Commercial Loans and Fun Blog

One of our commercial loan officers said to me this week, "George, this commercial loan cash flows really-really well."  To which I replied, "I would much rather make a commercial loan that didn't cash flow worth a darn."  Why of EARTH would I say such a thing?

Poor folks with lousy credit pay far more for a 2-bedroom, 1 bath apartment than renters of nicer units with good credit.  The reason why is that in order for landlords to be willing to rent to folks with poor credit, they need to make a large premium in order to make up for the flakes who skip out in the middle of the night and the lowlifes who trash their property.

Its much the same way for rent-to-own funiture and appliance stores.  Used car dealerships, which sell most of their cars to buyers with poor credit, do the same thing.  They charge a huge premium for their cars.

Therefore any time you see a multifamily or commercial property that cash flows unusually well, be alert to the possibility that the property may be in a rough area and/or may have low-class, dangerous tenants.

Another way to look at the same issue is to look at the cap rate.  Remember, a cap rate is just the return on your money that you would enjoy if you bought a commercial property for all cash.

For example, if you paid $1 million for a property that generated $80,000 in net operating income, you purchased the property at an 8% cap rate ($80,000 NOI / $1,000,000 purchase price times 100%).

What would you say if I told you that in order to collect your 8% return, you would have to drive through the ghetto every month to collect your rent?  Would you still pay $1 million for the property, when you would literally be risking your life every time you drove to see your own property?  If you got a flat tire, you might never see your sweet wife and kids again.  I can see the headline now, "Landlord Beaten to Death With Lead Pipe.  Local Toughs Suspected."

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Here's an interesting offer.  You can either buy The Blackburne List of 2,000 Commercial Real Estate Lenders for $39.95 or trade us the contents of a single, dog-eared, and dusty business card sloshing around in your pencil drawer.

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Okay, so clearly you wouldn't pay $1 million for just $80,000 coming out of the ghetto.  How about $900,000?  Naw.  How about $750,000?  Tempting ... but no.  How about $600,000?  Well, every person has his price.  You could hire an armed guard to accompany you every month when you went to inspect the property and collect your rent.

Okay, so if you buy the property for just $600,000 - what is your cap rate?  C' mon, guys, this is just 7th grade math.  Chug a Red Bull and stay awake here.

Cap Rate = (Net Operating Income / Purchase Price) x 100%

Cap Rate = $80,000 NOI / $600,000 Purchase Price - all times 100%

Cap Rate = .133 times 100%

Cap Rate = 13.3%

The good news for you is that your new commercial loan from the bank is going to cash flow very well.  If the bank is financing 70% of the purchase price ($600,000 times 70% LTV = $420,000), and the bank is offering 5.5% commercial loan, with a 20-year amortization and a 5 year term, your debt service coverage ratio would be a whopping 2.31.  Wow.  This commercial loan has to be really-really safe, right?

Well ... until the tenant moves out, the two pit bull terriers are no longer manning the barbed-wire fence, local druggies quickly strip the building of all of its copper wire, and then the local gangsters vandalize the building, just for fun.

Okay, now let's compare this industrial building in the ghetto to a nice apartment building within walking distance of Chinatown.  That same $80,000 in Net Operating Income, because the property is in a such a wonderful location, might sell for $2,286,000 (a 3.5% cap rate).  The building would only carry a $858,000 new loan, if the commercial lender insisted on a 1.25 debt service coverage ratio.  Holy smack, the property will only carry a new commercial loan of 37.5% LTV because the property is selling at such a low cap rate.

But let's forget about cash flow for the moment and assume that the lender made new commercial loans of 60% LTV, based on the purchase price, on both properties.  Then let's assume that the borrowers defaulted and the lender has to foreclose both commercial loans.

After the foreclosure auction, which property do you think would be in better condition, the property in the ghetto or the property in the far nicer neighborhood with better quality tenants?

This brings me to the point of this article.  Any time a commercial property cash flows extraordinarily well, be on guard.  Perhaps the property is being valued at a very high cap rate because it is located in a very dangerous and very yucky area.

At the end of this article, I am going to make you the most favorable offer of your life.  It's like Jennifer Anniston asking you if it would okay if she kissed you.  Is this a trick question?

Placing a commercial loan is like finding a wife for your best friend.  You can introduce your buddy to a lovely lady, who is a solid 8 to your buddy's 6.  She's one year younger, two inches shorter, slender, and the same religion as your buddy.  They go out on a date, she digs him, and ... he's just not feeling it.  Go figure.

Placing a commercial loan can be very similar.  You take a small commercial loan to a small commercial bank, located just two miles from the subject property.  Your borrower has excellent credit and a net worth 1.35 times the size of the commercial loan amount.  (The Net-Worth-to-Loan-Size Ratio says the borrower's net worth must be at least as large as the loan amount.) But the bank's just not feeling it.

The solution?  Don't be dependent on just five or six banks.  If you want to close more commercial loans, develop a large databank of banks.  Then, when you are trying to place a commercial loan, you can quickly offer it to two-dozen different banks at the same time.  The first bank to step up wins the commercial loan.

