Commercial Loans and Fun Blog

All of my work life I have heard smart real estate people use fancy terms like conforming, legal nonconforming, illegal nonconforming, conditional use permits, and variances.  I would always nod my head and try to look intelligent, but the truth is that I never knew what the heck they were talking about.

Then I read the following blog article by Dan Harkey, one of the smartest minds (the smartest?) in the hard money business.  With Dan's generous permission, I am republishing his recent blog article, Conforming vs. Nonconforming - Making Your Property Lending Decisions. Dan writes:

Conforming vs. Nonconforming -
Making Your Property Lending Decisions

When underwriting commercial real estate loans, or even residential loans, as a lender, it is absolutely necessary (George: Note the emphasis) to determine the property's conforming status.  Is the subject property conforming, legal nonconforming, or illegal nonconforming?

Conforming Use

A conforming use is one where the subject property is in compliance with local zoning laws and the use of the property is legally permitted. Conformity is a byproduct of zoning laws and municipal ordinances which may change over a period of time.

Legal Nonconforming

A legal nonconforming use is a use of lands or structure which was legally established according to the applicable zoning and municipal building laws at the time, but which does not meet current zoning and building regulations. A use or structure can become legal nonconforming due to rezoning, annexation, or revisions to the Zoning Code.  (George:  The government changed the rules.).

As long as a nonconforming property’s use status does not change, its legal nonconforming designation may be protected by municipality or regulatory agency. A legal nonconforming designation usually requires the property to be in continuous use. If it is vacant for a period of time, its legal nonconforming status may be lost. In some communities special or conditional use permits, variances, or site development permits may be obtained to extend or even modify legal nonconforming use.

Communities vary in the way they treat legal nonconforming properties which are destroyed. Most will allow the rebuilding of the property to its prior condition only if 50% or less of the structure is destroyed. If, however, the entire structure is destroyed, most often the owner would be required to rebuild to current zoning standards.  (Helloooo?  Are you lenders pay attention?  You could easily lose your butt if you could only rebuild two units rather than four!)  

A lender in such a case may experience a serious loss in collateral value but may be able to mitigate such a risk by obtaining the correct property and casualty insurance coverage.  Endorsements to hazard policies may be available that would allow insurance proceeds to be used to build a different structure as a result of changes to building laws and ordinances. (Pay attention here!  Lenders should can get a special endorsement to the fire insurance policy.)

For example, a retail strip center situated on a small lot may not have enough parking spaces to comply with current zoning requirements. If zoning changes regarding parking requirements have increased from requiring 3 spaces per thousand square feet of building to 4 spaces per thousand, the owner may be required to reconfigure the retail center’s footprint. The owner should seek knowledgeable insurance counsel to obtain this special protection. The lender should verify the type of coverage and require that they be named as mortgagee and loss payee as well as an additional insured.

Illegal Nonconforming

Lenders are most at risk with a property which is nonconforming and has been illegally modified or is operating without proper conditional use permits. For economic reasons, owners may elect to illegally modify a property to a use that falls outside current zoning standards or the use permit framework. For example, a 4-unit building of 2 bedroom/2 baths units is converted into an 8 unit building of 1 bedroom/1 bath units.  If done covertly, without approvals or permits, it becomes illegal nonconforming.  This process is sometimes called bootlegging.

This example of bootlegging may be perceived as subjecting the surrounding community to unnecessary burdens.  Negative impacts could include traffic, ingress and egress, inadequate parking, more transient occupancy, and a lack of approved (and possibly dangerous) electrical, plumbing and general construction.

Dan Harkey has worked for over 45 years in the hard money lending business.  (To old veterans like myself, Dan is respected as an icon.). He currently consults with borrowers in need of hard money loans.  Dan can be reached at 949-533-8315 or at dan@danharkey.com.

Attention Accredited Investors:

A large percentage of our trust deed investors started out as borrowers.  I met these guys when they applied for a $1 million loan on their strip center... and within three years I had convinced them to invest $30,000 in a first trust deed.

I know, I know, your main concern right now is getting a commercial real estate loan; but do you want to retire with $4 million or $5.5 million?

You need to put some of your retirement savings into first trust deeds.  For example, are your IRA funds earning 7% to 12% interest right now?  Betcha they aren't.  I strongly urge you to take a quick look at our first trust deeds.

George 

What on earth is a TIC roll-up?  Do they bite when you try to roll them up?

In order to understand a TIC roll-up, you first have to understand a TIC.  A tenancy-in-common investment ("TIC" or "TIC Investment") is an investment by a taxpayer in real estate which is co-owned with other investors.

Since the taxpayer holds title to the real estate as a tenant-in-common, TIC investments qualify under the like-kind rules of §1031.  In other words, if the 67-year-old owner of a big apartment building, in which he has lots of equity, gets tired of the hassles of management, he can do a delayed exchange into a TIC.

TIC investments are typically made in projects such as apartment houses, shopping centers, office buildings, etc.  Management responsibilities are provided by management professionals.  Cash returns on these types of investments are typically in the 6% to 7% range.  Syndicators of TICs are called "sponsors."

TIC investments are commonly structured in one of the following ways -

• A single-tenant property with an established credit rating; or
  
  
• Multiple tenants subject to a single master lease with the TIC sponsor who subleases to the tenants; or
  
  
• Multiple tenants each with separate leases managed by professional management.

TIC's do have a few drawbacks.  These investments have extended terms, so the investor is pretty much stuck in the deal for a long period.  To make matters worse, there is no liquidity.  A TIC investor can't easily sell his tenancy-in-common interest.

Okay, now that we know what a TIC is, we are once again ready to ask, "What on earth is a TIC roll-up?"

That's the question I asked my buddy, Yoni Miller, of QuickLiquidity.com.  Yoni had just sent out another tombstone announcing the closing of a $6.8 million subordinated loan secured by a portfolio of industrial buildings along the Eastern seaboard.  The senior debt was a CMBS loan.  The proceeds of Yoni's loan were used to effect this strange transaction known as TIC roll-up.  

In response to my question, Yoni wrote:  

I have a real treat for you today.  A buddy of mine, Yoni Miller of QuickLiquidity.com, makes preferred equity investments and second mortgage loans on commercial property.  He has generously agreed to write today's fascinating blog article about all of the unique types of preferred equity investments and commercial second mortgages that junior commercial lenders can make.

