Commercial Loans and Fun Blog

When you get an adjustable rate home loan, the Promissory Note is always very, very precise about any interest rate readjustments.  For example, "Every six months the Rate will readjust to 3.57% over the weekly average yield on 12-month constant maturity Treasuries."

When most banks write a 10-year, fixed rate commercial loan, there is almost always a provision that calls for one rate readjustment or "reset" at the end of five years.  The rate is then fixed for the next five years.  This is as close as you're likely to ever get to a 10-year, fixed rate commercial loan on an office building or industrial building.

What has always amazed me is that the language surrounding the rate readjustment is often very loosey-goosey.  Instead of saying that the rate will adjust to so many basis points over some index, the language will effectively look like this:  "At the end of five years, the loan will readjust to whatever rate the bank is charging on similar loans at that time."

Really?  That loosey-goosey?  Yup.  Often these fixed rate commercial loans from banks are larger than $2 million, but no one seems to care that the borrower is completely at the mercy of the bank.    Legally the bank could raise the rate from 5.5% to 7.5%, even though other banks are quoting just 6.0% at the time.  Later I will explain why this is not really an issue.

A rate reset is more than just a rate readjustment.  The amortization of the loan is also accelerated.  For example, the typical bank permanent loan on an office building is a fixed rate, ten-year loan with a rate reset at the end of year five.  Most bank permanent loans start out with a 25-year amortization, but when the monthly payments are re-computed at the rate reset, we are five years into the loan.  Therefore the remaining loan balance is reamortized over just 20 years (although it is still all due and payable at the end the the next five-year period) at that time.

So why don't commercial borrowers freak out over the loosey-goosey language of the rate reset?  For some reason commercial bankers don't believe in capitalism.  They don't believe in charging whatever interest rate the market will bear.  Bankers think it is a sin to charge a higher interest rate than the bank down the street.  

As a result, banks across the country almost always charge about the same interest rate for commercial real estate loans.  Remember, a banker would consider himself a sinner if he charged a higher interest rate than his competitor, as if he was some sort of filthy capitalist.

Now you might find a 0.25% to 0.50% difference between banks on commercial real estate loans, but you will almost never see one bank quoting 5.5% and another bank 7.5%.

Okay, let's review what you've learned today:

1.  Rate readjustments are called resets in commercial mortgage-ese.

2.  Most commercial loans have a 25-year amortization.

3.  Ten years is usually the longest term available on a fixed rate, commercial loan.

4.  The rate will reset at the end of year five to whatever rate the bank is then charging.

5.  The interest rate reset language is usually surprisingly loosey goosey.

6.  Banks around the country charge almost same the same rate on commercial loans.

7.  Banks do not charge whatever the market will bear.  Capitalism is bad.

8.  It is a sin for a banker to charge a higher interest rate than a bank down the street.

9.  Therefore borrowers rarely get hit with an above-market rate increase at the reset.

Are you an accredited investor?  Please focus on this for a moment.  You have money set aside for your retirement.  You have more dough set aside for your kids' college educations.  The stock market is booming right now, and I personally think that it will continue to boom; but its danegerous to have all of your eggs in just one investment basket.

You really need to consider investing in first mortgages.  Private money (hard money) first mortgages from Blackburne & Sons are yielding 8% to 12% today - although I urge you in the strongest terms to stick with our less-risky, lower-yielding ones.  Make no mistake:  You can easily lose most or all of your investment in first mortgages.  Investing in first mortgages involves substantial risk, and this blog article is not intended to be a solicitation to invest in our securities.  Such an solictation will always be accompanied by a Private Placement Memorandum.  We're just talking about the concept - the idea - of hard money first mortgage investments today.

I am about to surprise you.  Blackburne & Sons has been in the hard money business for thirty-seven years now.  Are we the oldest surviving hard money shop?  Not quite.  I am an attorney, licensed in both California and Indiana.  To some this may sound corny, but my two sons and I are cadet graduates of Culver Military Academy (Honor System), and all three of us are Eagle Scouts.  Okay, maybe a little corny.  Ha-ha!

