Commercial Loans and Fun Blog

In late 2014 I wrote a blog article suggesting that industrial real estate was heating up, and I gave my reasons.  Apartments have enjoyed sensational appreciation for the past several years, but an investor looking to invest in commercial real estate in 2015 doesn't want last year's winner.  He wants to invest in that type of commercial real estate which is going to perform the best in the next 12 months.

This week I flew to Las Vegas for the California Mortgage Association's semi-annual training session for hard money mortgage companies.  The conference had a number of speakers, but by far the most entertaining and informative speaker was Luis A. Belmonte, the gentleman who gave the economic outlook for the upcoming year.  Mr. Belmonte is a former partner in Lincoln Properties and formerly the Executive Vice President of AMB Institutional Realty Advisors, the asset manager for 15,000,000 square feet of industrial property throughout the United States.

Mr. Belmonte made some very interesting points.  First of all, he remains bullish on multifamily due to the fact that leading edge of the children of the Echo Boom generation - the grandsons and granddaughters of the Baby Boomers - have reached the age of sixteen.  Soon these 80 million Americans will be forming new households, and they will need apartments.

Office space, in his opinion, is still greatly overbuilt.  The office space vacancy rate in most cities remains in the mid-teens.  Rents are going nowhere.  Retail space - he wouldn't touch it with a ten foot pole.  Amazon.com is eating retail's lunch.

But then he got to industrial space.  "Industrial space is the best type of commercial real estate in which to be invested today."  He gave a number of reasons:

1. There has been almost no new construction of industrial space for eight years.
   
   
2. Absorption of industrial space is outpacing new construction in almost every major city.
   
   
3. Wages in China have increased dramatically in recent years.  It's not that much cheaper to manufacture goods in China anymore.  [George's note:  The Boston Consulting Group maintains a cost index for the various counties, and China is only 4.5% cheaper than the U.S. right now, mainly because our natural gas / energy costs are tiny compared to the rest of the world.]
   
   
4. But then he gave a reason that rocked my world.  "For every two square feet of retail space that the internet makes unnecessary, the U.S. needs one square foot of warehouse space" (for internet retailers to store their products).

End of article.

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Do you know one banker making commercial real estate loans?  We'll trade his contact information for our list of 2,000 commercial lenders.

Do you enjoy my "everyman's language" style of teaching commercial real estate finance, where I use lots of examples and war stories?  Why not become a near-expert in commercial real estate finance? 

A joint venture is a sort of a "partnership" between a developer and one or more passive investors to build a commercial property.  The developer brings to the partnership the project; his expertise, as described in detail in his CV or curriculum vitae; and some prepaid expenses, such as architectural fees, engineering fees, and his down payment on the land.  The investor brings to the "partnership" the majority of the equity required by the construction lender.  I've used the term "partnership" throughout this article, but these business entities are almost always set up as limited liability companies ("LLC's").

Almost all commercial construction loans are made by banks.  Banks today are not going to take all of the risk of a construction project by loaning to the developer 100% of the total cost of the project.  Usually the bank will only cover part of the total cost of construction, and the developer will have to cover the rest.  How much of the total cost of the project that the bank will cover is determined by their loan-to-cost ratio.

Example:

Doug Developer wants to build six town homes.  The total cost of the project - including land costs, hard costs, soft costs, and the contingency reserve - is $2,500,000.  This is a relatively small project, so his construction loan request will be small.  He therefore wisely applies to a small bank located close to the subject property.  (George's note:  Doug did two smart things here.  First he matched the size of the loan to the size of the bank to which he applied.  Secondly, he applied to a bank with a branch located just down the street.  Construction lenders greatly prefer local projects.)

Nearby Neighborhood Bank NT&SA has a bank policy that it will only make commercial construction loans today up to 70% loan-to-cost.  Remember, the total cost of the project is $2.5 million.  Seventy percent of $2.5 million is $1,750,000.  This is the largest construction loan that Nearby Neighborhood Bank will make.  Doug Developer will be expected to come up with the remaining $750,000.

Doug paid $500,000 for the land, and he put down $125,000.  The seller carried back a short term first mortgage of $375,000.  Doug also paid $65,000 for all of the architectural plans and another $22,000 for the engineering work.  He therefore has $212,000 in equity into the project.  He is short $538,000.  

$750,000 required equity - $212,000 in developer contributions = $538,000 shortfall

Where is Doug going to come up with the missing $538,000 in cash?

Doug approaches Dr. Dan Deeppockets, a retired neurosurgeon, and invited Dr. Dan to enter into a joint venture with him.  Doug Developer and Dr. Dan negotiate the following deal:

Dr. Dan will contribute the needed $538,000 in additional equity.  If the project is successful and the condo's are sold off, Dr. Dan first gets his $538,000 investment back.  Then, if there is any money left over, Doug Developer gets back his $212,000 cash contribution.  If there any money left over, Dr. Dan gets a preferred return (before Doug Developer) of 15%.  If there is still any money left over, Doug Developer earns a 15% return on his $212,000 cash contribution to the project.  Any money left over?  Dr. Dan and Doug developer agree to split any remaining profit 50-50.  This repayment schedule is known as a waterfall.

End of example.

Who can qualify for a joint venture?  In order to qualify for a joint venture, a developer needs one heck of a curriculum vitae (construction experience resume).  After all, the developer is saying, "With my brains and your money, we are going to make a fortune together."  I don't know about you, but if I were the guy putting up the dough, that developer's brain would have to be pretty darned impressive.

In real life, almost no one ever qualifies for an institutional joint venture - a JV with some huge fund.  If you are an average commercial mortgage broker, I strongly urge you never to work on a joint venture.  You'll never get paid.  Personally I have come to the conclusion that the only developers who can convince a life insurance company, a REIT, or some wealth fund to JV with them are developers who are rich enough to build the project for cash using their own dough.  You and I, as commercial mortgage brokers, will never get to represent one of these guys.  Helloooo?  You will never get paid.  The guys we as brokers get are the developers who spend their last dimes on the architectural and engineering fees.