Before we get into Yoni's wonderful article, I first just want to give you a quick refresher course on preferred equity investments.  Preferred equity is similar to a second mortgage on a commercial property.  You own a $6 million shopping center, and you owe just $2.5 million against it.  You need $1 million to convert a former K-Mart space into self-storage space.

You just can't go out and refinance the building because you have a defeasance prepayment penalty.  You would have to pay a prepayment penalty of $850,000 just to borrow $1 million.  The first mortgage loan documents prohibits second mortgages.  You can't even put a mezzanine loan on the property because the first mortgage loan documents prohibit mezzanine loans too.  The trust that bought the first mortgage does not want the owner to take on any additional loan payments.

A preferred equity investment is NOT a loan.  Therefore it does NOT have any loan payments.  A preferred equity investment is a purchase of some of the membership interests (think of shares of stock) in the limited liability company (think of a corporation) that owns the commercial property.

The preferred equity investor only gets paid if the property is generating enough cash flow.  Because the investment is preferred, the preferred equity investor gets a paid its return first, right after the first mortgage payment, but before any of the other owners of the property can pull out a dime.

Now on to Yoni's insightful article.  Who knew such unique financing and liquidity strategies actually existed?

Commercial real estate owners strive to create additional equity in their investment properties.  (George: By renovating the property, leasing out vacant units, replacing existing tenants with higher paying tenants, and paying down on the first mortgage.)  Once they have created a significant amount of equity, they unfortunately have few ways to monetize it.  (George:  Pay attention here folks.  Lots of investors have tons of equity, but they don't know how to monetize it!)

The most common way to monetize equity in a commercial real estate investment is a cash-out refinance, but some borrowers' existing first mortgages have hefty prepayment penalties, meaning if they were to refinance and payoff their existing mortgage, they have to pay extra fees, which can vary greatly.  In many cases these prepayment penalties make it costly to do a cash-out refinance with a new lender, making them look for alternative options for them to monetize their equity.

Two of the most popular options are second mortgages and equity recapitalizations, which may allow them to monetize their equity without disturbing their existing first mortgage. Let’s discuss what each of those are and then provide a few real life examples.

What is a “Second Mortgage”?

Investopedia answers the questions for us.  “A second mortgage is a type of subordinate mortgage, made while an original mortgage is still in effect. In the event of default, the original mortgage would receive all proceeds from the liquidation of the property until it is all paid off.  Since the second mortgage would receive repayments only when the first mortgage has been paid off, the interest rate charged for the second mortgage tends to be higher and the amount borrowed will be lower than that of the first mortgage.”

What is a “Equity Recapitalization”?

An equity recapitalization in commercial real estate is changing the mix of the capital that creates the real estate capital stack (George: On $100 million office building purchases in New York City, the capital stack often gets very, very layered.  For example, there's the first mortgage, then mezzanine loan #1, then mezzanine loan #2, then the senior preferred equity, then the junior preferred equity, then the venture equity, and finally the developer's or borrower's cash contribution.)

An equity recapitalization is often done to buy out existing partners, create liquidity for new investment opportunities, or for capital needed for tenant improvements. A common way to achieve this is by bringing in a new capital partner or preferred equity investor. This helps an owner create the liquidity they need without giving up management control or majority ownership of the property.

Here are four examples of how QuickLiquidity, a direct lender and preferred equity investor recently helped commercial real estate owners and limited partners monetize their existing equity.

1)    QuickLiquidity funded a $1.4 million second mortgage on a $50 million shopping center located in a suburb of Kansas City, MO. The borrower, who is an experienced developer, needed to monetize his equity in a 235,000-square-foot shopping center without refinancing their existing first mortgage. The borrower had recently created significant equity in the shopping center by redeveloping it and securing new long-term leases with national tenants. The borrower's existing first mortgage lender would not increase their loan for the purposes of a cash-out, leaving the borrower with a limited amount of financially feasible options to quickly monetize their equity. If the borrower were to refinance their first mortgage with a new lender, the closing costs and fees to replace the large first mortgage would be significant compared to the relatively small $1.4 million cash-out amount. QuickLiquidity offered a solution by providing the borrower with a second mortgage on the property. This saved the borrower a ton of money in fees and provided them with the capital they needed in the time frame they needed.

2)    QuickLiquidity purchased a 2.53% partial interest for $460,000 in a real estate partnership that owns a 199-unit apartment community in Fairfax, VA. (George: Pay attention here.  QuickLiquidity actually purchased a tiny interest in the LLC that owned the property.  This was NOT a preferred equity investment.  After the purchase, the interest that QuickLiquidty purchased was pari passou with that of the other investors in the project.  In the words of the Church Lady, QuickLiquidity was NOT special.)  The seller inherited the partial interest over 30 years ago and was seeking an immediate exit strategy from their illiquid and non-controlling interest. By QuickLiquidity coming in as a new passive investor, the seller was able to receive immediate liquidity without having to wait until the partnership decides to sell the property, which might not occur for many years.

3)    QuickLiquidity provided $1 million of post-petition debtor-in-possession (DIP) financing to a commercial real estate investment fund in Chapter 11 bankruptcy. The DIP financing is secured by a priority lien against the funds ownership interests in 5 properties totaling almost 500,000-square-feet, between three office buildings and two retail shopping centers. This loan provided the necessary capital to allow the fund to operate while pursuing a confirmable plan of reorganization.

4)    QuickLiquidity made a $500,000 loan secured by a 9.39% illiquid and non-controlling ownership interest in a $30 million shopping center located near Cincinnati, OH. The property is 320,000-square-feet.  The shopping center is 100 percent occupied, with its anchor tenants being The Home Depot, Kroger, and Kohl’s, who have leases that continue until 2024 and 2025. The borrower looked to monetize its illiquid and non-controlling ownership interest to access capital in order to invest in a time sensitive real estate development deal. By bringing in QuickLiquidity as the lender, the borrower was able to receive the capital he needed, while maintaining complete ownership of his interest. (George:  Note, unlike example 2 above, QuickLiquidity did NOT buy the borrower's membership interest in the LLC that owned the shopping center.  Instead, they made a loan against it.  This is incredibly rare and invaluable to know.)  This allows the borrower to receive the property’s future appreciation and upside, while leveraging his existing investment.