If you click on the maroon button below, no one is ever going to call you and try to sell you first mortgages.  We sell exclusively by email, and once you start nibbling on our offerings, you will probably miss out on your first few deals because you waited too long.  We have well over 1,000 (1,500?) private investors in our various loans.  My point is not that we are wonderful.  My point is that no one is ever going to call you to hard-sell an investment.  Please feel free to camp out on our investor email list for five years before you make your first investment move.  We're like Christmas tree farmers, planting a half-decade ahead.

You can invest with incredibly small amounts - $5,000 - but you absolutely, positively must be an accredited investor - a $1 million net worth exclusive of your personal residence.  First mortgage investing is HUGE in California, but the new JOBS Act makes it possible for accredited investors residing outside of the State of California to now invest with us.  Do this - and then just watch our investments for a few years.

Investopedia defines a core asset as follows:  A core asset is an essential, important or valuable property of a business without which a company cannot carry on with its profit-making activities. A business would dissolve without its core assets, and companies that sell off core assets are usually liquidating and on the verge of bankruptcy.

In the context of super-wealthy real estate investors, I would argue that the term has a slightly different meaning.  When the wealthy speak of their core real estate assets, they are usually speaking about their multifamily, office, retail and industrial properties.  These four major commercial property types are known in commercial real estate finance as the four basic food groups.

A wealthy investor's core assets are typically under-leveraged; often less than 45% loan-to-value.  Have you ever been frustrated when a life company refused to loan higher than 55% loan-to-value?  Have you ever asked yourself, "Who on Earth could be satisfied with a loan of only 55%?"  Well, its these supper-wealthy investors who intentionally keep their core assets under-leveraged.

Lastly, core assets are usually very attractive properties in their class.  For example, if the the core asset is an office building, it will be one of the most attractive and best-located office buildings in town.  The thing about a core asset is that the property is usually so desirable that it will remain leased, even in a bad recession.

I was in New York City twenty years ago, trying to place a $25 million commercial construction loan, when I found myself walking in front of Jackie Onassis' (JFK's widow) apartment building, directly across from Central Park.  It was a stunningly beautiful and desirable location.

As rich as Jackie O was - she inherited the Onassis shipping fortune - did you know that she did NOT own the building or even the $50 million apartment in which she resided?  She was forced to just lease it for a very long time (thirty years?) from the SUPER-wealthy family that owned the building.  When people talk about old money, the family that owned this incredibly valuable building were probably really-really old money.  

I would not fall off my chair in surprise if this primest-of-prime buildings was owned by the descendants of the famous Rothchild banking family.  The Rothschild family is a wealthy family descending from Mayer Amschel Rothschild, a court Jew in the Free City of Frankfurt, who established his banking business in the 1760s.  Unlike most previous court Jews, Rothschild managed to bequeath his wealth and established an international banking family through his five sons, who established themselves in London, Paris, Frankfurt, Vienna, and Naples.

Guys, each one of these five Rothchild sons went on to grow their banks to be one of the very largest in each country.  They made the equivalent of tens of billions of dollars by financing wars between each other; e.g., one brother in Paris might loan Napoleon enough dough to wage war against England, which borrowed money from N.M. Rothchild & Sons in London.  What a racket!  Ha-ha.  Jeff Bezos, Bill Gates, and Warren Buffet are poor peasants compared to the very secretive Rothchild family.  And yes, the Rothchild family, if they actually owned it, would surely have considered Jackie's building a core asset. 

So I was walking in front of Jackie's building when a epiphany hit me:  There are some pieces of commercial real estate that are so desirable that they will stay leased, even in the most severe of recessions.  The rich always have money, and they simply want this quality space.  In my own mind - and I teach this concept to my sons and staff - I consider properties like this to be top 40% properties.  The wise investor will strive to invest in top 40% properties.

