from now.  

The worst two years of my career were between 1981 and 1982, when Fed Chairman Volker broker broke the back of inflation.  The prime rate fell every month for fifteen straight months.  Talk about an excuse to procrastinate!  Absolutely no one was looking for a commercial loan.

Nag-Nag-Nag:

Are you religiously saving the contact information and the loan data on every single wealthy real estate investor with whom you speak?  This even applies to wealthy real estate investors to whom you merely quote a commercial loan!

Dear Dr. Nguyen:

You may recall that in October of 2020 we had the pleasure of working on a $2,300,000 first mortgage on your shopping center in Kansas City, Missouri.  Today I am writing you about earning 10% interest in first mortgages.

Oh, nooo!

In truth, you merely spoke to Dr. Nguyen for about three minutes... but you saved his data, you clever lady.

Brutal Truth:

The money in commercial real estate finance ("CREF") is in loan servicing fees.  If you are not working towards building your own loan servicing portfolio, you should get the heck out of the commercial mortgage business!  

"Ouch.  That was rude, George."  Folks, the typical commercial mortgage banker earns six to ten times more than the typical commercial mortgage broker.  Heavens, imagine the freedom of being Loan Committee!

Mortgage bankers service their own loans and earn loan servicing fees.  These loan servicing fees carry them through the real estate depressions that hit every ten to fourteen years.  (It's been 13 years since the crash of 2008.)  The easiest way to build a loan servicing portfolio is to become a hard money lender.  

"Oh, my goodness, George!  I have no ideas how to service loans."

Quit being a weenie.  Just hire a sub-servicer to service your first forty loans.  With computers, servicing commercial loans is easy - as long as they don't default.

The picture above is an old-time bathtub still used to make gin during Prohibition.  My son recently asked me to write a blog article on how a hard money lender like Blackburne & Sons goes about securing a first lien on a liquor license when making a commercial loan on a restaurant or a hotel.

I confess that I am an absolute idiot on the subject, so you must not rely on this article; however, I did find some good material on the subject on the internet.  I have plagiarized shamelessly, but I have tried to give credit and a valuable link to the more knowledgeable folks who wrote the following wonderful articles.

LendingTree has a fabulous article on How to Get a Liquor License in All 50 States. They start out answering the question, “What is a liquor license?”  There is far more to it than just being allowing to sell the gin you make in your bathtub.  See photo at top.

“A liquor license enables your business to sell alcohol for on- or off-premises consumption.  States usually offer licenses based on the business you’ll run and the type of alcohol you want to sell.”

“The application process for how to get a liquor license can take anywhere from a few days to months.  License fees vary greatly from state to state, with some charging just a few hundred dollars and others putting licenses up for auctions that can bring in more than $100,000 for a single license.  Some states require that businesses begin the process with their city or county, which may charge its own fees.  If you sell alcohol without a license, local or state authorities could fine you and/or suspend your license.”

“Most states have a commission or group that provides liquor licenses. The typical process requires you to fill out an application and await approval.  However, some states may ask you to publicly post your application and then appear in a hearing that includes public comment.  Others that have quotas on the total number of liquor licenses enter you into a lottery, and some put their licenses up for auction.  In some cases, you might have to find a license through a private sale.”

“Whichever the case, you’ll need to provide documentation regarding the type of business you want to run (restaurant, bar, distillery, brewery, etc.); which alcohol you want to sell (beer, wine and/or spirits) and an application fee that’s separate from the fee you pay for your license.  Even once you’re approved, it’s likely you’ll have to renew your license on a regular basis."

"All licenses usually fall into one of two categories: on-premises and off-premises.

On premises: These licenses are for businesses that sell alcohol that people drink at, for example, a restaurant’s indoor or outdoor seating. You’ll find that most states have separate licenses for restaurants, bars, breweries and brewpubs.

Off premises: Usually reserved for grocery stores, package stores, wineries, breweries and distilleries, this type of license allows you to sell alcohol that customers drink elsewhere. In most cases, you’ll need to apply for a license specific to the type of alcohol you’ll sell."

The wonderful article on LendingTree goes on to describe exactly where to apply for a liquor license in each of the fifty states.  Wow.  That is great reference tool.

The real money is in loan servicing income.
You can just hire a sub-servicer.

How to Secure a Lien on a Liquor License:

The law firm, Starfield & Smith, has a great article about how to secure a lien, if it is even possible, entitled, Best Practices: Liquor Licenses as Collateral.  Here is what they have to say:

“There are a number of occasions where a SBA lender (George: …or a hard money lender) may wish to lien a liquor license as part of its collateral.  Not only may a liquor license be a valuable asset of the borrower, but also SBA (regulations) require Lenders to take a first security interest on all assets financed with 7(a) loan proceeds.”