QuickLiquidity is a direct lender and preferred equity investor providing equity recapitalizations, subordinated debt and partner buyouts on commercial real estate nationwide. QuickLiquidity allows real estate owners to monetize their existing equity while maintaining majority ownership and control of their property without disturbing their existing first mortgage or triggering any prepayment penalties. For more information you can visit www.quickliquidity.com/recapitalizations.html or call Yoni Miller 561-221-0881.

You don't see many new second mortgages on commercial properties these days.  The reason why is because most modern first mortgage loan documents contain an outright prohibition against any sort of junior financing.  It's not just conduits that prohibit junior financing.  Commercial banks now also prohibit junior financing.

The section of a first mortgage that prohibits junior financing is called the alienation clause.  An alienation clause is one that says that the alienation (transfer) of any interest in the property, without the permission of the lender, is grounds to accelerate the loan and to demand that the loan be immediately paid in full.  The really sucky part of such an acceleration is that the payoff demand will contain the full prepayment penalty!  Ouch.

"But George, what if there is tons of equity in the property?"

One way a big-time investor can pull equity out of an underleveraged commercial property is to obtain a mezzanine loan.  Unfortunately mezzanine loans and preferred equity investments are also considered junior financing and are usually prohibited.  In some cases, however, an intercreditor agreement can be negotiated.

An intercreditor agreement is an agreement between a first mortgage holder and the provider of junior financing, which could be a second mortgage lender, a mezzanine lender, or a preferred equity investor.  The first mortgage lender looks at the junior lender for experience in actually operating the type of property involved and for his financial strength.  If the junior lender is a newbie with no financial strength, the first mortgage lender will say no.  If the junior lender is an old pro with deep pockets, the first mortgage lender will sometimes agree in writing to permit the junior financing.  There is often a provision that says that the first mortgage lender will notify the junior lender immediately in the event of a default.  The intercreditor agreement will also often allow the junior creditor to buy the first mortgage in the event of a default.

Okay, with this long-winded background in mind, we finally get to the point of today's training lesson.  This week a buddy of mine who makes preferred equity investments (like a second mortgage but with no required monthly payments) sent out a tombstone.  He proudly announced that his company had just made a second mortgage of $1.4 million behind a $32 million first mortgage on a $50 million shopping center in Kansas City.

Holy crap!  A second mortgage of only $1.4 million behind a $32 million first mortgage???  So I wrote to him, "My friend, this loan grossly violates the New-Money-to-Old-Money Ratio."

Back in the old days of hard money, second mortgage lenders learned the hard way never to make a small second mortgage behind a huge first mortgage.

Example:

Newbie Mortgage makes a $20,000 second mortgage behind a $500,000 first mortgage on a house worth $1 million.  There is tons of equity.  Then the borrower becomes a crack addict and stops making all payments.  By the time the second mortgage finds out, the first mortgage is behind 7 payments of $4,000.  Just to cure the loan, Newbie Mortgage has to come up with $28,000.

Then Newbie Mortgage is facing another nine-month ordeal to march to a trust deed sale and to obtain relief from the automatic stay of bankruptcy.  That’s another $36,000.  And then there are attorneys fees and foreclosure costs.  That’s an advance of over $54,000 - just to protect an original investment of $20,000.

Ninety percent of similar investors, in real life, end up just walking away from their $20,000 loan.

The Irony: 

The first mortgage lender goes to a foreclosure sale.  No one bids, so the first mortgage investor ends up owning the property.  After a $15,000 clean-up and facelift, the lender ends up later selling the property for $1.3 million.  Arghh.

New-Money-To-Old-Money Ratio

New Money / Old Money > 33%

In plain English, the wise second mortgage investor will avoid making any second mortgage where this ratio is less than 33%.  In other words, the second mortgage should be at least one-third the size of the first mortgage for the reasons explain above.

Now back to my buddy's deal:  Let's compute his New-Money-to-Old-Money Ratio.

($1.4 million / $32 million) x 100% = 4.3%

Holy crap!  This ratio is never supposed to be less than 33%.

Now my buddy is pretty sophisticated and he pointed out that his Fund had negotiated a very good Intercreditor Agreement.  The underlying first mortgage holder had agreed to notify them immediately in the event of a default.

In addition, his Fund had the option to purchase the underlying first mortgage in the event of a default.  His Fund would love to own this $32 million first mortgage because it had an attractive default interest rate.  It would also love-love-love to own this gorgeous shopping center for a mere $32 million.

He had also gotten personal guarantees from the high net worth borrower and other high-equity LLC's.  Lastly, the shopping center had a number of long-term leases from credit tenants and near-credit tenants.

By the end, I agreed that his was a reasonably prudent investment, but only because his Fund had deep-deep pockets.

Folks, I have done a pretty smart thing.  I have started to trade my wonderful video training courses  to mortgage brokers all across the country for a list of ten bankers making commercial loans.  We are adding these banks to CommercialMortgage.com ("CMDC") in huge handfuls.  Man, CMDC is getting soooo useful.  And its free!

If you are a multifamily or commercial property investor yourself, today's training article is really going to open your eyes.  Banks dislike you just for breathing.

Example #1:

Bob Tool opens a successful tool and die business.  He has a net worth of around $2 million, and he clears about $140,000 per year.  Bob hears about a competitor going out of business, and he has an opportunity to buy $3 million's worth of equipment for just $600,000.  Bob therefore applies to Steve Veteran, a very experienced commercial mortgage broker, for a $600,000 on his industrial building.

Now Bob Tool's industrial building is not terribly pretty.  It is a 30-year-old steel building that is showing its age.  Old industrial equipment litters the yard.  Bob had approached a couple of banks on his own, but the answer was the same.  The banks just didn't like the collateral.

Now Steve Veteran has survived for twenty years in the business for a reason.  He understands banking.  Bob therefore does a Google search for small banks located close to Bob Tool's business. He find the First National Bank of Nearby.  Then Steve calls the bank president (branch manager), and sets up a meeting between the three of them.

At the bank, Steve introduces Bob to the bank president and explains, "Mr. Banker, Bob owns a successful tool and die company near you.  He needs to borrow $600,000 for five years, but he is willing to change banks and move all of his corporate and personal accounts over to your bank."  