One final thought about core assets:  The wealthy do not churn core assets.  Core assets are keepers.  Think of the Rothchild family and Jackie O's apartment building.  If the Rothchild's actually  do own that building, they might have bought that building when it was built 60 years ago.  Even if Jackie O tried to buy it at 20% over its appraised value, I could easily see the trustee of the Rothchild Trust saying, "Thank you, Madam, for your very generous offer, but this building is one of our core assets."

Stay close to the Blackburne family.  Blackburne & Sons Realty Capital Corporation (est. 1980) stayed in the market making commercial real estate loans every day of the Great Recession.

Cisca, my  lovely bride of 34 years, and I recently moved from Northern Indiana to Indianapolis.  Our daughter, Jordi, just graduated from Culver Girls Academy, so we were free to leave our home near the campus of the prestigious Culver Military Academy to be closer to my son, Tom, and our granddaughter.  If you get a chance, be sure to click on that Culver link above.  You'll quickly see why Cisca and I lived in the cornfields of Indiana for 18 years to send our kids to this very special academy.  Jordi recently rode in President Trump's Innaugural Parade.  George IV and Tom rode in George W. Bush's Innaugural Parade, and I rode in Nixon's Parade in 1971.

It's wonderful to work alongside my son, Tom, here in Indy.  Anyway, I write this blog to teach my two sons the business of commercial real estate finance (CREF).  It's my legacy to them, so I try to teach them "good stuff" at least twice a week.  By subscribing to this blog, you get to enjoy that same training for free.

Everybody gets some wonderful free commercial loan goodies today.  Nobody spends a penny.  The first freebie is our wonderful commercial loan calculator developed by my son, George IV.  Guys, a commercial loan calculator is NOT about computing the monthly payments on a commercial loan.  That's kid's play.  There must be 10,000 commercial loan payment calculators available on the internet.

But sizing a commercial loan is different.  The term of art, sizing a commercial loan, is the process of computing several different financial ratios and then determining the maximum loan size that a lender will permit.  The lender will almost always choose the lowest loan size produced by the debt service coverage ratio, the debt yield ratio, and, in the event of a construction loan, the loan-to-cost ratio.

Our commercial loan calculator instantly computes these ratios for you and tips you off where you are likely to have a fight with your commercial lender.  Forewarned is forearmed.

Sliding around in your pencil drawer is the business card of a banker who makes commercial real estate loans.  We'll trade you the contents of that one business card for a free regional copy of The Blackburne List, a list of 750 commercial real estate lenders.  Seven-hundred-and fifty for one - not a bad trade.  If you give us three bankers, you can get all three regions, 2,500 for 3.

Our main commercial mortgage portal, C-Loans.com, is a fabulous free tool.  It takes just four minutes for an investor or a broker to enter his commercial loan request.  Then the site filters out hundreds of unsuitable commercial lenders - based on the loan amount, the loan type, the property location, the property type, etc. - and produces a list of 30 or so commercial lenders who are perfect for your particular commercial loan.

But we here at C-Loans, Inc. have a problem.  We can't get investors and brokers to register on the site.  If we could get them pre-registered on C-Loans.com, investors and brokers could come back later and enter a new commercial loan request in moments.  Geez, guys, we're just talking about filling out your name, address, phone, and email so our lenders can contact you.  We're not asking you to clean out the Augean Stables.  Okay, then we'll BRIBE you to pre-register on C-Loans.com.

When you come back to CommercialMortgage.com ("CMDC"), you are going to note some huge changes.  When your custom-created Commercial Lender List is now created, you will find it divided into three sections.  The top section contains our Recommended Lenders.  These are the commercial banks so hungry to close your commercial deal that they are willing to pay for advertising.

Next you will find the Hungry Lenders section, which are those commercial lenders who have recently taken advantage of our free listing on CMDC for direct lenders servicing (collecting montly payments, folks) on at least $20 million in commercial loans.  Lastly you will find our Other Lenders section; but the point is moot. Our Recommended Lenders and our Hungry Lenders will devour your deal long before you get to the bottom of the list.

