Commercial Loans and Fun Blog

The concept of equity is far more complicated than you probably think; but if you want to play in the big leagues of commercial mortgage finance and structured finance, you need to be able to understand the dozen or so different meanings of the word, equity.

Let's take an easy example first - the equity in your home.   Your house is worth $400,000.  You have a $250,000 mortgage against it.  The difference between the value of your house and what you owe against it is your equity - or $150,000 in this case.

Can a business have equity?  Let's say your mortgage business is worth $2 million because you have a huge book of repeat clients.  The company owes $30,000 on a car loan, $75,000 on your furniture loan, and another $95,000 to the bank on its line of credit.   The difference between the value of company ($2 million) and the debt against the company ($200,000) is the owner's equity in the company ($1,800,000).  So you can have equity in a company, just as you can have equity in real estate.

In fact, investment bankers (think: stockbrokers) are in business of raising both debt (think: loans) and equity (think:  investments by outsiders) for corporations.  In order to raise equity dollars for a corporation, an investment banker will find buyers for the corporation's stock.  The difference between the assets of a corporation and its liabilities is called the stockholder's equity.

Now the wonderful thing about equity is that equity has no required payments.  If you borrow from the bank to grow your company, you might have to make payments of, say, $9,000 per month.  If the economy goes into a severe recession, you may not be able to make your $9,000 monthly payments.  The bank might foreclose and wipe you out.  You could lose your company.

But if you were able to raise the money to expand your business or to renovate your apartment building by selling equity, you would be far better off in a recession.  There are no required payments on equity investments.  You do not have to declare a dividend to the stockholders if the company is struggling.  The investors in common stock cannot foreclose on your company if you cannot afford to pay them a dividend.  They just have to wait until better times to get a return on their investments.

Equity investments are risky because the equity investors are the last to be paid if the company or project fails and the assets are sold off to pay the creditors.

Suppose you cannot afford to make the monthly payments on your house.  You can't even afford repairs.  The house deteriorates, so it is now only worth $360,000.  The mortgage has been unpaid for months, and with interest and penalties, the balance grows to $290,000.  The house sells at the foreclosure sale for only $300,000 because hardly anyone ever bids at foreclosure sales in real life.  Guess what?  The bank gets their entire $290,000 and the owner - the equity investor - only gets $10,000.

The equity investors are the last to be paid when a business or a piece of real estate is sold off to pay the debt.  The equity investors take the biggest risk.

Equity also is an important concept in construction financing.  Suppose a project will cost $10 million to build.  The bank will usually insist that the owner of the project (the developer) must put up 20% of the total cost of the project, or $2 million in this case.  This $2 million is the developer's equity contribution and can consist of his equity in the land, any costs he has pre-paid (architectural fees, engineering fees, etc.), and the cash he can bring to the loan closing.

What if the developer doesn't have enough equity dollars in the project?  The developer can sell part-ownership of the project to some rich doctors that he knows in order to raise more equity.

Another alternative would be to get a mezzanine loan (sort of like a second mortgage) behind the construction loan.

Finally, the developer can go to a company that specializes in raising equity dollars for real estate projects.  You can think of real estate equity investors as venture capitalists who help provide the equity required by construction lenders.  In return for their equity investments, these investors typically require a preferred return (they get paid before the developer gets paid anything), as well as a large share of the ownership of the project.

As you can see, equity means a lot of different things, depending on the context.  But the important concept to understand is that equity provides a protective buffer for the  lender, and from the lender's point of view, the more equity, the better.

It is possible to finance a commercial property in Chapter 11 bankruptcy, but only with the court's permission.

Suppose the Jones family is in the business of manufacturing widgets.  The Jones family owns the industrial building occupied by Jones Widgets, Inc.   The property is worth $1 million.

Suppose further that Hometown Bank has an existing $400,000 first mortgage on this industrial building, and the loan has matured.  The Jones family therefore has to obtain a new first mortgage to pay off the $400,000 balloon payment.

Peter Jones therefore applies to First National Bank of Hometown for a new loan to pay off the balloon. Several months go by, and the maturity date comes and goes; but Mr. Jones assures Hometown Bank that  his refinance is almost completed.

