Commercial Loans and Fun Blog

A smart commercial lender should arguably never foreclose on a commercial property without first entering into a forbearance agreement with his borrower.  I'll explain why in a second.

I just returned from Las Vegas, where I spoke at Leonard Rosen's 26th National Hard Money Lending Conference.  Leonard always brings in top attorneys to speak on how to become a hard money lender.  Even though I have personally owned a hard money lending company, Blackburne & Sons, for more than three decades, I find that I always learn important new things at these conferences.  The wise technique that I will now describe was suggested by one of Leonard's veteran attorney-speakers.

Suppose a commercial borrower falls behind in his payments.  He has personally guaranteed the commercial real estate loan, and his wife is terrified that they may soon lose the family home.  Husband and wife are losing sleep.

The borrower contacts his commercial lender and begs for help.  The unwise lender brushes him off and files a lawsuit to foreclose.  The borrower countersues!  He claims that the bank's loan officer promised to increase the borrower's loan from $1 million to $1.2 million.  The borrower, the lawsuit claims, detrimentally relied on the loan officer's promise, and he just spent $100,000 - the last of his cash reserves - ordering new raw materials for his widget-manufacturing business.

Now the bank has a problem.  The countersuit will drag out the foreclosure for at least another 2.5 years, during which time the building is being neglected.  After all, why should a borrower keep the building in good repair when he is poised to lose it in foreclosure?  The roof starts to leak.  The mold starts to grow ...

This was a huge mistake that could easily cost the bank hundreds of thousands of dollars, assuming the building does not have to be completely demolished after the bank completes the foreclosure.

Here is what the bank should have done:  The bank should have executed a Forbearance Agreement with the borrower, offering the borrower lower payments for, say, six months, in return for ... a waiver of all prior claims against the bank!

This would almost certainly have cut off any effective countersuit by the borrower and allowed the bank to complete its foreclosure, if necessary, without opposition.  What a terrific technique!

Our hard money commercial mortgage company, Blackburne & Sons, has continuously been in the market to make new commercial mortgage loans for more than 25 straight years.  In other words, we're always in the mood to make commercial loans.  This is not just some advertising plug.  I have an important point to make in just a moment, and my point will be made in red.  It will surprise you.

In contrast to the "always ready" hard money brokers, a great many banks are constantly in and out of the commercial mortgage market every few years.  For two years a bank might be hot-to-trot to make commercial real estate loans.  Then, for the next three years, the bank might turn down all but the most perfect commercial mortgage loans (about as common as unicorns).  It's fair to say that 99% of the banks in the country today are only making commercial real estate loans to unicorns asking for perfect commercial loans.

So why are hard money brokers always in the market to make commercial real estate loans?  Hard money brokers are just market-makers.  They just have to lower the loan-to-value ratio and raise the rate until they reach a point where some private investor will invest in the loan. 

For example, let's suppose the stock market is tumbling 500 points a day.  Unemployed Americans are marching in the streets, and the demonstrations are becoming more and more violent every day.  Already dozens of cars have been burned, and the police have been forced to fire over the heads of the protestors in order to quell the violence and vandalism.  (I actually foresee this for America within two to three years.)

Now suppose a retired real estate investor owns a very nice office building in one of the more desirable areas of town.  He owns it free and clear.  Suddenly the retired investor gets nervous.  He wants to have more cash in hand, so he applies to a hard money broker for a quick commercial loan.  At the first the broker offers his private investors a loan of 70% loan-to-value at 12%.  No one invests in the mortgage loan.  The investors are too frightened to invest in a first mortgage.  The true unemployment rate is over 20%, and there is far too much violence in the streets.

Therefore, the broker might cut the loan to 60% loan-to-value and re-offer the loan at 14%.  If there are still no takers, he might eventually cut the commercial loan all of the way down to 45% LTV and offer the loan at a whopping 18% interest.  Finally, the investors will probably start buying, and the loan will finally sell out.  You could say that the loan has finally cleared the market.  The hard money broker finally found that combination of low loan-to-value ratio and high yield that would prove irresistable to wealthy mortgage investors.

Therefore, for most modern and desirable commercial properties, there is some combination of loan-to-value ratio and yield that will allow a hard money mortgage broker to arrange a commercial loan.

Ah, but here's the rub!  Here is the whole point of this article.  Sometimes, because private mortgage investors are nervous, the interest rate on a hard money commercial loan has to be so high that the borrower cannot afford the monthly payments!  And everyone loses if a hard money mortgage broker is ever forced to foreclose.

This is why Blackburne & Sons has recently developed the participation mortgage.  A participation mortgage has a very low interest rate - say, 7.9% in a market where most hard money investors are demanding a yield of at least 14%.  The missing yield is recaptured as an income kicker and and an equity kicker.  In other words, the hard money mortgage investor takes a piece of any future increases in the property's gross monthly income and in the property's fair market value.  In effect, the current owner of a commercial property gives up future income and appreciation, in return for a much lower monthly payment today.