The banker's face breaks into a BIG smile.  "Welcome, Bob, you've come to the right place."  The banker knows that Bob may end up keeping his accounts at the bank for the next decade or two.  Because Bob's business is successful, he will probably maintain sizeable cash balances in those those accounts, money with which the banker can make loans to other customers.

This is The Banking Game, and Steve Veteran, the old-time commercial mortgage broker, played the game to perfection.

Example #2:

John Investor does not own a company.  Instead, he owns and manages several apartment buildings.  Like Bob Tool, he has a net worth of aound $2 million, and he clears about $140,000 per year.  John Investor hears about a five-plex that was just forclosed upon by a hard money commercial lender.  The building is worth, once it is cleaned up and rented out again, on the order of $3 million.  He can buy this building from the hard money lender for $900,000.  John has the downpayment, but he needs a $600,000 loan from the bank.

John Investor therefore call the bank and sets up a meeting with the bank president.  At first the banker is all smiles, but as soon as the banker hears that John is a real estate investor, his attitude markedly changes.  "I'm sorry, Mr. Investor, but I know that apartment building.  It's pretty rundown.  This deal is not for us."

Frustrated and sensing some distinct coldness from the banker, Steve argues, "But, Mr. Banker, I am going to be fixing up the building.  Within 18 months, the building will be pristine.  I'll even move my bank accounts over to your bank."  "I'm sorry," stonewalls the bank president, "but this deal is not for us."

Okay, so what happened?  Both borrowers were successful businessmen.  Both had good credit.  Both made good money.  Why did the banker dump all over the real estate investor, like he was some sort of low-life?

Answer:

Real estate investors seldom leave large cash balances in their bank accounts.  As soon as they have amassed a decent grubstake, they go out and buy another building.  In addition, real estate investors like to use leverage, so most of them are paying on large real estate loans.  

Real estate invesors are not good bank customers; i.e., they don't maintain large cash balances in the bank.

Much of the Above is No Longer True

Huh?  Not true?  Its pretty easy for banks these days to raise deposits.  All they have to do is to raise their interest rates a little higher than that of the competition, and new deposits will flow into the bank.  The problem, however, is that this is hot money, and hot money can flow out as quickly as it flowed in.

Money center banks and the big regional banks will seldom turn down a good real estate loan these days because of the lack of deposits.  These big banks are experts at matching their deposits with their loans.  By the way, a money center bank is a very large bank located in an economic hubs (large cities such as Los Angeles, New York, London, and Hong Kong) and earn revenue from transactions between themselves and governments, big businesses, and other banks, rather than the individual consumer.

While money center banks and large regional banks typically have all of the desposits  they need, this is not true of community banks.  Community banks still have to play The Banking Game, using their ability to make short term loans to entice businesses to maintain large cash deposits in their bank.

Whether you're a borrower, commercial broker, or commercial loan broker, today's super quick lesson applies to you.

You're working with a commercial lender, who is considering your commercial loan application.  You have read my single most important blog article ever, which explains that commercial lenders make loans for their friends.  In other words, if the commercial lender likes you, he will ignore a lot of black hairs in your package.  Therefore you want to develop a friendly relationship with this commercial loan officer.

Now think about it.  Would you want the receptionist telling your commercial loan officer, "Hey, Steve, that rude and pompous George Blackburne is only line three."  Or would you prefer her to say to Steve, "Hey, Steve, that little charmer, George Blackburne, is on line three.  Get him to tell you his little snail joke.  Ha-ha!"

The moral of the story is pretty simple:  Charm the socks off the receptionist.

One of my mentors, the great Bill Oldenburg, taught me this lesson.  He would fuss all over the receptionist whenever he telephoned his lender, and when he would make a personal visit, he would bring her flowers.  He was a charmer, and to his credit, he sincerely meant it.  He considered these receptionists and assistants to be his friends.  Its no wonder that he syndicated some of the largest commercial construction loans of his age.

PLEASE NOTE

The purple call-to-action button at the top of this page talks about my popular 9-hour commercial mortgage brokerage training course.  The course teaches a new broker everything from marketing for commercial loans, underwriting commercial loans, packaging the commercial loan, finding the right commercial lender, and lastly, fee collection.  We sell this course for $549.

But let's suppose you are a starving commercial mortgage broker.  You would love-love-love to own this course, but you don't have $549.  I will give you this 9-hour commercial mortgage brokerage training course course for free, if you will complile a list for me of ten bankers making commercial loans.  These are DVD's, so you will have to pay $30 or so for the shipping.

Please send your list to me by email.  Please insert in the subject line, "Trade for 10 Bankers."  Obviously I'll need your address and phone number.  Obviously this is George Blackburne III (the old man) at george@blackburne.com.  Guys, I get 1,300 emails every single day, so it is very easy for me to miss your email.  Right after emailing me your list, please send a text to 574-360-2486, "George, I just sent you a list of 10 bankers." 

I will please need the name of the loan officer, the bank, the address, the phone number, and his email address.  And guys, these commercial real estate loan officers must work at either a FDIC-insured bank or a NCUSIF-insured credit union.  I will not accept commercial real estate loan officers working for any other type of commercial lender.  I just want bankers.

You will probably have to call the ten closest banks to your office and ask for a commercial real estate loan officer.  Sometimes getting the banker's email address can be tricky.  They don't like giving it out.  I like to ask, "If I wanted to send you a package, to what email address would I send it?"

You can also choose instead our 4-hour video training course, "How to Find Private Mortgage Investors."  I have been telling you guys for years, the money in the mortgage business is in loan servicing fees.  My company enjoys $87,000 per month in loan servicing fees, whether we close a new loan or not.  There has never been an easier time to start a hard money mortgage company.  If you send me 20 bankers, you can have both training programs.

We take these dozens and dozens of new bankers, and we add them to CommercialMortgage.com.  Since the site is free and super-fast, you would be crazy not to search for commercial lenders using CommercialMortgage.com.  

When applying for a commercial loan to buy a small apartment building, you are likely to run into the following problem:  When the lender applies a 1.25 Debt Service Coverage Ratio to the Net Operating Income, the property will only qualify for a loan of 62% Loan-to-Value.  The commercial lender will then insist of a down payment of a whopping 38% of the purchase price!  Remember, purchase money second mortgages, behind bank or conduit first mortgages, are forbidden nowadays.