But what about private joint ventures - joint ventures with wealthy private investors?  Many years ago, scores of broker-dealers raised money for development deals.  Then the rolling commercial real estate depression hit in the early 1990's, and all of these broker-dealers were sued into oblivion.  For 25 years developers found it extremely difficult to raise equity dollars from private investors.

Then something changed.  During the Great Recession, President Obama signed the JOBS Act, which now allows real estate developers and entrepreneurs to publicly advertise to accredited investors for investments, just like hedge funds have been allowed to do for decades.  This is huge.  

Thirty years ago the syndication business was enormous, far larger than the hard money business nationwide.  The syndication industry is not back yet, but I predict that it will return over the next five to seven years.  My own hard money commercial mortgage company, Blackburne & Sons, is looking at a relatively tiny ($1.8 million) joint venture in California.  In fact, we just issued a  Letter of Interest.  Risky-risky-risky, but I remain very bullish (after 20 years of being a perma-bear) on the future of the U.S. economy.

A hypothecation is defined, at least in the context of commercial real estate finance, as a loan secured, not by a piece of commercial real estate, but rather by a mortgage note owned by the borrower, which is itself secured by a piece of commercial real estate.  In short, its a loan to a guy who owns a mortgage note.  He pledges his mortgage note receivable for a smaller loan.

It is normally far-far better for a note holder to hypothecate his mortgage note rather than to sell it at a huge discount.  Normally when an investor sells a mortgage note, he is forced to take an enormous haircut (loss).  If he simply borrows against his mortgage note receivable (hypothecates it), he can pay back the hypothecation loan and regain title to the full value of his mortgage note.  An example will make this much more clear.

Example:

Once upon a time Billy Whiteshoes (he wears plaid pants and a matching white belt) owned an 80-unit apartment building in Naples, Florida free and clear.  He was 68-years-old, and it was finally time for his bride of 55 years and him to retire.  He sold his apartment building for $4.2 million and carried back, for tax reasons, a $3,700,000 first mortgage at 6% interest for 20 years, a wonderful return considering that banks are only paying 0.50% for deposits right now.

Sadly his beloved bride is snatched by an alligator while feeding the ducks in a pond near their Florida retirement community.  Billy Whiteshoes is devastated and realizes that life is short.  He resolves to live his last remaining years with gusto.  That's when he meets Lola La Boom-Boom, a 42-year-old retired stripper, working as a bartender in a nearby watering hole.  It's love at first sight (of Billy's assets).  Lola convinces Billy to take her on an expensive cruise and to buy her an enormous diamond engagement ring ($120,000).

Needing $150,000 in cash for the rock and the cruise, Billy contacts a mortgage note broker, who offers him just $2,250,000 for his $3.7 million first mortgage note.  "This is a 20-year mortgage, Billy, and while 6% may sound like a great yield today, in five years it may be well below market.  Then my investors will be stuck with a below-market yield for 15 more years.  In any case, we buy our mortgage notes discounted to yield at least 13%."  Outraged, Billy calls a half-dozen more mortgage note brokers, but the offers he receives are all about the same.

Billy is inflamed with desire for Lola, but he is not a complete idiot.  He keeps calling commercial mortgage brokers, until he reaches a subscriber to George's blog.  "You know, Billy," the wise commercial mortgage broker explains, "there is another way.  I can arrange for a $170,000 loan, secured by your first mortgage note receivable.  You don't have to sell the note at a discount.  You can just borrow against it.  This is a private money lender, so you are going to pay 12.9% and 4 points, plus my loan brokerage commission.  But when you pay off this hypothecation loan, you'll still own the entire $3.7 million first mortgage note.  Your cash flow from his mortgage note receivable is large, so I recommend that you triple up on your monthly payments.  Billy, you would be an idiot to sell your $3.7 million note for just $2.25 million!"

My private money commercial mortgage company, Blackburne & Sons, will hypothecate commercial first mortgage notes.

How much can you borrow against a commercial first mortgage note?  For how much can you hypothecate it?  Most lenders (there are very few of us) who hypothecate commercial first mortgage notes will lend up to 80% of the discounted present value of the note.  Without trying to teach a whole college-level course in business finance, most hypothecation lenders will discount the monthly payments and the balloon payment back to present value.  Blackburne and Sons will use a discount rate of 13%, the yield required by our private investors.  Since we charge a 4-point loan origination fee on hypothecations, we would use as our value of the note 96% of its discounted present value.  Just like we are not going to lend 100% of the value of a property, we will lend up to 80% of the value of that note (to us).

So how do you package a hypothecation loan?  If you are a commercial mortgage broker, what documents do you ask for?  One of our newer loan officers recently ran across a hypothecation loan request, and our brilliant EVP, Angelica Gardner, sent this to him:

Good Morning, (New Loan Officer),

I received your voicemail message regarding a hypothecation loan. I figured it would be better to send you the details so you can review (the deal) first, then we can discuss details or questions.

First, the definition of a hypothecation: The established practice of a borrower pledging an asset as collateral for a loan, while retaining ownership of the assets and enjoying the benefits therefrom. With a hypothecation, the lender has the right to seize the asset if the borrower cannot service the loan as stipulated by the terms in the loan agreement.

Below is a list of the documents that I would want to see. It is unlikely that you will be able to gather all of the documents listed below, but try to get as many of them as possible.

1. Color photos of the property.
   
   
2. Copy of Promissory Note and Mortgage*
   
   
3. Original title insurance policy (or fresh prelim)*
   
   
4. Something showing the payment history*
   
   
5. Closing statement from when note was created*
   
   
6. Financial statement on the maker/borrower (when the note was created)
   
   
7. Credit report on the maker/borrower (when the note was created)
   
   
8. Two years’ tax returns on the maker/borrower (when the note was created)
   
   
9. Appraisal - an old one is very helpful and a new one is blissful
   
   
10. Rent roll and/or commercial leases (when the note was created)
    
    
11. Current financial statement of the Maker (hypothecation borrower), current credit report on the Maker, last two years tax returns on the Maker, current Rent Roll, current commercial leases.