Suddenly, for no justifiable reason, First National Bank of Hometown decides not to make the loan.  Now Peter Jones is in trouble.  Hometown Bank has filed for foreclose, the foreclosure sale is in one week, and he is in danger of losing a $1 million property for a lousy $400,000 loan!

Fortunately the government has a procedure where creditors (lenders) can be held at bay while a solvent family or business rearranges its finances.  This procedure is called a Chapter 11 Reorganization Bankruptcy.  While filing bankruptcy will smear the credit and good name of the Jones family, it sure beats losing $600,000 in equity.

Now the $24,000 question.  Can the Jones family get a loan to pay off Hometown Bank while they are in a Chapter 11 Bankruptcy?  The answer is yes, as long as they get the court's permission.  Be careful here.  It is not the bankruptcy trustee's permission that you need.  It is the court's permission!  A letter from the bankruptcy trustee will NOT suffice.

While a debtor, here the Jones family, is in a Chapter 11 Bankruptcy, they are no longer the legal owners of their assets.  Those assets are owned by the bankruptcy court trustee in trust for the unpaid creditors.  Fortunately the Jones family gets to keep living in their home, driving their cars, and Jones Widgets, Inc. gets to stay in the industrial building while the Jones family is in Chapter 11 Bankruptcy.  This is because there is a presumption that the Jones family will be able to sell off some of their assets and pay all of their creditors.  Therefore they get to keep their stuff ... at least for awhile.  They are called debtors-in-possssion (of the assets).

While a hard money commercial mortgage lender (like Blackburne & Sons) would be happy to make a $400,000 loan on a $1 million building to pay off Hometown Bank, Peter Jones no longer has title to the industrial building in order to give the lender first mortgage title.

But all is not lost.  The hard money lender merely issues a commitment letter that the Jones attorney will take to the bankruptcy court.  The court will smell the deal, make sure that there is enough money to pay everyone, and then give it's legal blessing (in the form of an order).  The Jones attorney will give a copy of the order to the hard money lender and the title insurance company, and the hard money mortgage company will make the loan.

If you own a commercial property, and you are in bankruptcy, you can apply directly to Blackburne & Sons by clicking on this easy mini-app.

If you are a commercial mortgage broker or a commercial lender, you can supercharge your volume of new commercial loans by using marketing leverage.

Just imagine that you had a magic machine that multiplied every one of your marketing dollars by 400.  For example, if you had just $100 to spend on marketing for commercial loans, this magic machine would suddenly turn that $100 marketing budget into a $4,000 marketing budget.  Wouldn’t that be wonderful?

Such a magic machine actually exists.  It’s not really a machine but rather a technique to take advantage of marketing leverage.

Here is that magical technique:

Advertise to the companies that are currently advertising.

Here’s how it works.  The typical residential mortgage broker spends around $400 per month on marketing for mortgages.   If you can reach this residential mortgage broker every three weeks with a $1 mail piece, and if he refers you every commercial loan request generated by his $400 marketing budget, then you have just achieved a 400:1 marketing leverage.

You can also achieve marketing leverage by mailing to banks and other commercial lenders.  The typical commercial lender spends far more than $400 per month advertising for loans. 

In theory, you could achieve similar marketing leverage working with a commercial real estate brokerage company sending newsletters or email newsletters to commercial property owners.  If you could somehow hitch a ride in their newsletters, in return for a promise to pay them referral fees, you will have achieved substantial marketing leverage.

So look for mortgage companies and mortgage lenders that are advertising heavily for mortgage loans.  These will be the guys with the most commercial leads to refer your way.

Did you find this article interesting?  Why not make our blog, Commercial Real Estate Loan Tips, one of your home pages.  I try to add a new article every other day.

Over the past 31 years I have invested at least $250,000 in advertising directly to the public for the commercial real estate loans. I have tried postcards, newspaper display ads, classified ads, magazine ads, bulk mail, and individually word-processed letters.

Every such marketing campaign directed at the public for commercial loans was a complete and utter failure.