I own Blackburne & Sons (est. 1980), a hard money commercial mortgage company.  We don't try to keep track of which of our 1,200 private mortgage investors has money to invest today.  We don't try to remember which of our investors would invest in a mobile home park in Fresno, California.  Instead, we blast out the Investment Bulletin to all 1,200 of our investors.  The first 15 investors to step up and commit to participate get the commercial loan.

Banks can find all kinds of reasons not to approve a commercial loan.  They could be fully-invested.  They could be over-concentrated in mobile home parks, even though they love them.  The commercial bank could have just taken a loss on a mobile home park commercial loan, and now the bank is especially leery about lending on mobile home parks.  Your loan officer at this particular bank could be a complete wimp in front of Loan Committee.  "God has never stopped inventing new and unique ways to kill commercial loans." -- George Blackburne III (1982)

Do you know why I get to play golf four times per week, when its not snowing in frigid Indiana?  I never rely on a handful of commercial lenders or private investors to fund my commercial loans.  I always put my commercial loans out for sale to a huge list of commercial lenders and/or private investors.  "I'm sorry, Mr. First-Time-Investor, but that deal is already sold out.  I'll be happy to put you down as a backup, but the truth is that you're the 7th backup.  You probably won't get into this particular commercial loan."  Talk about the opposite of high-pressure sales tactics ...

Okay, let's talk about your needs.  You need to have a huge databank of commercial lenders to whom to offer your commercial loans.

I'll trade you just one commercial banker making commercial loans for a list of 2,000 commercial lenders.  In 17 more seconds, Jennfier Anniston is walking away and kissing the next guy she sees.  (She is trying to make her boyfriend jealous, and if she accidentally meets a good kisser in the process ... after all she's not married.)

I'm not asking you to introduce me to your best banker.  Your 5th best banker will work just fine.  Sixteen - 15 - 14.

"But George, if I tell you about a banker, every broker on the internet will be able to find him."

Of course C-Loans, Inc. will solict this banker to join the C-Loans System as a lender, but did you know that only one out of every twenty bankers that we solict ever joins C-Loans?  And the process usually takes at least two years.  The chances that you are ever going to lose a commercial loan because you introduced us to your fifth best banker is something like one in several million.

Here's the real reason why we are willing to trade 2,000 commercial lenders for your one lousy little banker (your fifth best banker), who is only making commercial loans in the three counties surrounding the eighth largest city in Oklahoma:  We solicit these bankers for their turndowns.  "I'm sorry, Mr. Jones, but your commercial loan is too large - too small - too far away for us.  Have you tried entering your commercial loan into C-Loans.com?"

Jennifer Anniston is getting ready to walk away.  5-4-3 ...

Blackburne & Sons is announcing a new commercial loan today - a bridge loan with a much lower interest rate.  To understand how earth-shattering (earth-shattering?) this is, you need to understand a little bit about economic history.

You will recall that a permanent loan is a first mortgage commercial loan with a term of at least 5 years and with at least some amortization.  Conventional commercial loans are usually amortized over 25 years, but they balloon after just five, seven, or ten years.  If the property is older than 40-years-old, many banks and other commercial lenders will amortize such permanent commercial loans over just 20 years.

Historically, Blackburne & Sons has only made permanent commercial loans.  There was an important reason for this.  We knew that a deflationary depression was coming, and we were anxious to book long-term loan servicing rights.

"Okay, George, but what's so special about loan servicing rights?  You're always harping on the fact that the real money in the commercial loan business is in loan servicing fees.  What's so special about loan servicing income?  It sounds like a lot of work to me." 

Loan servicing income is dreamy.  When Blackburne & Sons books a permanent commercial loan, we might charge the borrower 12.9%.  We then sell off this commercial loan at just 11.0% to a syndicate of private investors that we assemble.  We then keep that 1.9% spread as our loan servicing fee.

Its a lot more work for us, but we actually assemble a new syndicate of private investors for each new commercial loan that we make.  Don't worry about speed.  After 33 years in the commercial loan business, we can syndicate a new commercial loan in 24 hours without making a single outgoing phone call.  That's how ravenous our 1,500 private commercial loan investors are for our deals.

Although we manage two large mortgage funds, but I am not a big fan of mortgage funds.  Large commercial loan mortgage funds always fail during real estate depressions.  We seem to have one of these commercial real estate depressions about once every eight to twelve years, and typically commercial real estate values fall by 45% during such depressions.

Having a diversified portfolio of commercial loans doesn't help when the value of the collateral falls by 45% as to every single loan.  It's like a life insurance company having a diversified portfolio of 2,000 different life policies, but every insured is a passenger on the Titantic.

By the way, did you know that Blackburne & Sons was the only commercial hard money lender that was actively making commercial loans every single day of the Great Recession?  Almost every other commercial hard money lender had been funding their deals using a commercial loan fund, and their funds were now facing large losses and massive redemptions.  In contrast, we were not relying a commercial loan fund.  We just kept syndicating individual commercial loans - albeit at higher rates because of the fear in the marketplace.

Okay, so the year is 2000.  I am a serious student of economic history.  I know in my gut that the mother of all deflationary real estate depressions is coming.  Therefore I refuse to make bridge loans.  Instead I make permanent commercial loans that give me long-term loan servicing rights.  By the time the Great Recession hits, we have almost $45 million in long-term commercial loans in our portfolio.  A 1.9% annual loan servicing income on $45 million produces over $70,000 per month in passive loan servicing income - money that comes in every month whether we arrange a new loan or not.