* Very, very important.

Find out early who has possession of the original Promissory Note and Mortgage. It is legally impossible to properly assign a note and mortgage to the assignee (buyer of, or lender against, the discounted commercial loan) without delivering the original promissory note.  In fact, if the assignee (buyer of, or lender against, a discounted commercial loan) fails to take physical delivery of the original promissory note, and if the assignor (the seller of, or borrower against, the discounted commercial loan) later files Chapter 7 bankruptcy, the promissory note becomes the asset of the bankruptcy estate!  (In real life) the intended assignee is completely wiped out.

Another important note: We will require that the underlying borrower makes his payments directly to us. We want to always make sure that the payment on our loan is covered by the payments from the underlying borrower. Please let me know if you have any questions.

Sincerely,

Angelica D. Gardner
Executive Vice President

Today's article is far more important than a mere training lesson about some archane financial ratio.  The gold-to-silver ratio actually explains much of the history of the modern world.  Prepare to learn a ton.

The gold-to-silver ratio is the amount of silver it takes to purchase one ounce of gold.  Today the gold-to-silver ratio stands at approximately 50 to 1.  That means, at the current price, it would take around 50 ounces of silver to buy 1 ounce of gold.  (By the way, this ratio should really be called the silver-to-gold ratio because the number of silver ounces required to buy one gold ounce is, by custom, listed first; e.g., "The gold-to-silver ratio in the year 1425 was 24:1.")

Since 1687, which is as far back as the records reach, the gold-to-silver ratio has varied between roughly 14 and 100.  Beginning around 1900, the ratio steadied and remained relatively flat at around 16 because many countries were using gold-and-silver-backed currencies. The United States, France, and several other countries actually assigned statutory limits on what the ratio could be.  The U.S. Geological Survey estimates that there’s 17.5 times more silver in the Earth’s crust than gold, which is another reason why the pre-1900 gold-to-silver ratio usually stayed between roughly 14 and 100.

"I'm falling asleep here, George.  Why do I care?"

Did you know that Venice was once the financial capital of the modern world?  Venice?  Venice was just a medium-sized city!  It did not have some huge standing army.  Nevertheless, if you were a king in 1425, and you wanted to finance a war, you would probably have to borrow from a Venetian bank.  If you were a merchant, and you wanted to open a trading office on Cypress, your representative (maybe one of your precious sons) wouldn't carry a huge sack of gold.  He would be quickly robbed and murdered.  Instead, you would go to a Venetian bank and obtain a letter of credit.

Here's why such a relatively small city could become the center of the financial world:  In ancient times the gold-to-silver ratio was dramatically different in China and India than it was in Western Europe.  For example, the gold-to-silver ratio in Italy might be 25:1, but the gold-to-silver ratio in India might be just 8:1.  In other words, a European merchant could buy an ounce of gold in India for just 8 ounces of silver.

Why was silver so relatively precious in India and China?  Why was gold valued so relatively little?  The average person in India and China in the old days was dirt poor.  There was no way on Earth that the average person in India would ever be able to save up enough wealth to own a gold coin or to ever conduct a trade in gold.  Silver was the currency of the people, and the demand for it in India and China was immense.  

Arbitrage is the process of spotting a price differential in two different markets for the exact same product and then buying in one of the markets and selling it in the other.  

The gold-silver trade is one gigantic arbitrage effort.  Merchants would buy cheap silver in Europe and sell it for big handfuls of gold in India.  Whichever power controlled the gold-silver trade became the economic powerhouse of the world, the center of lending and investment.  

Before a sailing route to India was discovered around the Cape of Good Hope - the southern tip of Africa - Western trade with India was conducted across the Silk Road.  

The Silk Road was a dangerous caravan trek over the mountains of Afghanistan and across the deserts of Iran and Iraq.  Bandits, sandstorms, and dehydration took an enormous toll.

As soon as possible, trade goods were transferred aboard ship and (relatively) quickly sailed across the Mediterranean Sea to their final destination.  In the days of the early Pharaohs, Egypt controlled the Mediterranean Sea.  The opportunity to control and profit from the gold-silver trade with India made Egypt the center of the civilized world for hundreds of years.

Later the Phoenicians (Lebannon) and the Carthaginians (North Africa), who were famous sailors and sea trading nations, controlled the Mediterranean Sea.  The Carthaginian traders made an enormous profit carrying the East-West trade, with which they could build fighting ships and hire huge land armies.

For fifteen years the famous Carthaginian general, Hannibal, terrorized Rome and the Italian peninsula.  Hannibal led an army of Spanish mercenaries and elephants over the Alps in winter and surprised the Romans.  At the battle of Cannae, Hannibal surrounded 70,000 Roman legionaires and then squeezed them so tightly that they couldn't even lift their arms to defend themselves.  All but 10,000 were slaughtered.

But then Rome got smart.  Rome built a fleet of its own and destroyed the fleet of Carthage.  By doing so, Rome claimed lordship of the seas and the East-West trade.

"Delenda est Carthago," said Cato the Elder after every speech.  "Cathage must be destroyed."  Rome and Carthage fought three long wars before Rome finally burned Carthage to the ground and slew almost all of its inhabitants.  Rome tore down every building in Carthage and sowed the ground with salt, so that nothing would ever grow there.  

Now it was Rome's turn to control the seas and rake in huge profits from the East-West trade.  In 284 AD, for easier administration, the Roman Empire split in two, with Byzantium (later renamed Constantinople) serving as capitol of the Eastern Roman Empire (Byzantine Empire).  The Western Roman Empire fell to the Visigoths in 475 AD.  (As I am writing this article, I just realized that when the Empire split, the Western Roman Empire lost all of the riches that came from controlling the East-West trade.  Hmmmm.)

While the Western Roman Empire was overrun by migrating German tribes, the Byzantine Empire endured for another 1,000 years.  Because the Byzantine fleet controlled the Mediterranean Sea, and hence the East-West trade, including the profitable gold-silver trade, Constantinople became the largest and richest city in the Western world.