"George, I'm confused.  What's the difference between CommercialMortgage.com and C-Loans.com?"

C-Loans.com is a portal, where you invest four minutes in creating an online commercial loan application, something that looks good and includes some nice pics, and then shop that single mini-app to scores of different commercial lenders.  CommercialMortgage.com is NOT a portal.  It's just a commercial lender search engine.  It just gives you the contact information of suitable commercial lenders.  You can't submit your deal online through CMDC.  

Want to learn commercial real estate finance (CREF) for free?  I write at least two CREF training articles every week.

You will recall that an exit fee is just like a prepayment penalty, except that the borrower owes the exit fee whether he pays the loan off early, exactly on time, or late.  

I was reading one of George Smith Partners' tombstones last night, when I ran into this description of a $7.4 million bridge loan that they had just closed:

"The loan is structured with an increasing exit fee in lieu of an upfront lender origination fee to minimize upfront costs and incentivize the Borrower to execute the business plan in a timely manner... After an initial 12 month spread maintenance period, the exit fee is 1.33% for months 13 through 24, increasing to 1.66% for months 25 through 30 and 2.00% for months 31 through 36."

Huh.  I had never heard of an increasing exit fee before.  It makes sense.  It lights a fire under the borrower's tush to hurry up and pay off the loan.

By the way, a tombstone is an annoucement of the successful closing of some financial deal, like the taking a company public or the closing some large loan or bond issue.

Do you need a commercial loan?  Banks offer the best rates on commercial real estate loans.

Do you work as a commercial real estate loan officer for a bank or credit union?  You can now list your bank on CommercialMortgage.com ("CMDC") and enjoy three to five commercial loan leads every week at no cost.  CMDC is truly free to banks, with no strings attached.  We make our dough by working the commercial loan leads generated by this new commercial lender search engine.

Get a free list of 750 commercial lenders.

Are you a mortgage broker?  Been cheated out of a big loan fee recently?  I'm not just talking about a borrower closing a deal and not paying you.  I am talking about a borrower totally lying to you about his qualifications.  For example, "Sure, the second mortgage lender will subordinate."  After you have worked 20 hours on the loan, the truth comes out.

Do you own a real estate website?  C-Loans, Inc. once paid a $21,250 referral fee to Alan Dunn of Spydercube.com for placing a link, "Commercial Loans", on his web site that pointed to C-Loans.com.  That's it.  Create a link on your website that says, "Commercial Mortgages" and point it to C-Loans.com.  Our software captures the fact that the lead came from you.

As you get into the very large commercial loans, especially in California, the issue of earthquake risk looms large.  When lending on large commercial properties constructed prior to 1980, commercial lenders will sometimes require a PML Report.

A PML Report is an earthquake damage report completed by a civil engineer. The report asks the question, “How badly damaged would this building be if there was a really big earthquake?” Is the building going to completely collapse, like those unreinforced masonry buildings in San Francisco did in 1989 during the Loma Prieta earthquake?

My old friend, Mike Thurman, was actually at Candlestick Park for game three of the World Series when the Loma Prieta earthquake hit. Fortunately the stadium was well-designed to absorb earthquake shock, and everyone was able to calmly leave the stadium to drive home.

Unfortunately those driving home to the East Bay discovered that the central strand of the Oakland Bay Bridge had collapsed, hurtling several passengers and their cars to their death hundreds of feet below. Interesting note: When a section of the upper-deck freeway in Oakland collapsed onto a lower deck, sadly crushing and killing 60 drivers below, among the victims was a car thief attempting to make his getaway.

More specifically a PML Report seeks to quantify the Probable Maximum Loss. The Probable Maximum Loss (PML) is a tool used to evaluate the seismic risk of a building and identify assets with high seismic risk. The Probable Maximum Loss report identifies the PML value, expressed as a percentage of the building's replacement cost and estimates the potential damage during a 475-year earthquake - the lower the percentage, the lower the expected damage. The PML value can be expressed either as the Scenario Expected Loss (SEL) or the Scenario Upper Loss (SUL). They mean the same thing.