“Some examples of loans that may involve a lien on a liquor license include the financing of a hotel with a restaurant that serves alcohol, or the acquisition of a liquor, convenience, or 'package' store.  In these scenarios, it’s important to understand that many states prohibit the holder of a liquor license from pledging it as collateral for a loan.  In addition, many states do not allow liquor licenses to be transferred or assigned from the original licensee to another person or entity.”

“Determining whether a liquor license may be subject to a lien and whether it can be transferred or assigned requires a state-specific analysis, which may entail a close review of the applicable state statutes, local county regulations and case law.  For this reason, lenders should investigate as early as possible in the loan process whether a particular state allows a liquor license to be liened and/or transferred.”

“Assume, for example, a lender is extending credit in Arkansas to a borrower that will have a liquor permit.  The Arkansas statutes governing alcoholic beverages clearly state that liquor permits “shall not” be pledged as collateral for a loan, nor may they be transferred or assigned.  Accordingly, the lender in this instance would likely remove the lien on the liquor license from the collateral section of its Credit and Authorization, as the license cannot be pledged or sold.”

“By contrast, in Massachusetts, “a [liquor license] may be pledged by the licensee for a loan, provided approval of such loan and pledge is given by the local licensing authority and the commission.”  Massachusetts law also allows the transfer of a liquor license with approval from the local licensing authorities.  Consequently, a lender working with a Massachusetts borrower/licensee is likely to include a security interest in the liquor license in its collateral section of its Credit and Authorization, and then seek the required local approvals and proceed to perfect the lien.”

“If a lender finds that a borrower cannot pledge its liquor license as collateral, there “may” be a workaround if licenses are transferrable in that state.  In New Jersey, for example, a liquor license cannot be pledged to a creditor, but it may be transferred if approved by the issuing authority, depending upon the circumstances.  Balancing the risks of state vs. SBA compliance, some lenders attempt to indirectly secure access to a borrower’s liquor license by taking a pledge of the ownership interest in the entity that holds the license.”

“For example, if the borrower is a limited liability company (“LLC”), the lender could take a pledge of the borrower’s membership interest in the LLC.  (Lender would file the appropriate UCC’s to secure the membership interest.)  In a default situation, a lender “may” be able to exercise its secured rights under the pledge and take ownership and control of the entity that holds the liquor license.  Presumably, then, the lender could seek approval to sell the license and collect the proceeds of that sale."

"However, other lenders in New Jersey take a more conservative approach. These lenders believe that a sale of the ownerships interest under the pledge constitutes a violation of the states; Alcohol Beverage Act, and the transfer of the lender interest to a third party without the borrowers consent would be rejected as an improper transfer.”

Those poor mothers!  

"Again, the laws governing the pledge and transfer of liquor licenses are very state specific and require careful research and analysis.  Lenders should evaluate their options as early as possible and modify the collateral sections of their Credits and Authorizations to reflect the interests available in a borrower’s liquor license under a particular state’s laws.  For more information regarding liens on liquor licenses, contact us at (215) 542-7070 or at info@starfieldsmith.com."

Bankruptcy:

"Bankruptcy can also be serious issue when trying to liquify (turn into cash) a lien on a liquor license.  An interesting website called PocketSense, in their article, Can a Lien Be Put on Liquor License, explains the bankruptcy issue. 

“In many states, a liquor license is a valuable commodity, worth hundreds of thousands of dollars.  For restaurant and bar owners in these states, the license is their most valuable asset, in part because some states restrict the number of licenses available and allow licencees to buy and sell them. It is at times used as collateral for loans. Whether a lien can be attached to a liquor license is a matter of state law, which can, at times, be complicated by federal bankruptcy law.”

Me doing yoga:

Liens

“Liens are legal claims to property. They can be levied by creditors or taxing entities for money owed.  In some cases, a lien might be placed on a property as a condition of a loan, as is often the case when a lender offers a mortgage.  In some cases, a lien prevents an owner from transferring property until the lien is paid off or requires the owner to pay the lien with proceeds of a sale.  In other cases, a lien might empower a creditor to auction property as in a foreclosure sale.

Asset or Privilege

“While in many states, the liquor license is an asset, other states view holding a license as a privilege.  Licensees might be subject to background checks, and people of poor moral character might be barred from the privilege of holding these licenses.  No matter how much they are worth, these states might forbid creditors from placing liens on liquor licenses.  Even states that view the licenses as property might require background checks, so consult a lawyer.  States that consider liquor licenses to be privileges might consider them to be intangible property.”

Federal Taxes

“Whether your state views a license as a privilege or an asset, the Internal Revenue Service has different views.  If a person owes back taxes, the IRS considers whether the licensee has rights under state law.  Therefore, the IRS might be able to place a lien on a liquor license even if state taxing authorities and business creditors cannot."