It was on this residual income that our company survived the Great Recession.  It is for this reason I think that commercial loan servicing income is the greatest thing since sliced bread.

It's time to circle the wagons and to get the point of this economic history lesson.  The Great Recession is over.  I, George "The Sky is Falling" Blackburne III, have swung from being the biggest bear in the industry to the most confident bull in the industry.  The future is wonderfully bright.  The best economic years of our careers are immediately ahead of us.

Therefore Blackburne & Sons is now happy to make bridge loans, and our low rates will rock your world.

If you have a handsome California property, we will now make the following bridge loan:

Interest Rate:  7.9% to 8.9%

Loan Fee:  Two points

Term:  One year

Prepayment Penalty:  None

We love the primary markets in Texas (Austin, San Antonio, Houston, Dallas).  Properties in other states may be at a slightly higher rate.

You will also find us more aggressive in terms of loan-to-value.  We might consider 75% loan-to-value on a purchase money deal to a good-credit borrower if he was putting down cash-to-loan.  Bottom line:  Blackburne & Sons is hungry for bridge loans.

Got a potential deal?  Please call:

Tom Blackburne (my son)
574-210-6686

Alicia Gandy (called the Loan Goddess because she's our biggest producer)
916-338-3232

Desmond Stoll (called Loan Atlas because he'll move mountains for you)
916-338-3232

Placing a commercial loan on a very desirable commercial property is often problematic.  When lots of commercial investors compete to own a well-located property (think of a well-maintained but small apartment building within walking distance of Chinatown), the prospective buyers bid up of the price.  This drives down the cap rate, and the purchase money commercial loan simply does not cash flow.

For example, most small, average-quality, apartment buildings in average locations sell at cap rates of around 5.5% to 7.0%.  You may recall that a cap rate is just the return on your money (think of it like an interest rate) you would earn if you bought an investment property for all cash.

But what if the small apartment building is within walking distance of Chinatown in any major U.S. city?  The Chinese are admirable savers, and many Chinese immigrants do not drive.  Therefore being within walking distance of Chinatown is a very desireable feature for an apartment building.  Thrifty Chinese real estate investors would bid on that property like hungry sharks.

If the apartment building was generating $50,000 per year in Net Operating Income (NOI), the first buyer might offer $800,000 - which works out to a 6.25% cap rate, a fair price for an average quality apartment building in an average area.  But then some other hungry investor might offer $875,000.  "I'll pay $975,000!" shouts another investor.  "No, I'll pay $1,250,00!" shouts another.  Up and up the bidding goes, until some investor closes out the bidding at $1,428,000 - which works out to a cap rate of just 3.5%.

Then the winning investor goes to the bank and applies for a commercial loan.  The loan officer at the bank, trying to underwrite the commercial loan, takes the $50,000 NOI and divides it by a 1.25% debt service coverage ratio.  This produces a Net Income Available for Debt Service of just $40,000.  Plugging $40,000 per year into his financial calculator, at a 5.0% interest rate and with a 25-year amortization, produces a maximum allowable commercial loan of just $564,000.

Now think about this for a moment.  The purchase price is $1,428,000, and the maximum allowable new commercial loan is just $564,000.  This means that the new buyer would have to put down a whopping $864,000.  That works out to 60% down!  This is because the property will only carry a new commercial loan of 40% LTV.

Small apartment buildings in Chinatown are not the only type of commercial property that will only carry a very small commercial loan.  Here are some more commercial properties that typically sell at a very low cap rates:  office condo's, industrial condo's, small commercial-investment properties that are affordable to a great many new commercial real estate investors, commercially-zoned homes on busy strips used as office buildings, small office buildings located close to a courthouse (attorneys love them), apartment buildings located near public transportation, and extremely well-located commercial properties, such as the grand buildings located near Central Park in New York City.

So how do you get a decent-sized commercial loan on such a property?  One way is to get a preferred equity "loan" from Blackburne & Sons.  Even though our preferred equity "loan" will not cash flow, we will happily add our preferred equity "loan" on top of a new bank commercial loan, in order to bring the capital stack up to 75% loan-to-value.  This means the buyer only has to put 25% down.

Let's return to our example above.  The bank will only make a new commercial loan $564,000 (40% LTV).  Blackburne & Sons will place a $507,000 preferred equity "loan" behind the bank's new commercial loan, bringing the entire capital stack up to 75% loan-to-value.  This means the buyer only has to put 25% down.

If you have a commercial loan request on your desk that seems to fit, you can apply for a preferred equity "loan" immediately by clicking on this link.

You may have noticed that I have always placed the word "loan" in quotation marks whenever I referred to a preferred equity "loan".  That is because preferred equity is actually equity capital, rather than a loan.  For a terrific whitepaper on preferred equity, written in simple layman's English, please click the gray button below.

Commercial loans on politically-charged properties are difficult to place.  Examples of politically-charged properties include X-rated bookstores, marijuana cultivation facilities, abortion clinics, gambling casinos, gentlemen's clubs, and gay nightclubs or resorts.