Who the fiddlesticks has 38% to put down????  What the hellions is going on?

The problem when trying to finance small apartment buildings - I am talking about multifamily properties of 5 to 20 units - is that everyone wants to own them.  The Apartment Game has been played for generations in America.  You buy a four-plex, rent it out, and run it for five years.  In the meantime, the rents go up by 35%.  Then you sell it for a nice profit and use your profits, plus your original down payment, to buy a ten-unit property.  Five years later you sell that 10-unit building and use your big profit to buy a 20-unit project.  By the age of 55, you are ready to retire and live off your rents.  Your success is virtually guaranteed, as long as inflation continues.

Because the Apartment Game is a virtually guaranteed path to a comfortable retirement, everyone wants to play.  If a small apartment building comes on the market, there is a feeding frenzy.  A 15-unit apartment building might have a NOI only $212,000, but the bidding is likely to go as follow:

"I'll pay $2,650,000 for that $212,000's worth of income."  This works out to an 8% cap rate.

"I'll pay $3,029,000 for that $212,000's worth of income."  This works out to a 7% cap rate.

"I'll pay $3,533,000 for that $212,000's worth of income."  This works out to a 6% cap rate.

When the bidding stops on this 15-unit apartment building, the price is likely to end at $4,348,000 - which equates to a cap rate of just 4.875%.  

Then, when the lender takes the $212,000 in NOI and divides it by the 1.25 Debt Service Coverage Ratio, he arrives at a loan amount of only $2,709,000 - assuming he used a 4.75%, 30 year constant.  Constant is just a fancy word for using a 4.75% interest rate on the new multifamily loan and a 30 year amortization.

Quick Review and Summary:

An investor is buying a 15-unit apartment building that has a Net Operating Income of just $212,000 per year.  The bidding to buy the building is fierce.  Everybody and their brother is bidding to buy it.  The investor is forced to pay around $4,350,000 for the building.  The loan officer at the bank working to make the loan can only get the deal to pencil at $2,710,000 - using a 4.75% interest rate and a 30 year term.

The investor has some serious down payment money, but who on earth has 38% to put down?  Does this mean that small apartment buildings cannot get financed, even though small apartments are the most desirable type of income property in the whole world?  Please read this again.  The hottest type of real estate - the best and most secure collateral for any real estate loan - is small apartments.

How Your Bank Loan Officer Must Handle This Situation:

First of all, the investor needs to choose a bank loan officer who is willing to go into Loan Committee and fight for the deal.  Then that loan officer must say:

"Boss, listen.  If we make a multifamily loan on a 100-unit apartment building, we could sit on that foreclosed collateral unsold for months, even though the loan had a 1.25 debt service coverage ratio originally. After all, there is not an unlimited demand for, and an unlimited number of buyers of, a 100-unit apartment building."

"In contrast, if we start to foreclose on a small apartment building (5-20 units), our REO department will have buyers lined up before the foreclosure sale even takes place.  You can verify this, Boss.  Just call the REO Department and ask them how many small apartment buildings we have unsold."

"The truth is, Boss, is that small apartment buildings are the single most desirable class of real estate to own.  The prices get bid up so high (in other words, the buyers are willing to accept very low cap rates), that the numbers don't work for a traditional apartment loan."

"If we want the BEST collateral for our loans, we have to show some flexibility on the debt service coverage ratio on small apartment deals.  We have to be willing to accept a 1.0 debt service coverage ratio, as long as the buyer's global income (salary, interest income, other net rental income) will support a few vacancies."

What I have written above is the absolute truth, and the bank loan officer, in Loan Committee, has to keep pounding the drum.  "Do we want fantastic collateral for our loans in real life or just so-so collateral that looks good on paper."  If the loan officer sticks to his guns, Loan Committee will eventually agree.

Here is one more arrow for the bank loan officer's quiver.  Any small apartment building that does pencil is almost assuredly in a slum.  For a small apartment deal to comfortably pencil for a 70% to 75% loan today, it must be selling at an 8% or higher cap rate.  In other words, in order to attract a buyer, the seller has to offer prospective purchasers a higher yield on the property.   The investor is thinking to himself, "The only way I am going to buy a property in this stinky area is if I am getting a huge return on my money."

So the last arrow in your loan officer's quiver is this:  "Boss, if a small apartment building loan ever pencils, I guarantee you that the area is so seedy that you wouldn't want your wife or mother walking around there at night.  The bank should want to make their apartment loans in good areas.  The reason why this deal doesn't pencil perfectly is because its in a good area."

One final point:  Banks, agency lenders (Fannie Mae, Freddie Mac, etc.), and conduits will not allow the seller to carry back a second mortgage behind their new first mortgage loans.  Blackburne & Sons will allow second mortgages!

Commercial loan brokers and borrowers often give up far too easily.  They get a commercial loan application in the door that they think is pretty good.  Then they take the deal to three or four commercial banks, who proceed to criticize the deal to death.  "I don't like the location."  "The borrower isn't strong enough."  "One of the leases expires in just 14 months."  "The borrower doesn't have enough liquidity."

Then the commercial loan broker loses confidence in the deal and quits.  He thinks to himself, "This must not be as good of a commercial loan as I thought it was.  I better go find a better one."  Arghhh!  There is probaly nothing really wrong with the deal.  Let me make something clear:

EVERY COMMERCIAL LOAN EVER CLOSED HAD A FEW BLACK HAIRS.

Read my lips.  Every commercial loan ever closed had a few black hairs.  An intelligent eight-year-old girl (boys are still pretty 'tupid at that age) could pick out flaws in a commercial loan package.  Bankers often think they are a genius when they find a flaw in a commercial loan, and then they tell you to come back when you have a better deal.  Horse pucky!  When you weigh the pro's and the con's of the deal, your commercial loan should probably be made.

So what happened?  You took your deal to a bank or a particular bank loan officer who just didn't feel like lending today.  Because the banker wasn't in the mood, he picked on the first black hair that he could spot and then sent you packing with a pat on the head.  "There's a good little boy.  You come back later with a perfect commercial loan or the broomstick of the Wicked Witch of the West."  Hellooo? There is no such thing as a perfect commercial loan!