Bankruptcy

“Federal bankruptcy courts might also supersede state law when determining claims to a liquor license.  Until 2004, for example, New Jersey forbade loans on a liquor license.  But when a licensee declared bankruptcy, the judge in the case ruled that a general lien on intangible property applied to the liquor license.”

Practical Suggestion From George:

I think I may tell my own commercial loan staff to always include the liquor license in the Security Agreement and the UCC-1, even in a privilege state.  It seldom hurts to have a colorable claim on the license.  A colorable claim is one that is plausible.

Then I think I will have my staff call the particular state licensing board – using the wonderful LendingTree article above to find the agency name – to see whether we can get formal permission, without having to spend a million dollars in legal fees and without having to endure weeks of delay.  If absolute perfection is impossible, unlikely,  or financially infeasible, we would need to disclose the extra risk to our investors.

Commercial loan demand in late March and April is typically very, very weak.  Commercial real estate investors don't want to mess around with paperwork, especially when they have just finished the painstaking task of preparing their tax returns.  In most cases, their complicated tax returns are not even done yet for 2020, so they have little choice but to put off shopping for a commercial loan until their tax returns are done in the mid-part of April.

The sun is also shining.  Many avid golfers are looking forward to their first rounds of golf for the year.  Many a nun has been run over by a golfer speeding to the first tee box.  Haha!

I once asked my mentor in commercial real estate finance ("CREF") from 45 years ago, Bill Owens, what I should do when the commercial loan market slows to an absolute halt.  "Sometimes you just have to go fishing."  

Bill would actually fly to Mexico and go deep sea fishing off the coast of Baja California.  Lucky guy.  With the drug gangs rolling bags of severed heads down the middle of Mexican highways (this actually happened) in Guadalajara, I wonder if he still goes to Mexico to fish?

Why should you care if commercial loan demand is weak?  Suppose you own a business, and you have a balloon payment coming due on your commercial or industrial building in the next year.  It might make sense to apply right now, especially if 2020 wasn't a great year for your company.  

Commercial banks are very optimistic about the future.  With the passage of the whopping $1.9 trillion stimulus package, you can bet their Boards of Directors are  screaming at their Senior Vice Presidents of Loans to make some stinking commercial loans.  Commercial loans can be very profitable for the bank.

If your marginal commercial real estate loan request is the only lending opportunity available to the bank this month, your deal may suddenly look a little stronger.  Kinda reminds me of when I used to go to nightclubs as a bachelor-hound-dog 45 years ago.  I suddenly got taller (I'm only 5'5" tall) and better-looking as last call approached.   Hey, girls can wear beer goggles too.  Haha!

Scary New Weapon of War

Last night I watched the free movie of Netflix, Angel Has Fallen.  It was an excellent movie.  The premise is that some bad guys use a swarm of suicide drones to try to kill the president.  A suicide drone is essentially a flying bomb designed to maneuver, evade, and then zero-in on certain targets, like an enemy tank, truck, or foot solider.

Folks, that attack scene was absolutely terrifying.  All thirty of our brave Secret Service men and women were slaughtered.  The premise of a swarm of suicide drones is also quite plausible.

There is no defense against swarms of suicide drones.  Someday we'll have automated laser beams or force fields to fight against swarms of suicide drones, but right now such weapons have yet to be invented.  It reminds me of the French in the late Middle Ages.  They had no defense against longbows releasing bodkin-tipped (armor-piercing) arrows.

Azerbaijan recently fought a war again Armenia, and the much smaller country absolutely crushed the Armenian army in just two weeks using swarms of suicide drones purchased from an Israeli armaments company.  Imagine a miniature missile chasing you across a field and then exploding at your feet with three times the force of a grenade.  There is no place you can hide.  Scary-scary stuff.  Yikes.

Updates on the Coming War With China

A military author recently pointed out that while China excels in anti-ship missile technology, and they can deny the South China Sea to even four or five of our aircraft carriers, much of the rest of their military is still under-equipped and inexperienced.  The Chinese military budget is $240 billion per year, while that of the U.S. is a whopping $732 billion.  That will help me sleep.

BUT... I also read this week that if war breaks out in the South China Sea, the first thing the Chinese are likely to do is to take out our communications satellites using software worms and space-based weapons systems.  

With our communications satellites crippled, the U.S. military would be half-blinded.  All of our advanced targeting systems would become useless without GPS technology.  You back here in the States would also be personally screwed.  Food.  You will quickly run out of food.  

Modernly, farmers depend on the GPS systems in their combines to sow and harvest their crops.  Food processing plants and transportation systems (trains, trucks, etc.) would be slowed if the internet slowed to a crawl.  There would be huge food shortages and massive unemployment.  What would you personally do to get the last loaf of bread for your starving child?