Most commercial banks would never make a commercial loan on such a property.  Banks are very sensitive about their image, and they just can't risk an adverse public reaction or some bad press in their local market, just to earn a little extra interest on such a commercial loan.

The issue of commercial loans on politically-charged properties reminds me a lot of the boycott on krugerrands and South African stocks during the 1970's and 1980's over the issue of apartheid.  Many large American mutual funds sold their South African stocks in protest, causing the South African stock market to remain depressed for two decades.

The krugerrand - the one-ounce gold coin minted by South Africa - sold for a $10 to $25 discount to the American Double Eagle or the Canadian Maple Leaf, even though it contained the exact same amount of gold.  Twenty years after the repeal of apartheid, the krugerrand still sells at a small discount to the other gold coins.

Nevertheless, in the 1970's and 1980's many mutual funds chose to ignore the public stigma of South African stocks.  If a South African stock was fundamentally sound and a good value, they would still buy the stock.  A social agenda was not allowed to interfere with a sound investment decision.

At Blackburne & Sons, we do not have the luxury of advancing some social agenda.  Our first loyalty has to be to the safety of our investor's money.  When your rates are 4% to 5% higher than most commercial banks, good commercial loans are hard enough to find as it is.  We simply have to jump all over any good commercial loan that will accept our higher interest rates.

My own private money commercial mortgage company will therefore happily make commercial loans on politically-charged properties, such as gentlemen's clubs and adult bookstores.  In fact, we have financed about 15 gentlemen's clubs over the years, and these commercial loans have paid well.  My view is that an investor can always count on the sun rising and on heterosexual males enjoying the shapely figure of an attractive woman.  We just closed a commercial loan this month on a restaurant with topless waitresses.  I was shocked - shocked I tell you - to observe that this business had been making good money for over 30 years.

Legalized marijuana is a new phenomenon.  Therefore we have yet to make a commercial loan on a marijuana cultivation facility, but we would definitely consider such a commercial loan.  Commercial loans on gay bars, nightclubs, or resorts?  Well, is it making good money?  If so, we would definitely consider making a commercial loan on such a property.

Bottom line:

1. Certain commercial properties are politically-charged, and it is difficult to place a commercial loan on such properties.
2. Examples of politically-charged properties include X-rated bookstores, marijuana cultivation facilities, gentlemen's clubs, abortion clinics, gambling casinos, gay bars, gay nightclubs and gay resorts.
3. Conduits do not make commercial loans on politically-charged properties.
4. Commercial banks don't not make commercial loans on politically-charged properties.
5. Would a credit union make such a commercial loan?  I dunno.  It's worth a few calls.
6. Hard money commercial lenders, like Blackburne & Sons, finance most politically-charged properties.

Most commercial real estate lenders seldom take additional collateral when they make commercial loans.  For example, conduits never make blanket commercial loans.

While banks will occasionally make blanket commercial loans, these blanket commercial loans are usually SBA loans.  Because the loan-to-value ratio on SBA loans is often so high, the bank will sometimes take the borrower's personal residence as additional collateral.

Only rarely will you ever see a commercial bank blanketing additional collateral on a conventional commercial loan.  A conventional commercial loan is a commercial real estate loan that is not guaranteed by either the SBA or USDA.

However, the one class of commercial lender that regularly bankets additional collateral is the hard money commercial lender.  I have an old and valued buddy, Paul Elis, who also owns his own hard money commercial loan shop.  Paul swears by blanket commercial loans.  When push comes to shove, mama is not going to allow papa to lose her castle.  The borrowers are not going to simply walk away from the commercial property because they would also lose their house.

A commercial lender can sometimes get comfortable with a tricky commercial loan by taking additional collateral.  For example, we were looking at a purchase money commercial loan this month where our borrower was buying an REO from the bank.  The problem was that the buyer was not putting a whole lot of cash down.  Normally we would have passed on the deal.

But then the borrower's commercial loan broker did a smart thing.  He offered us additional collateral, which included some land and a separate rental house.  The truth was that I was satisfied with the protective equity in the deal.  Our borrower was buying an REO  from a bank, and the subject commercial property was probably worth more than the purchase price.  If we foreclosed, we would probably get out of the deal without too large of a haircut.

But we didn't want to have to foreclose.  We just wanted reasonable assurances that the buyer would make his payments.  Normally, if a buyer puts down 30% of the purchase price, the size of the downpayment gives him plenty of incentive to make his monthly payments.

Here he was only putting down about 15% of the purchase price.  He lacked skin the game.  He lacked blood money - the blood on the stoop that a lender would see when he entered the property after completing his foreclosure sale.

When his commercial loan broker offered additional collateral, however, he solved my problem.  The borrower would lose both this valuable piece of land and his rental house if he ever defaulted on our commercial loan.

There is one scenario that always makes me chuckle.  Commercial loan brokers will often try to create equity where there is none.  For example, suppose the borrower needed a commercial loan of $200,000.  He offers up as collateral an apartment building, worth $2 million and with a $1.6 million first mortgage.  He also offers up as collateral an office building worth $1 million, but which has a $750,000 first mortgage.