But the Venetians were envious.  They too were a sea faring power, and they coveted the East-West trade.  When the knights and soldiers of Fourth Crusade (booty seekers, in reality) needed transport to the Holy Land, only Venice possessed a sufficiently large fleet.  "We'll transport your army to the Holy Land, if you do us a little favor.  There is an irritating little city (little?) along the way that we would like for you to sack.  They have lots of booty inside."  So the Christian crusaders stormed the Christian city of Constantinople and slew all of the inhabitants.  Now unbelievably rich with booty, the noble crusaders decided not to bother with the Holy Land, and they went home.  In the process, little Venice became the uncontested master of the Mediterranean Sea and the financial capital of the world.

What goes around, comes around.  For hundreds of years, the Byzantines had protected Venice (the ungrateful bums) and the rest of Europe from the Ottoman Turks.  While Constantinople eventually recovered from the sack by the Crusaders and repopulated, it was never able to regain its former strength.  In 1453 Constantinople fell for a second and final time to the Ottomans, and Venice would spend the next 200+ years fighting the Ottomans for control of the Mediterranean all by themselves.  When the Venetians were devastated by two plagues, the Ottoman Turks destroyed the last of Venetian fleets and took over control of the Mediterranean Sea, along with the gold-silver trade.  This control of the East-West trade was a high-water mark in Muslim history.

In 1488, a Portugese explorer became the first modern explorer to round the southern tip of Africa in hopes of finding a sea route to India.  The Portugese founded trading colonies in India, and the wealth of this tiny Eurpean nation soared.

But it was the Dutch who had the foresight to build trading colonies along the west coast of Africa, and they founded Johannesburg in South Africa.  Soon the Dutch controlled the Indian Ocean and the East-West trade.  Amsterdam in tiny little Holland became the financial capital of the world.  If you wanted to take a company public or if you wanted to borrow a huge sum of money - perhaps to fight a war - your most likely first stop was a Dutch bank.

Holland, unfortunately, was a small country, and her small land army was no match for invading powers.  Her navy, on the other hand, was powerful.  The Dutch even won the Second Anglo-Dutch War against the British with victories at sea.  (Until I researched this article, I never knew anyone could stand up to British sea power.)

Eventually, however, the British Navy was able to wear down the Dutch Navy and gain control of the seas and the East-West trade - one time by sailing into Holland's chief harbor and sinking the entire Dutch fleet before war had even been declared.  The huge profits of the gold-silver trade moved to London, and London became the financial capital of the world until the end of World War I.  London's investments banks (they were called merchant banks in those days) became the bankers for the world.

After World War I, the U.S. Navy took over control of the seas, and, not surprisingly, New York became the financial and banking capital of the world.  China is becoming wealthier, but until she controls the seas, New York will remain the banking capital.

You're an English ship captain in London, and the year is 1772.  You have made seven successful trading voyages to India, and when you successfully brought your return cargo home to London, you made your financial backers absolutely stinking rich.  They put up 2,000 pounds to finance your voyage, and they sold your return cargo of silks, spices, and gold for 37,000 pounds.

You are now ready for your next voyage.  You go to Barings Brothers, the largest merchant bank in London, and you negotiate a deal.  The merchant bank puts up 2,500 pounds to rent a large trading ship for you, to pay the exorbitant premium for ship insurance, to pay the wages of the crew, and to pay for the outgoing trade cargo of British textiles, machine tools, and gold.  You put up your life (only a handful of other captains have survived seven voyages), your expereince, and your leadership.  If the voyage is successful, you enjoy 10% of the profit.

Please note that Barings Brothers is not making the captain a loan.  The merchant bank is taking a tremendous risk, so it is not going to be content to earn some sort of interest rate.  Barings Brothers is actually investing in the venture.  If it fails, and you, the captain, somehow survive, you do not owe the merchant bank a dime.  The merchant bank simply gets 90% of the profit if you succeed.

The topic of merchant banks came up this month, and I doubt that even one finance worker in a hundred truly understands what a merchant bank really is.  Sooner or later in the commercial mortgage business someone is going to come up to you at a banking conference and claim to be a merchant banker.  Today's article will help you to recognize either a fraud or one of these very rare animals.

According to Investopedia, a merchant bank is "a bank that deals mostly in (but is not limited to) international finance, long-term loans for companies, and underwriting.  Merchant banks do not provide regular banking services to the general public."

I think this definition is wrong.  It was correct two hundred years ago, but not anymore.  Merchant banks are not banks in the sense of taking FDIC-insured deposits.  The Comptroller of the Currency would never allow a national bank to take the kinds of risks typically taken by merchant banks.  Merchant bankers are go-go investors.  They are almost like speculators.  They take very high risks in order to earn very high returns.

I like Wikipedia's defintion better:  "A merchant bank is a financial institution that provides capital to companies in the form of share ownership instead of loans. A merchant bank also provides advisory services on corporate matters to the firms in which they invest. In the United Kingdom, the term 'merchant bank' refers to an investment bank."

While this definition is much closer to modern reality, its still not quite right for America.  In America, investment banks are quite different from merchant banks.  Merchant banks actually invest in the equity (frequently the common stock) of the venture.  This is the key concept about merchant banks that makes them different from investment banks (stock brokers who help companies go public) and commercial banks (which accept insured deposits and make comparatively low-risk loans).

You will recall that equity is the business owner's share of the company.  If you own 20% of the outstanding common shares, you own 20% of the business.  Shares of publicly-traded companies are often called equity.  Equity is different than debt because there is no interest rate and there are no required monthly payments.  The equity holders merely share proportionately in any net profit, after all other bills are paid.  The equity holders are also the first capital holders to get wiped out if the venture fails.  They are the holders of the first loss piece, just like the guy who contributed the down payment for a real estate deal when the first mortgage forecloses.