I just don't think modern Americans would stand patiently in line in front of soup kitchens, like those famous pictures we have all seen of the Great Depression.  Instead, I see huge riots and burning cities.  Maybe the Mormons have it right.  They try to maintain a year's worth of food in their basements.  My point is that you should care deeply if the U.S. and China got to war in the South China Sea.

Now Some Fun Tidbits:

I wrote to you several months ago about the free TV channel, IMDb, available on Amazon Prime.  IMDb?  What does IMDb even mean?  Answer:  Internet Movie Database.

I love-love this channel.  I go there first to find my free movies and free TV shows, using my Fire TV from Amazon.  Anyway, earlier this month I watched a terrific action movie on IMDb, 24 Hours to Live.  I recommend it highly!

If you are not working every day towards building a
loan servicing portfolio, get OUT of the business.

The money commercial real estate finance is in servicing!

In 1988, Eddie Murphy released a terrific movie - one with far less profanity for a typical Eddie Murphy movie - entitled, Coming to America.  Not only was the movie delightedly entertaining, it actually had a wonderful morale.  

Amazon and Eddie Murphy released this month, Coming to America II, the sequel of what happens 32-years later.  Delightful!  But you first have to go back and watch the original Coming to America.  Both movies are free on Amazon Prime.

There is a difference between a bank and a Federal savings bank.  It has to do with their history.

Many years ago, in a galaxy far, far away, there was a huge industry known as the thrift industry.  A thrift and loan was an early name for a savings and loan association.  They mean the same thing.  

Now please don't get lost here.  We are talking about the difference between a commercial loan from a garden-variety bank and one from a Federal savings bank.

In 1933, after the disastrous bank losses of the Great Depression, the Federal Reserve promulgated Regulation Q.  This regulation limited the interest rate that banks could pay on deposits.  This meant that Bank of America couldn't pay a higher interest rate on deposits than the tiny Bank of Your Hometown.  They both could not pay more than, say, 2% interest.

In 1966, Regulation Q was extended to S&L's, with several provisos.  First, S&L's were not allowed to offer business checking accounts, nor were they allowed to make business loans.  S&L's were intended to be long-term real estate lenders, and they were to match their long-term loans with long-term certificates of deposit ("CD's").

The second proviso was that S&L's were allowed to offer interest rates on CD's that were one-quarter of 1% higher than what banks were allowed to pay.  Bank of America could offer 2% on a CD, but the tiny S&L on the corner could offer 2.25%.  Therefore, if you were a thrifty saver, you would keep your long-term savings in a S&L and your checking account in a bank.

As a result, S&L's became laser-focussed on real estate loans.  S&L's became far more focussed on the quality of the real estate and on the leases than on the financial strength of the borrowers.  Sure, S&L's looked carefully at their borrowers; but far more important to them was the cash flow of the property. 

This meant that if the property was nice and the commercial loan cash-flowed well, the S&L might make this loan, even if (1) borrower had a few credit flaws; (2) the borrower's net worth was not larger than the loan amount; or (3) the borrower lacked liquidity.  

Please re-read the above the paragraph.  It is the point of this entire training article.

Important Note:

Never go a bank if you need money.  Instead, go to a bank when you have lots of cash on hand, but when you see a time in the future when you will need cash.  Banks will seldom lend you cash if you have no cash.

In the late 1980's, President Ronald Reagan changed the tax laws.  No longer could passive real estate losses be used to shelter earned income.  Suddenly, the appeal of owning apartment buildings disappeared, and their values plummeted.

The S&L industry cratered.  The Federal Savings and Loan Insurance Corporation ("FISLIC") quickly ran out of funds to cover the massive losses.  Most S&L's went bankrupt, and the entire thrift industry became suddenly irrelevant.

The handful of surviving S&L's were offered a new charter - that of Federal savings association (Federal savings bank).  In the process, the restrictions on savings associations were removed.  Today, a Federal savings bank can offer the same deposit accounts and can offer the same kinds of commercial loans as any bank.  

For this article, I tried to discover how many Federal savings associations (savings banks) still exist today.  I was unsuccessful; but probably 600 to 800 of them still survive today.

But Here's the Point:

If you have a commercial loan where the property is nice and the proposed commercial loan cash-flows well, a Federal savings bank might make the loan, even if (1) borrower has a few credit flaws; (2) the borrower's net worth is not larger than the loan amount; or (3) the borrower lacks liquidity.  

"May you live in interesting times," is an English expression that is claimed to be a translation of a traditional Chinese curse.  While seemingly a blessing, the expression is normally used ironically.  Life is better in "uninteresting times" of peace and tranquility than in "interesting" ones, which are usually times of trouble.  Wikipedia.