Blackburne & Sons is rolling out a revolutionary new product for commercial loans called a participation mortgage.  Rather than make a new hard money commercial mortgage at 13.9%, we might now make the same loan at just 7.9%.  The loan, however, would have an income kicker and an equity kicker.

An income kicker is a share of any increase in the gross monthly income of the property.  For example, let’s suppose the gross scheduled income at the time the loan was originated was $10,000 per month.  If the gross monthly income goes to $16,000; then Blackburne & Sons would take a percentage of that $6,000 per month increase.  The typical income kicker would be between 15% and 50%.

An equity kicker is a share of any increase in the value of the property.  For example, let’s suppose a commercial building is worth $1 million at the time we originate a loan.  The borrower renovates the property and then leases it out.  Suddenly the property is worth $1.8 million.  Blackburne & Sons would take a certain percentage of that $800,000 increase in the value of the property, but only when the property eventually sells or our loan is either refinanced or paid off.  A typical equity kicker would be between 15% and 50%.

Why not just make the loan at 13.9% and forget all of this nonsense about income kickers and equity kickers?  The problem is that the monthly payments on a $1 million loan at 13.9% will break the financial back of many borrowers.  Hard money investors want their big yields, so it’s simply not possible to make a hard money loan at 7.9%, absent some sort of additional financial incentive, like these two kickers.

Very few commercial construction loans are being made these days.  I always figured that it was because the banks were just too darned scared to make new commercial construction loans.  After all, commercial real estate has fallen by 40%, and many commercial banks have suffered immense losses on commercial construction lending.

But not every company in America is losing money.  There are a great many companies tied to agriculture here in the Midwest that are making money hand over fist.  Why aren't they expanding their manufacturing facilities?

A developer buddy explained the problem to me.  A great many companies have enough dough to cover 20% of the construction cost of their new buildings.  Since these companies are also making money, the bank even tentatively approves their commercial construction loan - subject to the appraisal and other third party reports.

The vast majority of new commercial construction loan applications are falling out at the appraisal stage.  Many, if not most, commercial real estate appraisals are coming in at less than 75% of the actual construction cost. 

In order to be financially feasible, a new project should be worth 15% to 20% more than the cost of construction.  That difference is the developer's profit.

The Profit Ratio is the anticipated profit divided by the total cost to build the new building.  Bankers typically require this ratio to be at least 15% to 20%.  If the potential profit is too small, the developer will have little incentive to complete the project if he runs into any sort of cost overrun.  The last thing a bank needs is another half-completed project.

Modernly, not only are banks finding that the deals have no profit in them, but - even worse - the projects are worth, upon completion,  less than 75% of their construction cost.  Not surprisingly, you will see very few commercial construction loans getting funded.

There are still a few commercial banks willing to make new commercial construction loans.  You can submit your commercial loan to 750 hungry commercial lenders using C-Loans.com.

Four months ago I accepted an invitation from Leonard Rosen to be a panelist at his hard money lender seminar in Las Vegas. Folks, I was immensely impressed. Leonard Rosen is a warm, generous man; and more importantly, his Become a Hard Money Lender training course is the real deal. If you have ever dreamed of becoming a hard money lender yourself, you simply must attend.

You should come and meet me personally on July 28th at the Monte Carlo Resort and Casino at Leonard Rosen's next 8-hour seminar. At this conference, you'll learn how to become a hard money lender and earn residual income, in addition to just loan orrigination fees. You'll learn how to become the banker and to finally have control over your deals. You'll learn the hidden secrets of the hard money industry.

For more information, please click here.

A silent second mortgage is a second mortgage with no monthly payments.  The best way to understand how a silent second mortgage can be used is to see an example.

My hard money commercial mortgage company, Blackburne & Sons, was recently asked to refinance a balloon payment on a nice apartment building.  The problem was not the loan-to-value ratio.  That was fine. 

The problem was that the deal didn't cash flow.  The property was owned by a 401(k) plan, and the beneficiary of the 401(k) plan was not allowed to contribute money to the property to help cover the negative cash flow.  That would be an illegal 401(k) contribution.

We solved the problem using a silent second mortgage.  We convinced the private lender whose loan had ballooned to accept a partial payoff.  He was paid everything that he was owed, except for $75,000.

We had the original private lender then carry back his remaining $75,000 in the form of a second mortgage.  The loan carried an interest rate of ten percent, but there were no payments on this second mortgage!  The second mortgage had a term of three years, at which time the $75,000 in principal and the accrued interest would be due.