Modernly merchant banks no longer rent sailing ships for risky trading voyages.  Instead, merchant banks provide venture capital by buying late-stage shares in private companies that are close to going public.  They make high-yield mezzanine loans.  They invest in preferred equity.  They provide venture equity (most of the cash equity in a real estate development project required by the bank) to real estate developers.  The common theme is that these are go-go investments - high-yield, high-risk stuff.

So what does a modern merchant bank look like?  The modern merchant banks consists of two or three guys in suits sitting in a small office at the top of an office building owned by the life insurance company or privately-held bank.  Remember, merchant banks do NOT accept deposits.  They are merely an investment department.

So where does a modern merchant bank get its money?  Answer:  The profits of some cash cow company, typically a life insurance company or a bank, privately-owned by the same owners as the merchant bank.

Let me explain this in English.  You and two partners form a bank.  You set it up, for tax reasons, as a bank holding company at the top of the organizational chart, with the bank itself underneath it.  In other words, you and your partners own the bank holding company, and the bank holding company owns the bank.

The bank is phenomenally successful, and you award yourselves $4 million per year each in salaries.  You don't need more personal income.  Your house is so big that you seldom even visit most of the rooms.  The last thing you want to do is pull money money out of the bank because you're giving 55% to the state and Federal government in income taxes.

You want your profits to stay within the bank holding company, so they can generate even more wealth.  Therefore you pass your bank profits up to the holding company (an 85% tax-free transfer), and the bank holding company funds the formation of a little merchant bank, also underneath the bank holding company.  You then use this growing pool of cash to make go-go equity investments.  If you invest well, soon you are swimming in wealth.

Now here is something that will shock and surprise you:  Ninety-five percent of the guys who claim they are merchant bankers are either con men, liars, uneducated fools, or blowhards.  They are trying to either steal someone's advance fee or to dazzle you with their ... malarkey.  Never trust a man who claims he is a merchant banker.  In real life, there are only a handful of genuine merchant bankers.

By the way, it is highly-illegal to call your company a merchant bank.  The word "bank" implies that you offer deposit insurance, and the Office of the Comptroller of the Currency would go absolutely bat-snot if they discovered you.  Therefore if someone ever hands you a business card that reads, "So and So Merchant Bank", you will know instantly that he is a con man.

A few years ago, Alicia, who was running C-Loans at the time, called up a guy named Alan Dunn and said, "Alan, I'm about to make your whole day.  Do you remember that hyperlink entitled Apply for a Commercial Loan that you put on your website?  Well, guess what?  A borrower clicked on that link and applied for a $19 million commercial real estate loan using C-Loans.com.  The loan closed, and we have a referral fee check for you in the amount of ... $21,250!"  Holy Moly, can you imagine getting a call like that?

First of all, let me reassure you that referral fees for commercial real estate loans are perfectly legal, even if you are not a licensed mortgage broker or a licensed real estate broker.  You just can't be involved with negotiating loan terms.  All you can do is introduce the borrower and the commercial lender.  After that, if you are not properly licensed, you need to get out of the way and not try to play intermediary.

The strict prohibitions about referral fees or kickbacks that you've heard about apply to home loans.  Home loans are loans on single-family dwellings, residential condo's, duplexes, tri-plexes, and four-plexes, what we call in the industry one-to-four family homes.  The government doesn't want unsuspecting home loan borrowers being steered to unscrupulous, high-cost residential lenders simply because the lender is offering kickbacks.  Commercial borrowers are considered far more sophisticated and don't need such protection.

You too can earn some of these huge referral fees.  Here are more details:

Do you have a webpage?  If so, you could be earning $5,000 referral fees as you sleep. All you have to do is put a simple hyperlink on your web page that says, "Commercial Mortgages".  In return C-Loans will pay you 1/8th of a point on any closed commercial mortgage loan that came from your site. (On loans of $5 million and higher, C-Loans itself only earns 25 bps., so your referral fee will be one-third of 25 bps.)

The C-Loans On-Line Commercial Mortgage Application System is totally awesome.  The borrower or broker (yes, you get paid if brokers use it too!) merely completes a 4-minute on-line application.  Then he asks for lenders.

More than 750 nationwide commercial mortgage lenders participate in the C-Loans System, including several life insurance companies, virtually all of the largest 50 banks, dozens of major conduits, and even a handful of REIT's. The system also has a number of hard money lenders for subprime deals and bridge loans.

Your borrower studies the rates of each lender and then chooses six lenders.  He submits his loan application with just one simple mouse click. Within minutes he will receive by e-mail several quotes or turndown notices.   If the answer is no, he simply clicks on more lenders until his loan is approved.   The system is soooo sweet.

"Gee, George, it sounds great. I wouldn't mind getting a $10,000 referral check out of the blue someday. What do I do?"

Simply create a "Commercial Loans" hyperlink on your site and point it to http://www.c-loans.com

"But George, how will you know that the deal came from me?"

Our computer captures the URL of the referring site and prints it right on the bottom of the loan application. When a deal closes, we merely go to that site and tell them the good news.

"But George, how will I know you won't cheat me?"

C-Loans, Inc. is the sister company of Blackburne & Sons Realty Capital Corporation, one of the oldest hard money lenders in the country. Blackburne & Sons was founded in 1980, more than 35 years ago. We are entrusted by our 1,000+ private investors to manage and service more than $50 million of their mortgage investments.  The balance in our trust account is often over $2 million.  To be entrusted to handle this much money for this long, we pretty much have to be impeccably honest.

"Gee, George, this all sounds very interesting. Is there anything special I can do to increase my chances of making some serious dough?"

There are two things you can do. First of all, be patient. Don't give up. Commercial loans take on average four to five months to close.

Secondly, put our link on every one of your web pages at least three times. Maybe one link will say, "Commercial Loans". The second link might say, "Commercial Mortgages". The third link might say, "Apply for a Commercial Mortgage." They should all point to http://www.c-loans.com. One link might be at the top of each page; the second link might be on the left side; and the third link might be on the bottom.