Well, we are certainly living in interesting times.  As the future Dictator of the World, Xi Jinping, continues to mobilize his 1.4 billion citizens for world conquest, the Biden Administration continues its quest to print up $1.9 trillion to rescue the U.S. economy.

It's ironic.  I am a Republican and a fiscal conservative, but right now,  I generally agree with Biden's plan.  We have to do something; otherwise, the U.S. money supply will contract like an imploding black star.  Let me explain.

Loans have payments, and America sure has a lot of loans outstanding.  As Carl Sagan, the famous astronomer, might have said, "Trillions and trillions of them."

Congress, the U.S. Treasury, and the Federal Reserve can create all kinds of new money, but much of this new money just gets used to make all of the monthly interest payments on our existing debt.

Here's a metaphor that might explain this concept.  Picture the breakfast table in your kitchen.  Now cover it with 36 sponges.  Next, take your tea kettle, fill it with water, and then slowly pour the contents over the various sponges.

This is what is happening to the U.S. money supply.  Each time the Federal government prints up new debt and then has the Fed buy it - thereby monetizing the debt - its like refilling that tea kettle with more water.  

Yes, if we keep refilling that tea kettle, those sponges will eventually become over-saturated.  They will no longer hold any more water.  Water will then spill all over the table, down the sides, and onto the floor.  We will have horrible hyper-inflation.

But right now, those sponges are still holding water.  In fact, those sponges are hungry for more water.  The banks want their loan payments, so we have to keep creating new money.  

For the next few years, Congress should be able to keep deficit spending and the Fed should be able to continue its campaign of quantitative easing, without having the dollar completely collapse.

Yes, the dollar fell 6.7% last year.  A free-falling dollar would be the sign that the game was finally over.  At that point in time, Congress would have to stop deficit-spending and the Fed would have to greatly reduce quantitative easing.  That would send interest rates higher, which should greatly curtail inflation.

But for right now, we are in an unusual economic zone, when we can apparently create massive amounts of new money, at little immediate cost.  

If you fire a bullet into the air, eventually it will slow, as gravity pulls it back.  There will come a time when its upwards momentum has almost been been spent, and the bullet seems to float.

In terms of the money supply, this is where we are at. 

I always watch the price of gold.  As I have pointed out in the past, gold is only a so-so hedge against inflation.  Gold kicks butt, however, during times of deflation, when companies start defaulting on their bonds.  Remember, gold is one of the few assets that is not the debt of another.  Gold cannot default.

Important Warning About Gold:  

When the stock market crashes, about every ten to fourteen years (its been 13 years since 2008), gold crashes, along with everything else.  The reason why is because gold falls less than anything else, so investors dump their gold first to get liquid again.  After the initial panic and rush to liquidity, gold starts to pick sooner than stocks and bonds.  That's when to jump into gold.

So what is gold telling us today?  It has been trending lower recently, which suggests that massive corporate bond defaults are not immediately imminent.  That's a good thing.

The belief in the credit markets is that Biden will likely get his big relief package, which will continue to prop up the markets for a time.  This isn't a horrible financial and monetary zone to occupy for a few years.  "It's fun to float, a half-mile up in the air," said the bullet.

"That's all great and everything, George, but what was that comment about Xi Jinping being the future Dictator of the World?"

May you live in interesting times.  Haha!

Tom Brady photoshopped into a Bears uniform.
My golf buddies can be so cruel.

Even if you are not in the commercial loan business, you may still want to quickly scan this article.  Marketing is marketing, and some concepts are universal.

Think of legitimacy as the exact opposite of a cold call.  When you make a cold call, you are a complete stranger.  The potential customer has absolutely no reason to trust you.

But if you meet someone in the legitimate course course of business, that potential customer is far more likely to trust you.  Therefore you must treasure that contact like a Mickey Mantle rookie card.  That contact is unusually precious.  Don't lose it.

But how do you meet someone in the legitimate course of business?  Suppose you are dropping your car off at a body shop for some work, and you happen to meet the owner of the business.  You get to chatting about his business and whether he owns the building.  "By the way, Mr. Bodyshop, I am in the business of financing buildings just like this.  Do you happen to have a card?  Is this email address still current?  I'll send you my contact information in case you someday need a commercial loan."

By the way, small commercial loans like this are the absolute best commercial leads in the whole world.  Small deals close.  Larger deals?  Not so much.

Obviously, when you get back to your office, you should rush off a short email note to Mr. Bodyshop.  Then you add him to your email list of contacts and send him fun stuff every two to three weeks.

We all have buddies who send us funny memes and jokes.  Treat Mr. Bodyshop like he is one of your buddies.   You don't need a fancy newsletter like mine.  A funny joke or meme, along with your signature block, will do.  