Then the commercial loan broker says, "The apartment building has $400,000 in equity and the office building has $250,000 in equity.  That's $650,000 in equity to secure just $200,000.  Surely you'll make that deal, right?"

Hellooooo? Neither property has a lick of lendable equity.  At 80% loan-to-value, the apartment building is already mortgaged to the hit.  At 75% loan-to-value, the office building is also fully-mortgaged.  You cannot create lendable equity by combining various properties that are individually mortgaged to the maximum.

Now that you know that Blackburne & Sons will buy commercial loan discounted notes, how do you document the file?  If you run across the owner of a commercial loan who needs to discount it, for what documents do you ask?

Below is a Dream List of the documents that a buyer of a discounted commercial loan would love 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.  The better your discounted commercial loan is documented, the smaller the size of the discount.

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, current credit report on the Maker, last two years tax returns on the Maker, current Rent Roll, current commercial leases.  The documents listed in item 11 here are rarely available.

*  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 the discounted commercial loan) without delivering the original promissory note.

In fact, if the assignee (buyer of a discounted commercial loan) fails to take physical delivery of the original promissory note, and if the assignor (the seller of the discounted commercial loan) later files Chapter 7 bankruptcy, the promissory note becomes the asset of the bankruptcy estate!  The intended assignee is completely wiped out.

You are not going to run across discounted commercial loans every day.  Months from now you may need to refer back to this article for the list of documents to gather.  So be smart.  Please bookmark this page right now.

Got a discounted commercial loan right now?  Want to speak to a loan officer?  Please call or email:

BLACKBURNE & SONS REALTY CAPITAL CORPORATION

Alicia Gandy - (916) 338-3232
Desmond Stoll - (916) 338-3232
Tom Blackburne - (574) 210-6686 

My commercial loan, hard money lending company, Blackburne & Sons, competed this week to buy a discounted first mortgage note on an apartment building.  Do you know how to underwrite a discounted note when its a commercial loan?  You will after this blog article.

When underwriting a discounted commercial loan, perhaps the most important issue is the interest rate on the note being sold.  Private mortgage investors, when deciding whether or not to invest in a commercial real estate loan outside of California (yield requirements are 2% to 3% lower in California), usually insist on a yield of between 12%* and 14%*.

*  Gross yield before loan servicing fee.  I've been in the hard money mortgage business for 33 years now.  Show me a hard money lender that doesn't charge a loan servicing fee of at least 1% to 2%, and I'll show you a hard money lender that will not survive the next recession.  I've been preaching this to my fellow owners of hard money shops for years.  During the Great Recession, at least 60% (85%?) of all hard money commercial loan companies failed.  The handful that didn't fail only survived because they went back to their investors and raised their loan servicing fees to at least 2% per year.

Therefore, when underwriting a discounted commercial loan, you must first discount the loan back to present value at a yield that is appealing to a private mortgage investor.  In other words, what is the proper price to pay for this commercial loan for an investor wishing to yield 13%?

When discounting a commercial loan back to present value, much depends on the remaining term of the commercial loan.  For example, let's look at an 8% first mortgage commercial loan secured by an office building.  If there are just two more years remaining on the note, the discount might not have to be too large.

We said that the investor wishing to buy this commercial first mortgage note wants to earn, say, 13%.  Thirteen percent minus 8% equals 5% per year.  Five percent per year times the 2 years remaining on term of this commercial loan gives us a rough discount of only around 10 points.  I'll teach you a more precise way of calculating this discount in a moment.  Right now I want you to focus on the concept that the longer the remaining loan term, usually the larger the discount.

But what if this same 8% commercial loan had 10 more years to run?  Just doing some rough calculations, the discount would have to make up for a shortfall in the interest rate of 5% per year.  A 5% per year interest rate shortfall times 10 years is a whopping 50 (FIFTY) point discount!  Ouch!  A far better option in the above case would be to hypothecate the note - in other words, borrow against it - rather than selling it at a discount.

Below are instructions on how to properly and accurately compute the discount on a commercial loan.  Don't try to slug through them right now.  You can always come back and study this article in detail (bookmark it?) when you have a real deal to underwrite.  Instead, just skip right now to the rest of the article below the instructions.

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HOW TO COMPUTE A DISCOUNT ON A COMMERCIAL LOAN

How do you compute the discount on a commercial loan properly and precisely?  Take out your financial calculator.  You will notice that your financial calculator has a row of five buttons:

1. N (Stands for Number of payments until the loan balloons.)
2. I (Stands for Interest rate.  You may have to convert this to monthly.)
3. PV (Stands for Present Value or the loan balance)
4. PMT (Stands for Payment.  Usually this will be monthly)
5. FV (Stands for Future Value or balloon payment)

As long as you know four of the five values, you can compute the fifth.  In this case, we're trying to figure out how much to pay for this commercial loan.  In other words, we are trying to figure out the PV.  As long as we know the other four values, we can compute the PV.

Therefore, in the N field, insert the number of months until the maturity date.  

In the I field, insert, not the monthly interest rate on the actual commercial loan, but rather 1/12th of the desired yield by your private investors!  In this case, you would insert 1/12th of 13%.