Remember, this is a numbers game. The more loan app's you submit, the better your chances of making some serious dough. A nice referral check of $21,250 would pay some bills, huh?

Brand New Additional Option: For just $95 we will create a special partner link for you that will allow you to -

1. Imbed a "Commercial Loans" hyperlink in your email newsletters and even in the signature block of your daily emails. Without this special link, we can only track referrals from websites, not email newsletters or even everyday emails. I'd insert your special partner link right in your signature block. Hey, you never know when one of your wealthy borrowers or real estate brokers might happen to need a commercial loan.
   
   
2. Receive a copy of every commercial loan application generated by your website or emails. This way, if you happen to see a commercial loan that you want to broker out yourself, you can jump on the lead and call the borrower.

By creating Commercial Mortgage hyperlinks all over your website (I'd put two or three C-Loans hyperlinks on every one of my webpages - why not, huh?), you give yourself a chance to earn some big referral fees while you are sleeping.

Want your own partner link? Please call Mick Carlson at (574) 855-6292 or email him at mcarlson@blackburne.com.

If you don't regularly blast out an email newsletter, and you are not worried about getting a copy of every commercial loan app generated by your site, then you don't need to speak with Mick. Just insert the "Commercial Loans" or "Commercial Mortgages" hyperlinks all over your webpages and point them to C-Loans.com.  Remember, that lucky-lucky guy, Alan Dunn, didn't have this fancy, special partner link.  He just put pointed some hyperlinks on his website to C-Loans.com.  Our automated tracking system did the  rest.

Thirty-five years ago, when I first founded Blackburne & Sons, I had never closed a commercial real estate loan.  In other words, I founded a commercial mortgage company before closing my very first commercial mortgage loan.  Pretty audacious, huh?  Today my commercial mortgage company is one of the oldest commercial mortgage companies in the country, and it services over $41 million in private money commercial permanent loans.  You will recall that a permanent loan is just a garden variety first mortgage on a commercial property.

Therefore it is not as audacious as it sounds when I say that I am founding a business loan brokerage company today, despite the fact that I have never closed a single business loan.  I am going to learn the business as I go, and I am going to share everything I learn with the public using this blog.  My sons and employees will learn the business with me by studying this blog.  You can too.

First of all, what do I mean when I say "business loan brokerage"?  A business loan - as opposed to a commercial mortgage - is a commercial loan secured by something other than commercial real estate.  A commercial loan could be an unsecured loan to a business or a loan to a business secured by the personal property owned by the business.  By the way, personal property does NOT mean private property.  It doesn't mean my personal stuff, like my underwear.  Personal property is a legal term of art that means every kind of property other than real estate.  Real estate is land and that which is affixed to the land.

I don't know if you caught it, but I slipped from business loan to commercial loan in the above paragraph.  You will recall that commercial is just a fancy word for business.  They mean exactly the same thing.  Therefore a commercial bank is a bank that makes business loans (in other words, a garden variety bank), as opposed to an investment bank, which makes investments (buys and sells stock investments).

Business loan brokerage is the business of placing business loans with banks and finance companies for a commission, and very few states, if any, require a license to broker business loans.  This is huge.  This means that if you got financially beaten up during the Great Recession, and it is now impossible for you to get a mortgage broker's license, you can still earn a living brokering business loans.

Here's another reason to get excited about brokering business loans.  Business loans close fast.  Most business loans close within two to three weeks because there are no appraisals to obtain.  Some business loans have closed in less than one week.  Compare these times to the 60 to 120 days required to close a commercial real estate loan!

So how am I going to learn business loan brokerage?  I intend to have my staff (my oldest son George IV initially) interview scores and scores of business loan lenders and business loan brokers in search of answers to the following questions:

1. Quick Screening Questions.  No loan officer wants to waste time processing a commercial loan request that has no chance at all of closing.  There are surely quick questions that an experienced commercial loan officer will ask the borrower in order to pre-qualify him.  So what items of information will a lender want to know upfront in order to quickly pre-qualify the commercial loan request?
   
   
2. Initial Loan Documents.  In a preliminary package, what documents will a commercial lender need to see so that no one wastes time pursuing an undo-able deal.
   
   
3. Loan Pricing.  How are commercial loans typically priced today?  Are they fixed rate?  Adjustable rate?  What's a good price?  What price is an outrageous gouge?
   
   
4. Recognizing Do-able Deals.  What does a good deal look like?  What situations or conditions make a commercial loan tougher or absolutely impossible? How do you tell a good deal from a bad one?
   
   
5. Brokerage Fee.  What kind and size of fee should a business loan broker charge?
   
   
6.  Underwriting and Financial Ratios.  How are business loans underwritten?  What financial ratios do business lenders use?  What is a good ratio?  What is an unacceptable one?

Someone from C-Loans, Inc. - probably my son George IV - will blog on each one of the above subjects.  Some of the subjects, especially underwriting and financial ratios, will almost certainly require several blog articles.

But not every business loan is the same.  There are a number of different types of business loans, and my staff will have to blog on each of the above topics on each of the types of loans described below:

1. Equipment financing.
   
   
2. Equipment leasing.
   
   
3. Accounts receivable financing.
   
   
4. Factoring.
   
   
5. Inventory financing.
   
   
6. Asset-backed lines of credit.
   
   
7. Lines of credit.
   
   
8. Unsecured business loans.
   
   
9. SBA 7a loans.

As you can see, we have our work cut out for us.  I envision about 60 blog articles before we are finally through.  But you can also see that if we answer all of the above questions for you about all of the above different types of business loans, you will really know your stuff.

And remember, this training is free!  Just follow along.

A standby takeout commitment is defined as a letter promising to deliver a takeout loan upon the proper completion of a commercial building.  The terms of a standby takeout commitment are typically horrible - a very high interest rate, a big slug of points - just for issuing the letter, and another big slug of points if the loan ever funds.  In truth, a standby loan is never expected to actually fund.