Now we get to the point of today's training article:

Commercial loans should close EASILY.  If your banker is using weasel words, move on immediately to another bank!

When your banker uses weasel words like, "Well, I'm not sure," or "I'm worried about the loan-to-value ratio," he is just setting you up to turn you down tomorrow.  Commercial loan packages seldom get prettier overnight.  Banks seldom develop a voracious appetite for commercai loans overnight.  Therefore the instant your bank loan officer starts using weasel words, immediately submit your deal to three more lenders.  

Three is a magic number for me.  I try to make it a rule to always have my commercial loan submitted to at least three different lenders at the same time.  "Oh, my gosh, George, what if two lenders come back and issue me a term sheet at the same time?"  Oh my gosh, what if Michelle Williams and Mila Kunis both asked me out at the same time?  Ha-ha.  Ain't gonna happen in real life.  Always have at least three bankers looking at your deal at the same time.

Now remember, the lesson for today is this:  Commercial loans should close easily.  Why?  How?  The answer is that you have to find the right lender for the right deal at the right time.  That's the key.  When you find the right lender at the right time for your deal, you will be amazed at how easily the deal will close.  There will be zero hard-selling on your part, and the "huge" black hairs will appear trivial to the banker.  So if your banker seems like he is fighting you - if it seems like the going is hard - you just haven't found the right lender for your deal.

This leads me to my next point:  Be prepared to take your commercial loan to at least twenty to thirty banks, or other commercial lenders, before closing it.  Using email and Dropbox.com, this is super-easy these days.

Of course, if you take it to a bank, and the banker is drooling all over it, then it sounds like you have found the right bank at the right time.  You certainly should never quit on a deal after presenting it to just ten or fifteen lenders.  Placing commercial loans is a numbers game.  The more commercial lenders to whom you present your deal, the more often you will "get lucky" and find the right bank at the right time.

"But George, where am I going to find all of these banks?"  Finding banks is easy-peasy:

1. C-Loans.com has 750 commercial lenders, and you can actually submit your deal using C-Loans.
   
   
2. CommercialMortgage.com has another 3,500 commercial lenders.
   
   
3. There are 6,799 commercial banks in America.
   
   
4. There are 6,143 credit unions in America.
   
   
5. Go to maps.google.com and enter the address of the subject property.  Then ask Google to plot the nearby banks.  Banks love to lend close to their office.

One final point.  Let's suppose you have a commercial loan in Northeast Boston.  You approach the First National Bank of Northeast Boston, but the white, sixty-year-old, sleepy (lazy) commercial loan officer brushes you off.  Hmmm.  First National Bank should have been perfect for this deal.  The property was right in their sweet spot in terms of loan size and location.  Solution:  Wait 48 hours and then present it to a different loan officer at the same bank.  The new loan officer - Asian woman loan officers are often dynamos - might just love your deal.  I have successfully closed numerous commercial loans using this trick.  The new loan officer might be in the mood to close some deals.

On T.V. and at cocktail parties, you have probably heard all about people making big profits fixing and flipping houses.  The U.S. built only 1.2 million homes last year.  The U.S. must build 1.7 million new homes every year just to keep up with population growth.  How have we been filling that shortfall?  The answer is with fix and flips.   We are returning rundown homes to the housing stock.

When a fix and flipper renovates an older home, he is often providing a near-new home to some young couple, both of who are probably working.  They totally lack the time and experience to do the renovation themselves.  That fix and flipper is truly doing a good thing for that young couple.  The couple will enjoy a near-new home for 20% less than the cost of a new home.

Flipping homes is also great for the environment.  Think of all the trees that are spared because a new home is not constructed.  Lastly, think of the kids.  Older homes usually have much larger yards in which kids can romp and play, compared to new homes.

My point is that you should feel good about the work you are doing as a house flipper.

But How Do You Find a Home to Flip?

Here are some practical tips:

Consider using a wholesaler on your first deal.

Wholesalers are in the business of finding rehab properties, putting them under contract, and then finding a buyer who will execute the house flip.  You take the place of the wholesaler in the contract, paying a fee to the wholesaler for being the middleman.  Make sure the wholesaler doesn’t add a profit margin to himself that is so large that he doesn’t leave any profit for you.   I recently did a Google search, “home wholesalers Indianapolis”, and I found dozens of listings.

Hire an agent who specializes in REO’s. 

REO stands for "Real Estate Owned" and refers to property that is held by a lender as the result of a defaulted loan.  Most of these homes will have gone through an extensive foreclosure, and perhaps an eviction process.  In addition, the prior occupants probably did very little to care and maintain the property during the pendency of the mortgage default, foreclosure and eviction.  As a result, many of these properties are priced lower than the surrounding homes due to their neglected conditions, making them ripe for a house flip.  Many lenders and loan servicers align themselves with a small group of realtors that specialize in selling these types of properties.  The key to finding them for your house flip is to work with a realtor who has the inside track on these real estate listings and new rehab homes on the market.  You can find them by doing specific internet searches for REO real estate agents and brokers within a specific geographic area.  For example, I just did a Google search of “REO specialists Indianapolis” and found lots of listings.

Work with your favorite real estate agent using the MLS.

Have her set up email alerts for new listings based around key words, such as handyman’s special, fixer-upper, fix and flip opportunity, needs work, distress situation, divorce situation, neglected, needs repairs, foreclosure, REO, etc.

Attend foreclosure sales, estate sales, and auctions.

Real estate auctions, conducted at a public place, most often at the courthouse, are the best place to consistently source below-market real estate. The lenders are often times willing to take a discount from the amount owed.  This allows buyers to purchase a property at 60-80% of the market value. The investor can then quickly remodel (if needed) and resell the property for a profit. The downside is that oftentimes you need to pay all-cash for the purchase, and there is no title insurance or inspections on the properties.  Although there is some risk associated with this tip, with proper due diligence and patience you can do this profitably in any market in any area.  In addition, not every foreclosed home finds s a buyer at a foreclosure sale.  By attending foreclosure sales, you will be able to identify those lenders who are stuck with a foreclosed home that they do not want to own.

Most hard money lenders just want to get rid of their foreclosures quickly.