If the Maximum Probable Loss is too high – let’s say greater than 45% - a lender making a large commercial loan might require earthquake insurance. Earthquake insurance is phenomenally expensive, on the order of 2% to 3% of the value of the building annually!

To make matter worse, the earthquake insurance deductibles are huge – on the order of 15% to 20% of the value of the property.

Example:

Let’s suppose you own a $15 million commercial building in Los Angeles. The land is worth is worth $5 million, so you only insure the $10 million building. Suddenly an 8.2 earthquake hits L.A., the building collapses, and the loss is total. Even if you had the entire building insured, your insurance company might only pay you $8.5 million, rather than your entire $10 million loss.

And to make matters worse, the insurance company probably wouldn’t survive to pay the claim anyway.

Need a commercial real estate loan?  Try our commercial mortgage lender search engine:

Are you a loan officer working for a commercial bank or a credit union?  Do you want to meet more high-net-worth investors and close more commercial loans?  You can add your bank to CommercialMortgage.com at absolutely no cost to you or the bank.  It really is completely free.  My hard money shop pays for the site by working the commercial loan leads it generates.

Are you ready to finally learn commercial real estate finance? It’s funny. People pay $100,000 for a liberal arts college education and then seldom get a starting job in their field. Using this nine hour video program, an intelligent, articulate, and sales-oriented high school graduate can learn a better-paying profession in one long weekend for just $549.

For just $79.95 you can buy a copy of The Blackburne List, a list of over 2,500 commercial lenders nationwide.  Is money tight?  For just $39.95 you can buy the Regional Blackburne List for the area in which the subject property is located.

For forty years accredited investors residing in California have been able to earn 8% to 12% interest by investing in first trust deeds.  Unfortunately out-of-state investors could not legally participate.  A recent law change - the JOBS Act - now allows a resident of Illinois, for example, to invest in fractionalized first mortgage; i.e., he can take a $20,000 piece of a $400,000 loan on an apartment building in Chicago.  Blackburne & Sons has been doing this now for 37 years.  Sorry, but you must be very accredited to be suitable.

Do you need a commercial lender who will actually lend up to 75% loan-to-value on the purchase of a commercial building?

Do you need a lender who will allow the seller to carry back a second mortgage? Does your client have a balloon payment coming due on his commercial property? Has your bank offered him a discounted pay-off? Does your borrower have less-than-stellar credit? Is your client's company losing money? Is your borrower a foreign national?

Do you need a non-recourse loan? Do you need a commercial loan with no prepayment penalty? Is your client's commercial property partially vacant? Do all of your commercial leases run out in the next 18 months? Do you need a lender who will allow a negative cash flow? Do you need a lender who will also look at the borrower's global income - income from salaries, other investments, etc.? Do you need a loan against a portfolio of single family homes?

Get two new training lessons in commercial real estate finance every week for free!

Got a friend or co-worker who would benefit from learning commercial real estate finance (CREF)?

Today we are going to teach you how to underwrite a $50 million commercial construction loan.

C-Loans.com recently closed an $18.5 million commercial construction loan on a mixed-use project in Wisconsin.  The lucky broker who brought that deal to C-Loans earned a whopping $92,500 loan fee.  Wow.  I'll betcha that fee paid some bills.  Note to self:  Submit my commercial construction loans through C-Loans.com.

I recently wrote in one of my newsletters that for the past six years commercial banks have had a zero appetite for conventional commercial construction loans.  By conventional I mean a non-SBA, non-USDA, non-EB-5 loan.  In fact I described conventional commercial construction loan requests as being about as welcome as a male stripper at a (hetereosexual) bachelor party.  Ha-ha!

As a result, there has been very little commercial construction in the U.S. for the past six years.  In the meantime, many vacant and neglected commercial buildings have had their water pipes burst during a cold winter, making them essentially now almost worthless.  Other vacant commercial buildings have been vandalized and stripped of their copper wiring.  The roofs of other vacant commercial buildings have leaked, leading to dangerous black mold.  A great many productive commercial buildings are now unusable.