Whaaat?   Why on earth would a developer want to pay a big slug of points for a mere letter promising to deliver an absolutely terrible loan?  The reason why is because some construction lender is requiring a forward takeout commitment as a condition to funding its construction loan.  A standy takeout commitment satisfies this requirement, and even though a standy takeout commitment letter is very expensive, it can often prove to be the key financial ingredient to finally getting the building built.  I am going to give you an example in a moment that will make this whole issue clear.

"Gee, George, I am only half following you.  What is a takeout loan again?"  A takeout loan is just a permanent loan used to pay off a construction loan.  You can use a permanent loan for lots of purposes.  You can use a permanent loan to buy a commercial building.  You can use a permanent loan to refinance your existing commercial property to pull out some equity.  Who knows?  You might want to pull out some  cash to take your new girlfriend, Lola La Boom Boom, to Las Vegas.  Or you can use a permanent loan to pay off the construction loan that you took out to build your new building.  When you use the loan proceeds to pay off a construction loan, this special kind of permanent loan is called a takeout loan.  Understand?

So do the loan documents actually say, "Takeout Loan"?  Naw.  The documents look exactly the same as any other permanent loan.  There is a Promissory Note and a Mortgage.  Takeout loans look like any other garden variety permanent loans.  Hang in there guys.  Don't nod off on me.  An example is coming up that will bring everything together.

"Gee, George, I hope you don't think I'm stupid, but what's a permanent loan again?"  A permanent loan is defined as a first mortgage on a commercial property, where there is a little bit of amortization (typically 20 or 25 years) and a term of at least five years.  In plain English, a permanent loan is just a garden-variety commercial first mortgage, typically from a bank, a conduit, or a life company.

"Okay, George, I'm trying really hard to understand, but you keep using these big words, like forward takeout commitment."  A forward takeout commitment is just a letter promising to deliver a takeout loan in the future.  A commitment is just a letter.  Forward takeout commitments are typically issued by life companies, and they usually have great terms.  The developer actually plans to ask the life company to fund the loan.  That being said, a standy takeout commitment is a form of forward takeout commitment.

An example will hopefully make all of these fancy terms clear.  Once upon a time there was a developer named Doug.  Doug wanted to build a multi-tenant industrial building on spec; i.e., without any pre-leasing.   Doug was convinced that manufacturing in the U.S. was poised to go nuts and rents would go through the roof.  If only he could bring a new industrial center online in less than one year, he could capture the ballistic demand for newer industrial space in his gateway city.

Doug goes to the bank and sits down with his construction lender.  The conservative banker is not as bullish as Doug, and he tells Doug that the only way his construction loan will ever get approved is if Doug gets a forward takeout commitment from a bankable lender.  A bankable lender is a commercial real estate lending company with a net worth large enough to stand behind their promise to fund a loan in the future.

Doug tracks down several life companies who are issuing forward takeout commitments, and he submits his takeout commitment request.  All of them turn him down.  "Doug, we just don't believe that industrial rents are going to soar from $3.60 per SF to $5.50 per SF within 12 months.  We just don't believe it."  By the way, commercial rents are customarily denominated on a per-year basis.  Therefore $3.60 per SF means $0.30 per SF per month. 

Doug keeps looking for a forward takeout commitment and eventually stumbles upon a bankable lender issuing standby takeout commitments.  The terms are onerous.  The lender wants two points just for the standby takeout commitment letter.  If the standby loan ever funds, there is also an exit fee of one more point.  Lastly, in a market where banks are making permanent loans at just 3.75%, the interest rate on the standby loan is a whopping 8%.

By the way, an exit fee is a fee owed when a loan pays off - regardless of whether you pay the loan off early, late, or exactly at maturity.  It's like a prepayment penalty that you just can't escape.

Everyone tells Doug that he is nuts to pay for such a horrible standby takeout commitment, but when Doug sits down with his construction lender, the banker informs him that the letter will work.  His spec construction loan funds, the industrial building gets built, industrial rents indeed do skyrocket as industrial vacancies in gateway cities fall below 2%, and Doug ends up with a ten-year lease from a near-credit tenant lessee.  Once the lease is signed and this strong tenant moves in, Doug immediately sells the building to a REIT for almost twice what it cost him to build it.  Everyone admits that Doug is a genius.

By the way, a credit tenant lease is a long-term lease to an investment grade company - a company with a credit rating from Standard and Poor's of BBB or better.  A REIT is a real estate investment trust, sort of like a mutual fund that buys and operates commercial buildings.

The reason I am blogging on this subject is that I actually saw a standby takeout commitment today.  I haven't seen a standby takeout commitment for at least 12 years.  Most commercial construction lenders simply wrote uncovered or open-ended construction loans during the early 2000's (2000 - 2007).  An uncovered construction loan and an open-ended construction loan are the same thing.  The terms simply mean a commercial construction loan made with no forward takeout commitment in place.  The construction lender is betting that the developer will be able to find a takeout loan on his own, once the building is built and leased.  For most of the past 15 years, this has been a reasonable bet.

Do you need a commercial construction loan?  Simply enter the deal into C-Loans.com.  Our 750 participating banks are ravenous for commercial construction loan requests right now.  This is why I have been blogging on the subject of commercial construction loans so much recently.

Do you find my teaching methods helpful?  Wish you were a near-expert in commercial real estate finance?  Because so MANY commercial loans are ballooning in the next three years, now is the best time to be a commercial mortgage broker in history!

Remember, if you ever meet a banker who is making commercial real estate loans, you can parlay his contact information into a free directory of 2,000 commercial real estate lenders.

If you convince a banker to join C-Loans as a lender, we'll send you for free the training course of your choice and pay you an additional $250 every time he closes a commercial loan for a C-Loans user.  How do you convince a lender to join C-Loans?  Just send him the web page that pops up when you click the red button below.

You can now place business loans - not just commercial real estate loans but also loans secured by equipment, inventory, and accounts receivable - using C-Loans.

You are going to love me after this training article.  It's the best one I have ever written, and whether you are a developer or a commercial loan broker, this training is going to make you a ton of money.