Of course, your signature block should remind him what you do:

Sam Elliott
Elliott Antiques
123 Main Street, Anywhere, California 98765
(213) 555-5555
elliott@elliottantiques.com

We Buy and Pick Up Antiques

Another way to enjoy legitimacy is to have someone refer that customer to you.  A referral in search of a commercial loan is many times more like to close than a simple loan shopper.

This is why I also urge my commercial loan broker buddies to develop a big list of referral sources - bankers, commercial brokers (commercial real estate sale brokers), property managers, other commercial lenders, residential mortgage brokers (on a name and number referral basis only), residential realtors*, attorneys*, CPA's*, and financial planners (life insurance agents)*. 

*These particular referral partners will only work if the guy knows you and recognizes your name.

When you build this list of potential referrals sources and this separate list of business owners whom you have met in the legitimate course of business, don't be shy about offering referral fees!  

Referral fees in commercial real estate finance are perfectly legal, as long as the unlicensed referral source does nothing more than turn over a name and phone number.  A 20% referral fee is the norm.

The unlicensed referral source must NOT try to negotiate terms, fetch loan documents, or try to play play commercial loan broker.  If he does, he will step over a red line, and the result could be legal trouble or simply too many hands in the pot.  

I will blog further on referral fees later this week.

Here are some tips on how to succeed as a commercial loans broker:

Tip #1:  Never waste one nanosecond on international loans.  International loans never close.  The problem is one of taxation.  No country in the world wants a bunch of foreign banks to come into their country and take all of the good loans, thereby weakening their own banks.  As a result, if a foreign bank makes a loan across international borders, the host country will tax their interest income at some ghastly rate - higher than 30%.  As a result, if you need a loan in Mexico, and no local bank will do the deal, you need to use the Mexican subsidiary of some foreign bank; Deutsche Bank of Mexico or Citibank of Mexico.  If the subsidiary bank is chartered in Mexico, the tax laws aren't quite as brutal.  I still would never waste time working on international loans.  You could work on international commercial loans for ten years, full-time, and never close a deal.  Here are more details.

Worried that she might have been injured, I googled
this GIF.  I am pleased to report that it was photoshopped.  :-)

Still funny though.

Tip #2:  Commercial banks, credit unions, and savings banks (former S&L's) make 75% of all commercial real estate loans these days.  Start there.

Tip #3:  Big banks make big commercial loans, and small banks make small ones.  Therefore match the size of your deal to the size of the bank.

Tip #4:  Stay local.  Banks greatly prefer to make commercial loans close to one of their branches.  The closer the bank, the more likely it is that Loan Committee will approve the deal.

Tip #5:  It's easy to find commercial banks and credit unions in Maine, even if you are located New Mexico.  Simply go to Google Maps and type in the address of your commercial property in Maine.  Click the "Nearby button" and then type in "banks."

Tip #6:  The smaller the commercial loans, the more likely the deal is to close.  Small commercial loans close.  Larger deals?  Not so much.  I would much rather have a pipeline of three small commercial loans than a pipeline of thirty commercial loans larger than $3 million.  Small commercial loans close.

Tip #7:  This is going to sound terribly self-serving, but Blackburne & Sons loves to close small commercial loans in remote areas.  You will have much less competition working on these small or remote commercial properties, compared to competing against fifty other commercial loan brokers in your local big city.

Tip #8:  When you market for commercial real estate loans, you will speak daily with four or five wealthy real estate investors every single day.  Even if they never send you a package, be absolutely sure to keep their contact information and the following additional data:  (1) month of year, e.g. June of 2021; (2) the loan amount; (3) type of loan (first mortgage, construction loan, etc.); (4) property type; (5) city where the property is located; and (6) state where the property is located.

Tip #9:  Someday you will want to send out the following, individually word-processed letter:  "Dear Dr. Su:  You may recall that in June of 2021, ABC Commercial Mortgage Company had the pleasure of working on a $1,300,000 first mortgage on your medical office building in Kansas City, Missouri.  I am writing to you today about earning 8% to 10% interest in first trust deeds."

Tip #10:  Your ultimate goal in this business is to someday become "the lender" and be able to approve your own loans.  The real money in commercial mortgage finance is also in servicing income.  Commercial mortgage bankers service their own loans, and they are rich.  Commercial mortgage brokers do not service their loans, so when the inevitable real estate depression hits, they are crushed.   Servicing income continues, even during real estate depressions (45% declines).

You know that expression, "You're not the
boss of me?"  Doesn't work on cats.

Tip #11:  Don't get too excited about construction loans.  They seldom ever close for commercial loans brokers because if the developer had enough skin in the game (equity in the deal), some local bank would have made the deal in a nanosecond.  Banks love construction loans, so if no local bank will do the deal, there is a big problem.