At the same time, the population of the U.S. has grown.  Workers are finally getting back to work.  The auto industry in America is booming again, leading to the return of many manufacturing jobs in the Midwest.  Shale oil discoveries have caused a significant migration of workers to North Dakota, Wyoming, Texas, and other oil-patch states.  All of these areas need new commercial buildings.

Therefore the hot new commercial loan product for the end of 2014 and for 2015 will be conventional commercial construction loans.  And where do you find hundreds of commercial banks hungry to make conventional commercial construction loans?  C-Loans.com.

But how do you know if the commercial construction loan lead in your hand is a hottie or a complete waste of your time?  You need to know how to underwrite commercial construction loans.  This article will serve as a primer.

Conventional commercial construction loans are underwritten using six financial ratios.  The most important of these ratios is the loan-to-cost ratio.  The loan-to-cost ratio must not be confused with the loan-to-value ratio.

The loan-to-cost ratio is the construction loan amount divided by the total cost of the project.  Traditionally this ratio should not exceed 80%.  In other words, the developer is responsible for contributing at least 20% of the total cost of the project - usually in the form of free-and-clear and entitled land, with most of the architectural and engineering costs prepaid for by the developer.  Since many commercial banks are still licking their wounds from the Great Recession, many banks are limiting their loan-to-cost ratios to just 70% to 75%.  This means that the developer must modernly cover 25% to 30% of the total cost of the project.

The next ratio is the loan-to-value ratio.  The loan-to-value ratio on a commercial construction loan request is computed by taking the construction loan amount and dividing it by value of the commercial property, when it is completed and fully-leased.  The bank's appraiser will compute this value for you.  The loan-to-value ratio on a commercial construction loan request should not exceed today around 70%.

The third ratio is look at when underwriting a commercial construction loan is the debt service coverage ratio.  The debt service coverage ratio is the property's Net Operating Income (NOI), upon completion and leasing, divided by the annual debt service (P&I payments) on the proposed takeout loan.  A takeout loan is just a permanent loan used to pay off a construction loan.  This ratio should exceed 1.25.  The good news is that with interest rates so low today, most commercial properties easily pass this test.

The next ratio to look at when underwriting a commercial construction loan is the profit ratio.  The profit ratio is the difference between the fair market value of the property, upon completion and leasing, and the total cost of the project, all divided by the total cost of the project.  What we are trying to determine here is whether the developer stands to earn any profit by building this commercial building.  If not, he might be tempted to just walk away at the first appearance of a cost overrun.  The profit ratio should exceed 20% to 22%.  In other words, the commercial property should be worth at least 20% to 22% more than it costs to build.

The next ratio to look at when underwriting a commercial construction loan is the net-worth-to-loan-size ratio.  The developer's net worth should be at least as large as the construction loan he is requesting.  A guy with a $1.5 million net worth should not be requesting a $6 million commercial construction loan.  This ratio needs to be at least 1.0.

The last ratio to look at when underwriting a commercial construction loan is the debt yield ratio.  The debt yield ratio is a brand new ratio developed after the huge losses in commercial mortgage-backed securities suffered by CMBS bond investors during the Great Recession.  The debt yield ratio is computed by taking the property's net operating income (NOI) and dividing it by the construction loan amount.  This ratio should not be less than 8.5% to 9% today.

Please note that the debt yield ratio is different from the debt service coverage ratio.  It does not look at today's low commercial mortgage interest rates at all.  In fact, this ratio was invented to rein in the excessive leverage that can occur in commercial mortgage finance when interest rates and cap rates are low.

Do you need a commercial construction loan or any other type of commercial real estate loan?  If so, please click the maroon button below.

In addition to the 750 hungry commercial lenders you'll find on C-Loans, we also give away a free list of 2,000 commercial lenders.  The lenders on The Blackburne List are different from the 750 commercial lenders you'll find on C-Loans.