In the PMT field, insert the monthly payment.  On some financial calculators, you may have to change the sign of the monthly payments from positive to negative, or vice versa.  Be careful not to forget the final month's payment.  Is it included in the ballon payment?  Don't double count, but also don't forget the last monthly payment either.

In the FV field, insert the ballon payment.  On some financial calculators, you may have to change the sign from positive to negative, or vice versa.  Is the last monthly payment included in the balloon payment?  Don't forget it ... but don't double-count it either.

We are now ready to compute the size of the discount.  Ask your financial calculator to compute the PV - what you should pay for the commercial loan if you want to yield 13%.

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Let's suppose you are trying to buy a $100,000 commercial loan, and you compute the discount to be $17,000.  Does this mean that you should pay $83,000 for the commercial loan?  No.  You have forgotten about the loan fee being charged by your lender and your own loan brokerage fee.

Let's suppose that Blackburne & Sons is charging 4 points, and you are charging a loan brokerage fee of 2 points.  Therefore you should subtract from the purchase price of the commercial loan the combined loan fee of 6 points, or in this case, $6,000.

We're still not quite done.  There will be closing costs - attorney's fees, title insurance, and recording fees.  A good rule of thumb for these costs is 2.5 points for commercial loans with a face value of less than $500,000 and 1.5 points for commercial loans with a face value larger than $500,000.

Therefore we have a $100,000 face value commercial loan, minus a discount of $17,000 to make the yield attractive, minus $6,000 in combined loan brokerage fees, minus $2,500 in closing costs - for a net to the seller of $74,500.

Why would a seller take just $74,500 for his commercial loan?  (1) He needs money; and (2) he no longer wants to take the risk that the borrower won't pay.

We are not done yet underwriting the deal.  You need to look at the loan-to-value ratio.  The end private investor, in our example, is paying $83,000 for the commercial loan ($100,000 minus the $17,000 discount to bring the yield up to 13%).  Is this a reasonable loan-to-value ratio?  Divide $83,000 by the current value of the property to make sure that it does not exceed 70% LTV.

What is the payment history of the underlying borrower on the commercial loan?  The above discussion assumes that the underlying borrower has been paying essentially perfectly.  If not, the discount may be significantly larger.

What is the credit of the underlying borrower?  Did the original owner of the commercial loan pull a credit report on him?  Does the loan package include old tax returns, showing that the underlying borrower was making money, at least when the commercial loan was originally made?  Is the property owner-occupied?  Does the maker's (the underlying borrower's) business look like it is thriving?  Is this a rental property?  If so, does it look fully-occupied?

If the answer to all of these questions is yes, the private investor buying the commercial loan may only require an 11% yield, rather than a 13% yield.

One the other hand, if the answers are not so appealing, the discount may have to be larger.  That being said, this is a capitalistic world.  There is some discount that is large enough to make almost any first mortgage commercial loan worth buying.

Today you are going to learn a ton today about business financing.  By business financing, I mean commercial loans NOT secured by real estate.

As you know, I already own a very successful commercial mortgage portal named C-Loans.com.  C-Loans has now closed over 1,000 commercial real estate loans totaling over $1 billion.  But it wasn't easy to build this portal.  It took us six, long, painful, heart-breaking years to reach profitability.

We are now in the process of building a business financing portal.  Our plan is to use all of the lessons and much of the software that we used to build C-Loans to build a portal for business owners who need financing - accounts receivable financing, factoring, equipment leases, equipment financing, lines of credit, and about a dozen other forms of specialized business loans.  We have purchased the wonderful domains, CommercialLoans.com and CommercialLoan.com, to use for this new venture.

Okay, so I interviewed today a good friend, named Scott Jordan, of All Credit Lending Solutions.  Scott's business is almost the exact opposite of mine.  While I make all of my dough in commercial real estate finance, Scott makes almost 100% of his dough in business finance.

I took careful notes during my interview with Scott, and today's blog post is largely a data dump of everything Scott taught me.  I learned a ton, and I promise that so will you.  This is not a primer on the entire subject of business financing.  It's more a short collection of topics upon which he tutored me.

Business Lines of Credit:

Prior to the Great Recession, many commercial banks used to regularly make these loans - up to about $50,000 ($100,000).  The size of the line of credit was often based on the amount of the company's monthly sales, and sometimes the line of credit was even unsecured.

Since the crash, the appetite of commercial banks for such loans has greatly diminished.

Collateral Based Loans:

Collateral based loans are when the lender takes physical possession of the asset and lends you some modest percentage of its value.  There are lots of different names for collateral based loans - Pawn Loans, Car Title Loans, Asset Based Loans, and perhaps a layman would understand the term, Hard Goods Loans.

Examples of hard goods that could be serve as collateral for small commercial loans are car titles, truck titles, heavy equipment titles, boats, artwork, jewelry, gold, rings, and household goods worth at least $10,000.

Collateral based loans are very expensive, typically between 3% to 5% per month.  They are intended only to be short-term loans.

There are even a number of online collateral based lenders, the largest being PawnGo.com.  You send them the asset, they inspect it, and then they make you an offer.

Cash Advance Commercial Loans (Cash Advances):

Cash advance lenders are a newer breed of business lender that makes commercial loans to companies that make lots of regular daily sales.  They will examine your company bank statements or merchant account statements, and then they will lend you a certain percentage (65%?) of your average monthly balance.