They are not interested in becoming landlords or home renovators.  Their loans are often made at low loan-to-value ratios, so there is often sizeable equity in their foreclosures.  If you can find and contact these individuals or companies, you’ll likely get access to some great deals.  I just did a Google search of “hard money lenders Indianapolis” and found dozens of companies listed.

Network-network-network!

Build yourself a network of finders and contacts that - because of their jobs - run across distressed home opportunities.  The next several tips will explain exactly how to do this.

Don’t be shy about offering to pay a finder’s fee for a home that you end up buying.

Folks, I am an attorney, and let me reassure you that finder’s fees are perfectly legal.  Advertise your finder’s fee offer boldly and with confidence.  “A finder is a person whose employment is limited solely to bringing the parties together so that they may negotiate their own contract.”

It is essential that your finder does not try to play real estate broker and negotiate terms.

If your finder negotiates any terms, it is illegal to pay him because he is not a licensed real estate broker.  Therefore limit your finder’s work to setting up an introduction.

How much should you pay?

I recommend a cool $1,000.   Capitalism works, folks.

You need to institutionalize your marketing for homes to buy.

"Institutionalize?  That’s a big, boring, fluffy term.  I’m falling asleep here, George.”

By institutionalize, I mean that you need to develop a repeatable formula that works every time and which requires very little character on your part to implement.  For example, suppose I told you to get on the phone and call 15 people every day?  It’s a formula.  It would probably work; but who has the discipline to make 15 calls every day?  That requires an immense amount of character, so I don’t like it.   But how about this?  Could you develop a list of 70 to 1,000 particular people to whom you could forward a funny or interesting email once a week?  After the joke, you could have a signature block that reads, “I PAY $1,000 REFERRAL FEES FOR HOMES TO FLIP (in big, bold red print).  Please look for homes where someone has died, moved to a care home, or come back in foreclosure.”

 Choose your 70 to 1,000 finders by the nature of their work.

Certain people, because of the nature of their work, see good fix and flip candidates several times per year.   Here are the types of workers who see fix and flip opportunities on a regular basis - real estate agents who specialize in estates, antique dealers, estate sale professionals, clean-out guys, dumpster companies, divorce attorneys, and probate attorneys.

Don’t forget business cards.

You should have two types.  One should read in big, bold type:  “I PAY $1,000 FINDER’S FEES FOR HOMES TO FLIP. “ The other might say, “I’LL BUY YOUR HOME QUICKLY.”

Develop an elevator pitch.

What on earth is an elevator pitch?  An elevator pitch is a short, succinct sales pitch - something that you can deliver in the time it takes an elevator to go up four floors.  Here’s a hypothetical:  “Hello, my name is George Blackburne, and I own Blackburne & Sons.  I am a residential developer, and I specialize in restoring and repurposing run down homes.  I pay a $1,000 finder’s fee to people who find me homes to buy and flip.  May I give you one of my business cards?”

Put a magnetic sign on your car.

“$1,000 Finder’s Fee For Homes To Flip.  574-360-2486.”  You could find a great opportunity while your car is parked at the grocery store.

Get to know the mail carriers in the neighborhoods in which you want to buy.

Mail carriers know who is having financial difficulty, who is behind on their taxes, who is seriously ill, who is moving out, and more.  They know more than Google when it comes to the people on their routes, so get to know them.

Finding homes to flip is a skill that you will refine and improve over time.  Have you developed a great marketing trick of your own?  Would you please share it with me?  Write to me at george@blackburne.com, and please write in the Subject line, “Great Fix and Flip Tip For Old George.”  I would really, really appreciate it!

The following annual Christmas letter went out to all of our 1,300 wealthy private investors this week.  I hope you get a kick out of it too...  

Fortunately, the walkers were held back by a police barricade, but this did not stop them from snarling, gnashing their Zombie-like teeth, and reaching out for our delicate flesh with their angry, outstretched arms.  Was this the Zombie Apocalypse?  No.  These were the Inauguration Day J20 protesters, who so terrified my wife and my 64-year-old cousin, Patti. 

The three of us were walking towards the stands along Pennsylvania Avenue in order to watch my daughter, Jordan, ride her horse, along with the famous Culver Black Horse Troop (100 all black horses) and the Culver Equestriennes (20 lovely young ladies), in review past President Trump and Indiana’s own Vice President Mike Pence in the 2017 Inaugural Parade.  (I rode in President Nixon's Parade in 1971.  George IV rode in W's first parade, and Tom rode in in W's second parade.  A lot of legacy, huh?) 

There was a reason why the stands were so empty.  Police barricades were required to keep back the Zombies.  No, that’s unfair to the Zombies.  Even Zombies don’t behave this badly.  One of the protesters, a skinhead, targeted his rage at poor Cisca and Patti, shouting obscenities in their faces for absolutely no reason.  For all he knew, these two grandmothers might have voted for Hillary.  

With a daughter scheduled to ride in the parade, we were not to be dissuaded.  We eventually had to walk several miles to circle around the Zombie barriers, but finally we got to the stands.  We learned afterwards that most of the other Culver parents gave up trying to reach the stands.  Later, the press made great hay over the fact that the stands were so empty.  Helloooo? Would you want to be eaten by Zombies?  Plucking off your little toes.  Eating them like French fries.  Ketchup? 

In the stands, we were within 30 feet of the President as he walked down the parade route.  Melania Trump was stunning, of course, but I was most impressed by the lovely Ivanka Trump, wearing a tasteful, but close-fitting, cream dress and very high heels.  When one of her little boys, around four years in age, started acting like a little boy-onster (half boy, half monster), she scooped him up, threw him on her hip, and continued walking and waving without missing a step.  Talk about the modern woman.  Wow. There is a special place in the corner for any little boy-onster who acts up during his grandfather’s big parade.

As the Culver horses rode past the reviewing box, Jordi was on the left side, closest to the President.  One television news network (CNN?) zoomed right in on Jordi, who rocked 20 million Americans with her radiant smile.  I paid a lot of orthodontist bills for that smile, but it was worth it!  If you are ever suffering from insomnia, be sure to ask Cisca to show you pictures, including her 4-second video clip of Jordi dazzling the world.  Very nice, Cisca… zzzz... head bounce...   