Now is a terrific time to originate or obtain a commercial construction loan.  Its particularly easy right now to close deals for the reasons I will outline below.

In this blog article I will teach you exactly how to close a commercial construction loan.  I have assumed that you are complete rookie.  All you have to do is follow the precise steps enumerated below today's funny picture.

But first let me explain why it is so easy to close commercial construction loans right now.  First of all, there has been very little commercial construction for the last nine years.  The world needs new commercial buildings.  

In addition, banks are loaded to the gills with cash right now (almost $3 trillion in excess reserves at the Fed), and commercial construction loans are extremely profitable for the bank.  The bank earns its entire loan fee upfront, but it doesn't have to disburse most of it's loan proceeds for many months.  This supercharges the bank's yield.  Construction loans are also short term.  Banks love-love-love short term loans.

Bottom line:  In a healthy economic climate like today's, banks prefer construction loans to almost all other loan products.

For commercial loan brokers, commercial construction loans are large, therefore so are the loan fees.  And in particular right now, very few commercial loan brokers even know how to originate commercial construction loans.  Most of the experienced commercial loan brokers were either driven out of the business or retired during the Great Recession.  Commercial mortgage brokers:  You have very little competition.

Bottom line:  Commercial construction loans are not that hard for a commercial loan broker to originate.  Just follow the easy steps outlined below.

But how do you close a commercial construction loan?  Its easy.  Just follow these steps:

1. Start with a local bank.  Construction loans require progress inspections, so the lender needs to be located nearby.  You can find many hungry commercial construction lenders by using C-Loans.com, and C-Loans is free!
   
   
2. Choose your local bank by size.  Small banks (less than $1 billion in assets) make small commercial loans (less than $2 million).  Regional banks ($1B to $10B in assets) make medium-sized loans ($2MM to $8 million).  Money center banks (more than $10B in assets) make the commercial construction loans larger $8 million.
   
   
3. Gather a loan package:  Initially you will need the details on the land purchase - purchase price of the land, down payment, balance owing, value of the land today, and if the borrower claims that the land is worth more than the purchase price, a very convincing explanation of why this is so (the developer assembled three contiguous parcels over several years or he got the land re-zoned or Wal-Mart moved right next door).  You will need a construction cost breakdown, sales projections if this is a "for sale" property or a pro forma operating statement if this will be a rental property, a curriculum vitae or CV (building experience resume) on the developers, a financial statement on each of the developers, photo's of the land, and ideally an architect's rendering.  It's the rare project over $5 million that ever gets financed without an architect's rendering.
   
   
4. Run the deal by prospective lenders over the phone, keeping the identity of the developer and the exact location of the property close to your vest initially.  The first words out of your mouth should be, "Hello, Mr. Banker.  My name is John Jones with Jones Mortgage, and I'd like to run a deal by you.  Did I catch you at a good time?  If not, I'll be happy to call back later."
   
   
5. Some bankers are aggressive.  Some bankers are so"sleepy" as to make it almost a crime for them to collect a salary.  If one bank loan officer blows you off the phone, be sure to call back the next day and speak with a different loan officer at the same bank.  I have closed scores of loans in my time where Loan Officer A at Bank of the Neighborhood turned me down, but Loan Officer B at Bank of the 'Hood later said yes; but wait a day or two before you call the same bank back.
   
   
6. Once your borrower has sent you his initial package (the borrower needs to prove he is serious about this loan by putting in some sweat-effort), and once you have an interested lender lined up, its now time to ask your borrower to sign a Non-Circumvention Agreement.  Unless the developer intended to find out the name of your lender and then go behind your back, he should have no problem signing a short agreement protecting the mortgage broker.
   
   
7. Now its time to prepare your loan package.  Prepare an Executive Loan Summary, attach your pictures and the short stack of documents described above, and save it as a PDF.  Don't know how to create a PDF?  If you enter the loan into C-Loans.com and submit the deal to six commercial construction lenders, you can then - right as you leave C-Loans - press the Create a PDF button and save the PDF we create for you to your desktop.  One click.  Easy-peasy.
   
   
8. Submit your PDF to your interested lender by email.  He will not open it.  Whaaat?  You'll see.  He'll have some BS excuse (the dog ate Hillary's emails), but the truth is that bankers are incredibly... sleepy.  How about that for tact?
   
   
9. Therefore it is essential that you call your banker to confirm receipt of the package.  "Hi, Mr. Banker, John Jones here.  All I'm doing today is calling to confirm receipt of the package.  You did get it, right?  Oh, your email was down, but its up again now?  Great.  You'll read the package tonight?  Wonderful.  I really wasn't calling to bug you (yeah, right... and I'll love you in the morning).  I should call you tomorrow morning?  You got it!"
   
   
10. Don't worry if the banker nit-picks your deal and turns it down.  No problemo.  He is probably just lazy, or his bank has enough commercial construction loans right now.  If a banker really wants to make loans, a few black hairs is NOT going to put him off.
    
    
11. The secret to successful commercial loan placement is to just keep presenting the deal to different bank loan officers (they can even be at the same bank - see above) until you find one in the mood to lend.
    
    
12. Once the lender comes back and shows some serious interest, from there on its merely a matter of fetching and shuttling documents.
    
    
13. At some point in time the banker should issue a term sheet (also known as a conditional commitment letter or loan proposal), which outlines the likely terms of the proposed commercial construction loan and asks for a deposit of $3,000 to $8,000 for third party reports (appraisal, toxic report, title commitment, etc.).
    
    
14. Although a term sheet is NOT binding on the lender, in real life a term sheet means that you are almost certainly going to get the loan.  As long as the third party reports come back okay, you're golden.
    
    
15. That's it.  Easy-peasy.

Do you need a commercial construction loan right now?

Do you need a permanent loan, a takeout loan, a bridge loan, an SBA loan, a mezzanine loan, a nonprime/subprime commercial loan, or a hard money commercial loan?

Do you need a lender who will actually lend at 75% LTV, rather than just boast about it?  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 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?

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