There are two reasons why.

1. There are home loan lenders who will refinance your home with no points and no closing costs.  In stark contrast, commercial mortgages commonly require $3,000 to $4,000 appraisals and $2,000 to $3,000 toxic reports, in addition to points, closing costs, and legal fees.  The transaction costs are therefore very high.  As a result, few commercial real estate investors refinance their properties more often than once every five to ten years.  If you try to advertise directly to the public for commercial real estate loans, the chances that your mailer or advertisement will reach a commercial property owner at the exact moment he is in the mood to borrow, in real life, is very slim. 
   
   
2. Commercial property owners almost always call their own bank first before looking elsewhere for a commercial real estate loan.  Rather than respond to your ad in some magazine or newspaper, they will call their buddy at the bank first.

It really doesn't matter why advertising directly to the public for commercial real estate loans doesn't work, as long as you don't waste your precious marketing dollars trying.  Been there.  Done that.  My T-shirt says, "Wasted a Quarter Million Dollars."

So what does work?  Order our 90-minute video training course, "How to Market for Commercial Real Estate Loans."

Did you get some value out of this blog article?  Why not make the Commercial Real Estate Loan Tips blog one of your home pages?  I try to post a new training article every other day.

Commercial real estate brokers are a great source of leads for commercial loans. They call themselves "commercial brokers", even though a particular commercial broker may only have a real estate salesman's license, as opposed to an actual broker's license.

The typical commercial broker will have a dozen or so core clients.  These are wealthy real estate investors who each might own three to six commercial properties.  Since most commercial real estate loans have a balloon payment every five to ten years, these 12 core real estate investors will have balloon payments coming due on a regular basis.

The typical commercial broker handles many duties for his core clients, often including helping them refinance their ballooning commercial loans.  Since he seldom earns a fee for helping his clients place their commercial loans, the typical commercial broker is very receptive to solicitations from commercial mortgage brokers.  He views a commercial mortgage broker as someone who is going to reduce his work load.

While many residential brokers treat mortgage brokers like dog poop, commercial brokers treat mortgage brokers like dear friends.  This courtesy extends all the way to the receptionist.  If you call the receptionist of a commercial brokerage company, she will often and cheerfully provide you with a list of all of the brokers in the office and their email addresses!

It's therefore easy to build as huge email list of commercial brokers in your city.  Simply look for realty signs on commercial buildings that read, "For Lease" or "For Sale".  Dictate the phone number of these commercial realty offices into the tape recorder application on your smart phone.  Then, when you get back to the office, simply call the receptionist and ask her to please email you a list of the brokers in the office.

If you need a commercial real estate loan, and the deal is slightly flawed, you should take it to a bank located close to the property.  Most commercial real estate lenders greatly prefer to lend close to one of their offices.

Let's suppose that the commercial property that you are trying to finance is a very successful restaurant in the very best location in town.  Now banks normally do not like to make loans on restaurants because of the high failure rate.  If a local banker, however, dines regularly at the restaurant and appreciates the fact that this particular restaurant business is thriving, there is an excellent chance that he'll still make this commercial real estate loan.

Here's another example.  Suppose your borrower has credit that is slightly dinged, and most of the big banks have already turned down his commercial real estate loan request.  This is another example of where you should take his commercial real estate loan to the small bank located just down the street.

This small, local bank will probably demand a higher interest rate than Wells Fargo Bank or PNC Bank, but their rate will, almost certainly, be a whole lot better than even the cheapest commercial hard money lender, like Blackburne & Sons.

Banks will ocassionally make a near-hard-money quality commercial real estate loan simply because the commercial property is located close to their bank, and they are very comfortable with its value.

Using maps.yahoo.com you can easily pinpoint nearby banks to any property in America.  Simply type in the address of the commercial property that you are trying to finance, and then ask the software to plot all of the nearby banks.  (Use the "Find a Business" field and type in "bank".)  Or you can simply go to C-Loans.com and choose six banks located close to the property.

This is a fascinating story of a $160,000 commercial loan fee collection case that I originally wrote about in 2009 in my old blog.  It's worth retelling.