A merchant account is a type of bank account that allows businesses to accept payments by payment cards, typically debit or credit cards.  A merchant account is an agreement made between the business/seller, the bank where the merchant account is held, and the payment processor to settle all transactions made by debit and credit cards. The fees associated with these accounts are usually in the following categories: monthly, discount rate and transaction. The rate that a business is charged for debit and credit card services provided by its merchant account is called a merchant discount rate.

The interesting thing about a cash advance commercial loan is that the commercial lender will suck out a small, regular, loan payment from your business account every business day!

Asset-Based Line of Credit (ABL Loan):

An ABL lender will secure his commercial loan, and base the size of his commercial loan, by the amount of your company's accounts receivables, plus a certain percentage of the value of your inventory (35%?), plus a certain percentage of the value of your fixed equipment (35%?).

An ABL loan is often better than factoring your receivables because you don't have to pay as large of a monthly discount if you are not using the money.  You only pay interest when you have borrowed money on the line of credit.

ABL loans are not cheap.  The very best borrower will pay at least Prime + 4%, and interest rates of Prime + 10% are far more common.  Nevertheless, an ABL loan is cheaper than factoring, and you may be able to borrow more money.

Crowdfunding:

Crowdfunding is the collective effort of individuals, who network and pool their money, usually via the Internet, to support efforts initiated by other people or organizations.  Crowdfunding is used in support of a wide variety of activities, including disaster relief, citizen journalism, support of artists by fans, political campaigns, startup company funding, motion picture promotion, free software development, inventions development, scientific research, and civic projects.

Crowdfunding can also refer to the funding of a company by selling small amounts of equity to many investors. This form of crowdfunding has recently received attention from policymakers in the United States, with direct mention in the JOBS Act - legislation that allows for a wider pool of small investors with fewer restrictions.  (In my opinion, the JOBS Act is the single most beneficial piece of Federal legislation passed in the past 50 years.  The positive effect on innovation and job creation in the U.S. is going to be huge.)

Peer-to-Peer Lending:

Peer-to-peer lending is the practice of lending money to unrelated individuals, or "peers", without going through a traditional financial intermediary such as a bank or other traditional financial institution. This lending takes place online on peer-to-peer lending companies' websites using various different lending platforms and credit checking tools.

Using various P2P lending websites - such as Prosper.com and LendingClub.com - wealthy, accredited, private investors are making personal loans directly to borrowers, with either a dozen or more individuals investing together in a single loan or with a single private investor making the entire loan.  Typical loans are 9.9% to 13.9%, fully-amortized over a three to five year term.

So what's the difference between crowdfunding and peer-to-peer lending?  Crowdfunding raises equity, while P2P lending creates debt.

Using Linked-In:

So I asked my buddy, Scott, where he got his leads.  Do you get most of your business financing deals from brokers.  "No," he replied, "brokers only account for about 25% of my business.  Seventy-five percent of my business comes from business borrowers directly - word of mouth, my website, referrals, and Linked-In.  Linked-In is huge for me."

So how do you get business from Linked-In?  I don't personally participate on Linked-In, but Alicia Gandy in our Sacramento office - we call her The Loan Goddess because she is our biggest producer - gets a ton of business from Linked-In.

Scott replied, "I join lots of groups.  Also, if I see someone with a successful business in the newspaper, I'll send him an invitation to link with me on Linked-In.  Seventy-five percent of the people that I invite agree to link to me."

Great advice, Scott!  Great lessons.  Thank you.

Do you need a business loan not secured by real estate?  Please call my buddy:

Scott Jordan
All Credit Lending Solutions
303-887-2570
sjordan@allcreditls.com

Important reminder:

Sooner or later you are going to be working on a conventional commercial first mortgage, and the bank is only going to be willing to lend up to 63% loan-to-value.  Your borrower needs 75% loan-to-value financing.  Our new Preferred Equity Loan program will solve your problem.

A purchase money commercial loan is a commercial loan that is used to buy a commercial property and which is secured by the same property.  For example, if you refinanced your free-and-clear apartment building to buy a strip center, the new loan on the apartment building would NOT be considered a purchase money loan, even though the proceeeds were used to buy a commercial property.

Most purchase money commercial loans these days are SBA loans.  If an established and profitable business wants to buy a larger facility, in order to expand and hire more workers, the SBA will guarantee a large portion of that loan.  The buyer would only have to put down 10% of the purchase price (the new commercial loan would be 90% loan-to-value).

The opposite of an SBA loan is a conventional commercial mortgage loan.  A conventional commercial mortgage loan is a commercial loan made with no government guarantee.  By the way, the SBA is not the only Federal governmental agency that guarantees commercial loans.  Don't forget that the USDA also guarantees commercial loans using its Business and Industry loan program.  A USDA Business and Industry Loan is a commercial real estate loan, guaranteed by the USDA up to 90% LTV, and made in a rural, lowly-populated area, that will create more jobs in the rural area.