Tip #12:  Don't waste money advertising in newspapers, online magazines, or on Google Adwords.  You will spend a fortune and never close a deal.

Tip #13:  The best commercial leads come from referrals.  Build yourself a newsletter list of commercial bankers, commercial brokers (commercial realtors), property managers, other commercial lenders, residential mortgage brokers (on a referral fee basis only), residential real estate brokers, attorneys (who know you), CPA's (who know you), and estate planners (insurance agents).

If you have been reading my articles about the coming war with China, you know that I am super-freaked-out about accuracy of modern missile warfare.  The woeful Indians successfully launched a ship-to-ship missile that hit a steaming frigate that was 130 miles away four months ago.  

The Chinese are far better at missile technology than the Indians.  Our carriers are in serious trouble.  The U.S. is a carrier power.  China is a missile power.  It's like being a battleship power in World War II, rather than a carrier power.

In the years leading up to the attack on Pearl Harbor, the U.S. was overly-focussed on battleships.  British dreadnoughts (battleships) won the huge sea battle known as Battle of Jutland in World War I, even though British gunnery was absolutely atrocious.  The hapless Brits could hardly hit a thing; but if you throw up enough shells...  

In World War II, however, I don't think a single battleship from either side fired a single shot at an aircraft carrier in the entire war.  We're a carrier power.  China is a missile power.

You will recall from my earlier articles that the U.S. ran a war game simulation eight months ago between the Chinese and the Americans, assuming the Chinese were trying to take Taiwan.

In our own simulation, we got our butts kicked.  Super-accurate Chinese missiles hit our airfields on Guam so effectively that our $27 million fighters and bombers couldn't land to reload and refuel.  Our pilot were forced to ditch our incredibly expensive (and very few) jets into the ocean.

That's the bad news.  The good news is that U.S. Navy and Air Force officers are not afraid to push back against their admirals and generals.  "Admiral, if we don't do something different, we are going to get our butts handed to us."

I was therefore pleased to see that U.S. Air Force tested this month a new distributed force concept.  Rather than having all of our expensive jets located at our airfields on Guam, where the Chinese can quickly and easily destroy them in the first twenty minutes of war, the Air Force is fixing up old airfields on tiny little islands and atolls all throughout the South China Sea.  

These remote airfields are gawd-awful, with dirt runways that have not been cleared in thirty years.  There might be 150 indigenous inhabitants on these islands, with 25 head of cattle, and 60 wild boars.  When someone talks about Bum Flowers, Egypt,  this is what they are talking about.

First the Air Force cleans up the old landing strip.  Then we fly in just three moderns jets - maybe one bomber and two fighters - to Wild Boar Island.  We also fly in a C-130 military cargo plane, with a crew cross-trained in lots of different functions - reloading missiles and bombs onto our fighters and bombers, refueling them, repairing them in the field, and putting rested and fresh pilots onto the planes.  

The fresh fuel come right from the C-130, while the engines of our jets and fighters keep running.  Hot refuelling is a procedure to refill an aircraft with aviation gas while at least one engine is still running.  It is intended to reduce the amount of time it takes an aircraft to get back into the air and carry out an additional mission.

The idea is to turn these planes right around before a Chinese missile slams into the field.  Now I am sure the initial tests were a complete disaster, but I am thrilled that the U.S. Air Force is spreading out their forces in the South China Sea.  Our modern jets are siting ducks right now.

"Si vis pacem, para bellum" is a Latin adage translated as "If you want peace, prepare for war."

One final thought.  The Air Force general who was discussing with the press this concept of distributed and independent forces - where the force of two fighters and one bomber pick their own targets - mentioned something that startled me.  Startled me?  Heck, it made need fresh underwear.  Haha!

He said these little independent forces need to be able to operate all by themselves, even when all our satellite systems are down.  All of our satellite systems are down?  Holy poopski.  The Chinese can take down all of our satellites?

Why am I so freaked out about this coming war with China?  Your home in Kansas City or my home in Indianapolis will be within range of Chinese missiles, when a Chinese missile ship or submarine sails into the Gulf of Mexico.

Do you know any retired officers in the U.S. Navy?  Would you kindly forward to them  the following article about interlocking flight deck drone ships.   This is the proposal that capitalizes on Elon Musk's experience with drone ships to create a landing surface for our returning jets.

C'mon, guys.  This is fifth-grade math today.  Don't tune out simply because you see a handful of easy algebraic expressions.  Your math teach told you that you would need this stuff some day.  Haha!

A cash-on-cash return is a form of yield calculated on real estate investments.  It is seldom used for bond or other investments.

Lockdown Tip #1:  Never leave your rice uncovered.

Your cash-on-cash return is your actual net cash flow, after debt service, divided by the amount of cash you invested, times 100% to convert it a percentage.