About two years ago one of my former commercial loan brokerage students came to me and asked me to serve as an expert witness in a commercial real estate loan fee collection case.

My student had arranged for the delivery of an $8 million SBA loan commitment at a very favorable rate on a hotel near the Newark Airport.  The hotel had been shut down by the city a year earlier for regularly renting rooms by the hour (yup, you guessed it), and the prior owner had lost the property in foreclosure.  My student's client was buying the hotel from the bank.

Fortunately my student had used our commercial loan brokerage fee agreement that provided for arbitration.  He was based in Florida, the borrower lived in New York, and the property was located in New Jersey.  Per the terms of our agreement, the mortgage broker (my student) was allowed to file his Demand for Arbitration in Florida.  He did not have to travel to New York to sue this borrower.

This was a Florida action, and I am not licensed to practice law in Florida.  Therefore the mortgage broker hired local Florida counsel, who in my opinion did a terrific job.

I was called upon to testify as an expert witness on matters pertaining to the practice of commercial real estate finance.  Even though I live in Indiana, I was able to provide testimony through a deposition that was taken telephonically at the office of a court recorder in South Bend.  It was not necessary for me to testify at the actual arbitration hearing.

The borrower did not really dispute the mortgage broker on the facts.  Instead, the borrower defended on the basis that  the mortgage broker lacked a real estate broker's license in the State of New York.

Licensing for commercial real estate loan brokers in the State of New York is quite confusing.  The Department of Financial Institutions has adopted the position that out-of-state mortgage brokers do not need a New York real estate broker's license to broker fewer than five commercial loans per year in the state.  The law, however, appears to require just such a license.

The mortgage broker argued that he had never entered the State of New York, and that therefore the licensing laws of the state of Florida should apply.  Since the commercial lender was an institution and the borrower was technically a limited liability company, Florida did not require a mortgage broker's license.

The borrower's attorney argued that the contract was silent on the subject of choice of law.  Since there was an ambiguity and since the mortgage broker had prepared the contract, the ambiguity should favor the borrower.

The mortgage broker's fine attorney's argued that the borrower had already made a formal appearance in state court in Florida in connection with the case.  By doing so that they had subjected themselves to the jurisdiction of Florida laws and had therefore waived this defense.

The arbitrator agreed.  Four days ago the arbitrator granted the mortgage broker an award of $160,0000 - plus $5,000 in arbitration costs.  Hooray for the good guys!

Now the mortgage broker will need to get the award of the arbitrator confirmed by a Florida state court.  The borrower may choose to fight the licensing and choice of law issue again at this stage.  Later, the mortgage broker will need to take his Florida judgment (assuming he prevails) and get it domesticated in New York.  At this stage the borrower may choose to bring up the licensing and choice of law issues again.

Collecting unpaid loan fees can sometimes be a long battle, but with $160,000 at stake, the mortgage broker was right not to give up.  Fortunately the borrower is worth millions of dollars, so the mortgage broker should eventually collect every penny he was due.

Do you need an expert witness in the field of commercial real estate lending, commercial financing, commercial loans, or commercial mortgage loans, please click here for my expert witness qualifications and my expert witness fee schedule.

If you are a bank loan officer responsible for making commercial real estate loans, or if you are a commercial mortgage broker, it is absolutely essential that you grasp the following concept:

Commercial loan origination is a race, not a rate bidding war.

The practical effects of this are HUGE, and I'll explain them in a bit below.

I own two commercial mortgage companies - Blackburne & Sons, which is a very old hard money commercial mortgage company, and C-Loans, Inc., which is the largest of the commercial mortgage portals.

I started to notice that some of the very cheapest commercial real estate lenders on C-Loans.com were not closing many commercial mortgage loans for us.  At the same time, a handful of obscure banks, with rates 25 to 50 basis points more expensive than the cheaper lenders, were absolutely tearing up the system.  We have had several relatively unknown little commercial lenders close more than 50 commercial loans for C-Loans.