So a conventional commercial mortgage loan is a commercial mortgage loan that is not guaranteed by the SBA or the USDA.  Most conventional commercial mortgage loans are made by either commercial banks or conduits.  A commercial bank is just a garden variety bank, as opposed to an investment bank or a merchant bank.  The word "commercial" is just a fancy word for "business" and signifies that the bank is in business to make a profit.

An investment bank is a company that sells stocks and bonds and occasionally takes companies public.  A merchant bank is usually a small group of very wealthy investors - guys who often own a bank or life insurance company together - who use their excess profits to make equity investments in risky, potentially high-yielding investments.  There are probably fewer than 200 merchant banking companies in the whole country, and you'll probably never get to meet one.  If you ever meet a so-called "merchant banker" at some commercial lending conference, the chances are 20:1 that he is a con man, an advance fee scammer, and/or a huge slinger of bull-pucky.  Mortals like you and me don't get to meet real merchant bankers.

Purchase money commercial loans are often used to buy commercial investment properties.  Examples of commercial investment properties include apartment buildings, office buildings, shopping centers, strip centers, mobile home parks, and self storage facilities.  They are properties where the income comes - not from running a business, like a restaurant or a bowling alley - but rather from plain-vanilla monthly rent.  Commercial investment properties are purchased by real estate investors, rather than business owners.

Now we are finally getting to the point of this article.  If a real estate investor wants to purchase a commercial investment property, like a multi-tenant office building, right now, the typical bank is going to require a huge downpayment.  Why?  Because commercial banks are too scared to lend higher than 58% to 62% loan-to-value on commercial investment properties.

To make matters worse, commercial banks will not let the seller carry back a second mortgage.  Why?  They don't want to over-burden the property with debt.  They are afraid that if a tenant or two moves out and the cash flow dwindles, the commercial property owner might be tempted to use the cash flow earmarked for repairs and maintenance to make the payments on the second mortgage.  Soon the property becomes dilapidated.

This means that buyers of commercial investment properties today have to put between 38% to 42% down in cash!  Who has this kind of cash?

Now if the purchase price is huge, say $15 million or higher, the buyer will probably use a conduit loan (aka: CMBS loan).  Behind the conduit loan, the buyer will often take out a mezzanine loan of $3 million to $5 million.  Then the buyer will put just 25% down in cash.  The mezzanine loan fills the gap in the capital stack between 65% LTV (the maximum exposure of a CMBS loan) and 75% loan-to-value.

A mezzanine loan is not a second mortgage.  Instead, its a personal property loan against the membership interests of the LLC that owns one of these big, trophy commercial properties.  Remember, a share of stock is personal property, not real property.  A membership interest in an LLC is also personal property, not real property.  Seizures (foreclosures) of personal property can be completed in less than six weeks.  Real estate foreclosures can take 18 to 24 months in New York and many other states.  This why these junior lenders make mezzanine loans, rather than second mortgages.

Therefore, if your investor is buying some huge, trophy commercial investment property for more than $15 million, he can probably get away with putting down as little as 25% of the purchase price, by using a CMBS loan, capped off by a mezzanine loan.

Unfortunately, mezzanine loans are legally very complicated.  The legal fees alone can exceed $60,0000.  As a result, few mezzanine lenders will make mezzanine loans of less $5 million (maybe $3 million).

Therefore, if a buyer of a commercial investment property is paying less $10 million to $15 million, he has a real problem.  A commercial banks will only lend up to 58% to 62% LTV.  This means he has to put down 38% to 42% of the purchase price.  Not surprisingly, few smaller commercial investment properties are changing hands.

Until now.

Blackburne & Sons has just come out with an earth-shattering new commercial capital program.  Our hard money mortgage company is now making Preferred Equity "Loans" from $100,000 to $600,000 nationwide.

Preferred Equity is actually not a loan.  It's an equity investment.  Legally we become part owners of the property; but we are only entitled to a Preferred Return that looks almost identical to garden-variety interest.  Banks will allow Preferred Equity in "second position" because our payments are NOT required.  If the property doesn't generate enough cash flow some month to make the Preferred Equity payments, the payments do NOT have to be made.  

Don't worry about it if you are largely lost.  At the end of this article, I'm going to give you a link to brand new white paper that explains Preferred Equity in layman's language.

Here's what you need to know:  Commercial investment real estate is about to explode.  There has been virtually no new commercial construction for six years.  In the meantime, the U.S. has become the world's largest producer of oil.  We have so much natural gas, and its so stinking cheap, that our heavy manufacturers have an enormous competitive advantage over every other country in the world.  The U.S. economy - but for this miserable winter - should be exploding in production and hiring.  It will happen this Spring.

Folks, I am the guy who warned you for a decade that a deflationary depression was coming.  It came, but the Great Recession is over now.  Commercial real estate is poised, after a 45% decline during the Great Recession, to march upwards for a decade.

Commercial real estate values are going to appreciate, and lots of investors are going to want to buy some.  You won't be able to close any purchase money deals unless you find some company who can close the gap in the capital stack between 60% and 75%.  This what our new Preferred Equity program does.

Folks, our new tiny Preferred Equity Program is the most important development in real estate finance since the second mortgage.  You must - you absolutely MUST - download this free white paper and become more comfortable with Preferred Equity.  It is the only way you will close purchase money commercial investment loans for the next five years.