Example With No Leverage:

You buy an apartment building for $1 million all-cash.  There are no mortgage payments.  After all expenses, you net $57,000 in cash flow.  Therefore -

Cash-on-Cash Return = (Net Cash Flow / Cash Invested) x 100%

Cash-on-Cash Return = ($57,000 / $1,000,000) x 100%

Cash-on-Cash Return = 0.057 x 100% 

Cash-on-Cash Return = 5.7%

My golf buddies can be so cruel.  Haha!

Remember, the above calculation assumes that you paid all cash for the apartment building.

"So, George, the cash-on-cash return is the same as the cap rate, right?"

Not quite.  You will recall that that a cap rate is the return on investment that an investor would earn if he paid all cash for an income property.  

It is calculated by dividing the projected Net Operating Income (NOI) by the purchase price (and then multiplying result by 100% to covert it to a percentage.)

Cap Rate = (NOI/Purchase Price) x 100%

But here's the thing.  A property's net operating income (NOI) is really a budget for next year, assuming the use of a professional property management company.  Included in that budget is a Reserve for Replacements to replace the roof, to replace the HVAC system, and to repave the parking lot.  

A good rule of thumb, when preparing a Pro Forma Operating Statement for a  commercial lender, is to use 3% of Effective Gross Income as your Reserve for Replacements.  

The Effective Gross Income is the Gross Scheduled Income, plus any Parking Income and Vending Machine Income (which together is your Total Gross Income), less a 5% Reserve for Vacancy and Collection Loss.  The remaining number is your Effective Gross Income.

A Pro Forma Operating Statement also makes a deduction for Professional Property Management - sometimes onsite management as well - even if the owner intends to manage the property himself.

In contrast, the Cash-on-Cash Return will not factor in a Reserve for Replacements, nor will it factor in a property management fee, if the owner intends to manage the property himself.

In real life, most real estate investors use a mortgage.  Let's look at a cash-on-cash calculation where the borrower uses a mortgage.

Example With a Mortgage:

You buy an apartment building for $1 million.  You put $300,000 down and get a $700,000 mortgage.  The property throws off $57,000 per year in gross cash flow.  The annual payments on the $700,000 mortgage are $32,000 per year.

What is your Cash-on-Cash Return?

Cash-on-Cash Return = (Net Cash Flow / Cash Invested) x 100%

Cash-on-Cash Return = ($57,000 - $32,000) / $300,000) all times 100%

Cash-on-Cash Return = 0.083 x 100% 

Cash-on-Cash Return = 8.3%

You will recall that the Debt Yield Ratio is different from the Debt Service Coverage Ratio.  They are two completely different ratios.

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.  If this number is multiplied by 100%, the calculation produces a Debt Yield Ratio of 7.3%. 

What this means in real life 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 the Debt Yield 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.

A CMBS loan originator named StackSource recently sent out a very helpful update on the CMBS markets and on the Debt Yield Ratio currently being used on apartment loans:

"The CMBS market had a rough year in 2020, but (the CMBS market) has strengthened considerably and is ready to compete for loans on stabilized assets nationwide in 2021."

"As a reminder, CMBS stands for Commercial Mortgage Backed Securities, and this type of loan execution offers long-term holders of commercial real estate several advantages: competitive interest rates (George:  Not much higher than the rates from life companies), non-recourse loans, and the potential for interest-only payments."

George:  A good way to think about CMBS loans is to call them scratch-and-dent life company loans.  They might have qualified for a life company loan, but the property was a little too old, it was in a secondary location (not the single best location in a football team city), and/or it had mom-and-pop quality tenants, rather than national near-credit-tenants.

"Multifamily CMBS loans are beating the agencies (Fannie and Freddie) for certain assets today based on lower interest rates and full-term interest-only payments (I/O)."  

George:  Full-term interest only payments?  CMBS lenders beating agency lenders for apartment loans?  Wow.  For many years, CMBS lenders had trouble competing with agency lenders.  Fannie Mae and Freddie Mac have always offered terrific apartment loans, but these agency lenders were never known for offering the absolute largest loan amounts.

"The ideal scenario is up to 70% for full-term I/O or 75% with amortization.  A minimum debt yield of 7.5% (or 8.0% for smaller markets) for apartments will apply."

"Interest rates on apartment loans for full-term I/O will be around 3.00-3.55%, based on today's spreads."  

George:  With interest rates this low and interest-only payments, apartment investors much be raking in cash flow hand-over-fist."

"CMBS is even coming back for hotel financing, granted at a lower leverage point (60% LTV, 12% Debt Yield) and at relatively higher rates in the 4's."  

George:  As long as the loan is larger than $5 million, it might even make sense to work on hotel loans again.