When I would ask the big banks why they weren't closing many commercial loans for us, they would often answer, "Gee, George, I call the borrowers, but they never return my phone calls."  Strange, huh?

Over time I finally recognized that once a commercial mortgage borrower reaches a commercial lender with reasonable rates - say, within 0.50% of the best market rate - he stops returning phone calls from other lenders.

There is a very important moral to this story.  If you want to succeed as a commercial mortgage loan originator, you must learn to drop everything the moment you get a commercial mortgage lead and call the borrower immediately.

For example, suppose you arrive at work wanting to call your child's teacher about his missed homework assignment.  You also find a fresh commercial mortgage lead on your desk or in your email box.  Who do you call first? 

It's all about speed, silly!  Call your commercial mortgage leads at once. Remember, once a commercial mortgage borrower reaches a commercial lender with reasonable rates, he stops returning phone call from competing lenders.  

For me, this is counter-intuitive.  You would think that a sophisticated commercial borrower would shop the market.  In reality, they simply don't. It probably has to do with the fact that their time is so very valuable, either flipping commercial buildings or manufacturing widgets.

Whatever the reason, the important point to grasp is that most commercial borrowers do surprisingly little loan shopping.  Therefore, if you are not the first commercial mortgage loan officer to reach them, you're probably already toast.

So learn your lesson.  When you get a commercial mortgage lead - BOOM - drop everything, and call that lead immediately!

I just received a call from a commercial mortgage broker.  He was obviously a rookie, and he wanted to tell me all about the $54 million loan and the $21 million loan that he was working on. I kept thinking to myself, "This guy must be smokin' crack."

C'mon, folks, the only commercial loans that are closing today are SBA loans, USDA Business and Industry Loans (B&I loans), and small (less than $3 million) commercial loans on standing commercial properties. 

Unless you have an entire pipeline full of small, bread-and-butter deals like this, you are going to starve as a commercial mortgage broker.  Remember, a reasonable closing rate on commercial loans these days is about 1/15. 

To make matters worse, you will probably have to submit the one commercial loan that eventually closes to at least 40 or more different commercial lenders.  In recent conversations with old veterans of the business, they are telling me they have had to submit their commercial loan to over 100 different commercial lenders before finding a home for the deal.  This is a tough-tough market.

Here are the kinds of deals that have a virtually zero chance of closing:

1. Construction loans (unless it's an SBA or USDA deal).
2. Land loans
3. Land development loans
4. Commercial loans larger than $3 million (unless it's an SBA or USDA loan)

C-Loans.com is the largest of the commercial mortgage portals, and it's free.  You can quickly submit your four-minute mini-app to 750 different commercial lenders.

Whenever a mortgage company boasts to you that they are a correspondent lender for so-and-so bank, alarm bells should go off in your head.  Warning, Will Robinson, Warning!  We have a probable liar here!  Ninety percent (90%) of the mortgage companies that boast that they are correspondent lenders are full of beans. 

Here's another example of a common lie in the commercial mortgage finance industry: "We are merchant bankers."  Sure you are.  Ninety-nine percent (99%) of the mortgage companies that boast that they are merchant bankers are also full of beans.  A real merchant bank is usually a subsidiary of a life insurance holding company or a bank holding company that is funneled money by the profitable holding company to make go-go investments, like mezzanine loans or equity investments.

Going back to the subject of correspondent lenders, here's what a real corespondent lender is:  A correspondent lender is the eyes and ears for a long-standing lender in a particular market; say, Boston, New York City, or the Los Angeles area.

Correspondents get paid by being awarded the loan servicing rights, typically around 12.5 basis points (1/8th of a point) per year.  Therefore, the fastest way to bust a blowhard is to ask him if his commercial mortgage company services these loans for so-and-so bank.  Almost invariably these blowhards do NOT service any loans.  They are just garden variety mortgage brokers, and dishonest ones to boot. 

A lot of life insurance companies use correspondents because it is economically infeasible for a small-to-medium-sized life insurance company to have boots on the ground in every desirable commercial lending market in the country.  I have never run across any other type of commercial mortgage lender, other than life insurance companies, that uses correspondents.