The J20 Zombies are on trial right now for smashing windows, trashing cars, and eating human flesh on Inauguration Day.  According to the legal arguments being advanced by the Federal prosecutor, if you are part of a Zombie horde, and even one Zombie rips off a human arm and begins munching, you are guilty of mayhem, even if you are a vegan Zombie.  Hmmm.  That’s a pretty dangerous argument for the future of free speech and non-violent protests.  I mean, c’mon, how are you going to keep every single Zombie from grabbing a quick snack.  Even I have to admit that my Cisca’s lovely ear lobes are irresistibly delicious.  Oh, my gosh, am I a Zombie?

This is Christmas time, and I should be spouting sweet nothings and warm wishes of love… but I simply must say that 2017 was a pretty lousy year for America.  The Zombies and the Nazis can no longer talk to each other.  A Republican friend of mine admitted that he has no more liberal friends.  I was part of an email string that contained a pretty funny, but politically insensitive, joke.  A liberal mortgage broker in the string of 20 brokers objected to the insensitivity of the joke, and my buddy wrote to him, “You are no longer my friend.”  Huh?  That broker had brought business to my lender-friend for 10 years!  What?  That’s it?  In the words of the great Rodney King, that world-renown humanitarian, “Can’t we all just get along?” 

And before any Zombies jump all over my Nazi friend, I must say, in all candor, that many Zombies no longer allow Nazis to even speak.  Apparently believing in free markets and self-help makes all Republicans to be fascists, nationalists, white supremacists, misogynists, or some other form of “ist”.  In the 1960’s, bras were first burned and the Vietnam War was famously protested at the University of California at Berkeley.  Berkeley was the epicenter of free speech… but apparently Ann Coulter, the conservative commentator, is not allowed to speak there.  Apparently she’s a misogynist.  No, that’s not it.  Must be some other form of –ist.  Security concerns?  Hmmm. 

And if you think I am over-blowing this whole speech thingee, just watch any “news” show today.  Apparently both the Zombies and the Nazis have forgotten all about common courtesy.  They constantly interrupt each other while the other is speaking.  Let’s play a game.  Turn on Fox News or CNN and set your timer for one minute.  I’ll bet that the speaker will be interrupted at least three times in a minute.  My dear mother would have smacked me upside the head.  [Smack!] 

Okay, so my daughter, Jordi, had graduated from Culver Girls Academy. Culver was incredibly expensive - far more expensive than most colleges. I’m not bragging… okay, I’m bragging… but Jordi won First Team, All State, starting goalie for high school lacrosse in Indiana.  Fortunately for my wallet, she had been recruited to play lacrosse for Earlham College, an hour east of Indy, and she had received an “academic” scholarship.  Phew!  My personal future was now clear.  I had done my duty.  Now it was finally golf time with my 300 buddies at Pretty Lake Golf Club.

But then I got the call.  “Dad, your only granddaughter, Reagan, hardly knows you.  You have to move to Indy.”  So we loaded up the truck and moved to Beverly… er, Indianapolis.  We found a pretty little brick house in a gorgeous subdivision, just two houses away from the prestigious Geist Reservoir.  All I want for Christmas, Santa, is to squeeze my little house between two of those 8,000 square foot “cottages” ($$$) on the lake.  

Cisca and I love it here.  Indianapolis has two pro sports teams, Uber, and even food delivery.  Have you tried Uber Eats?  Works great.  We get to babysit Reagan three or four nights per month, and she even has her own bedroom.  I used to chase her up the stairs, pretending to pinch her little bottom.  “Make your run, Reagan.”  And she would squeal in delight.  But then she turned on me.  “Make your run, Gramp,” and she pinched my fat fanny all of the way up the stairs.  Smarty pants.  Actually she is.  She scored in the 99th percentile in math and 98 percentile in reading. 

Cisca is thriving here in Indy.  She found a Zumba Gold dancing class, and she is making lots of friends.  Then she got adopted by our homeowner’s association
representative, a warm, charming, and effervescent lady who lives just six houses down the street.  There are close to 1,800 homes in our homeowner’s association!  This wonderful lady actually came to greet us when we moved in, and she has convinced Cisca to volunteer on the home quality committee.  Cisca came home laughing one day.  One of the homeowners had painted, without permission, their gorgeous brick home “Pepto Bismal pink”.  The Gestapo whisked them away in the night, never to be seen again. 

George IV is absolutely killing it at work.  He will close $1.4 million in hard money loans this month.  Because I am George III and he is George IV, I get numerous calls for him by accident.  These brokers keep telling me what a great guy he is.  Makes a papa proud.  Sadly George IV recently broke up with his long-time love, but fortunately he has already met someone new.  Both of them are joining us for Christmas too, which makes me do dog-flips.  One big dog pile of love. 

Every workday, our second son, Tom (aka “M”, the neglected Middle child), comes over to my house, just nine minutes away, and we work together out of my walk-out basement.  (I have owned Blackburne & Sons now for 37 years.  Our big office with all of the bodies and machines is in Sacramento, California; but Cisca and I were financially blessed and able to move to Indiana to send our children to the fabulous Culver Academies 18 years ago.)  I now get to see my son every day.  Is this a great country or what?  Tom is working very hard these days.  He sounds great selling, and he is finally starting to produce some loans.  The renovation of his starter home is almost done.  Tom and his lovely girlfriend, Alex, take care of Reagan, our granddaughter, exactly half the time - one week on and one week off.  And then there is Bernie, their 70-pound, lovable, goofy, energetic, bouncing, flopping, playful, and absolutely adorable golden retriever puppy. 

Jordi is enjoying Earlham College, and because I am so close, I get to go to every game.  In soccer she started at center forward, as a freshman, until she severely twisted her ankle.  She still scored a lot of goals, including a last-minute game-winner (4-3) in the final game of the season.  I stood there quietly on the sidelines and barely cracked a smile.  Not!  I went crazy… crazy for loving you. 

As for me, I have a heart rhythm problem, where my heart doesn’t beat fast enough to pump out all of the fluids; but I am scheduled for another jump start right after Christmas.  I’ll still probably die at age 95, when Cisca catches me again not putting the dirty dishes in the dishwasher.  [Smack!]

What did I learn this year?  Frighteningly, I got a brief glance of just how easy it would be for this country to turn into a fascist state.  The Zombies played an important role in exposing the danger, but can’t we all just learn to fight a little nicer?  Just sayin’.  Merry Christmas, everyone!