Volia!  Because our loan was $75,000 smaller, it now cash-flowed perfectly.  The private lender got most of his dough now, without the need to foreclose.  The 401(k) plan could now handle the monthly payments to Blackburne & Sons without the need of monthly, illegal contributions.  This was a nice win-win-win.

Don't Count on the Second Mortgage Holder to Bring You Current

Let's suppose you are considering a first mortgage investment of $100,000 on the purchase of a $200,000 little office building. The buyer is putting $40,000 down (20% of the purchase price), and the seller is carrying back a second mortgage of $60,000 (30% of the purchase price). A first mortgage loan of only 50% loan-to-value sounds attractive; but keep in mind that if the deal goes bad, second mortgage holders rarely bring first mortgages current, and if they do, they almost never keep up the payments for long.

You will recall that if the borrower defaults, the second mortgage holder will (almost always) be wiped out if the first mortgage goes to foreclosure. This is true even when there is a lot of equity in the property. Why? Because (almost) no one ever bids at foreclosure sales. Therefore, the only way for the second mortgage holder to protect himself is to bring the first mortgage current and to keep the first mortgage current while the second mortgage forecloses.

In real life, this almost never happens. In fact, I have owned Blackburne & Sons, a hard money lender, for over 30 years, and I can think of very few cases where a second mortgage holder actually brought our first mortgage current. More importantly, there has not been one case in over 30 years where a second mortgage holder has kept our loan current while he foreclosed himself. Not one.

The wise first mortgage investor will therefore never rely on a second mortgage holder to bring his loan current.

This is not an offer to sell first mortgage investments. An offer is made only through an Offering Circular. Investing in first trust deeds and first mortgages involves substantial risk. Please be sure to carefully review the Risk Factors section of the Offering Circular before investing. A substantial and prolonged decline in real estate value is possible.

Please click here for more information on first mortgage investments.

Keep This in Mind When You Invest in Trust Deeds

When a trustee holds a Trustee's Sale (foreclosure sale) or when a sheriff holds a Sheriff's Sale, the reality is that almost no one ever bids at these sales. Even if a lender is entering a credit bid of just $600,000 on a property clearly worth $1 million, 95% of the time no one else will bid more than $600,000. I have been the owner of Blackburne & Sons, a hard money lender, for over 30 years, and I think we have been outbid at just two foreclosure sales.

So why doesn't anyone bid at these sales? The biggest reason is that bidders have to bid all-cash. In other words, a bidder would have to bring a cashier's check to the foreclosure sale of $600,000. Who has that kind of cash?

Another reason is that the bidder takes the risk that there may be some title issues or easement issues. In a normal sale, the buyer gets title insurance to indemnify himself against these risks.

Lastly, a great many foreclosure sales get delayed at the last moment. After painstakingly investigating title and after raising a whopping $600,000 in cash (cashier's check), the bidder will frequently have to wait around for a sale that gets postponed time and time again. It's so discouraging that most potential bidders just give up.

There is an exception to this general rule. If the property being foreclosed is an inexpensive home - a deal where the bidder would only have to raise $50,000 to $100,000 in cash - it would not be surprising to see one or two bidders competing to buy the property.

This is not an offer to sell first mortgage investments. An offer is made only through an Offering Circular. Investing in first trust deeds and first mortgages involves substantial risk. Please be sure to carefully review the Risk Factors section of the Offering Circular before investing. A substantial and prolonged decline in real estate value is possible.

Please click here for more information on first trust deeds.

The Population of America is Migrating to Mega-Cities Connected By High Speed Rail

The country's most sophisticated real estate investors are all buzzing about primary markets. A primary real estate market is a major metropolitan area that is enjoying significant job growth across a diversified spectrum of industries and a material net inflow of new residents. Examples of primary markets in the United States include Washington, D.C.; New York City, Boston, Chicago, Los Angeles, and the San Francisco Bay Area. If you are going to invest in first trust deeds, you should try to invest in loans secured by real estate located in a primary market.

Why are primary markets so important? Demographers, social scientists, and futurists point out that most new job creation starts in densely populated areas, where workers from different industries meet, mingle, and share ideas. Since most of the new job creation in the United States is occurring in primary markets, the population of the country is destined to migrate there, creating even denser concentrations of people.

According to George Friedman, author of the best-selling book, The Next 100 Years: A Forecast for the 21st Century, high-speed rail will connect two nearby major cities to create mega-cities. The population will live in suburbs along the rail lines.

Bottom line: If you are going to invest in first mortgages, you should try to invest in loans secured by properties located in primary markets.

This is not an offer to sell first mortgage investments. An offer is made only through an Offering Circular. Investing in first trust deeds and first mortgages involves substantial risk. Please be sure to carefully review the Risk Factors section of the Offering Circular before investing. A substantial and prolonged decline in real estate value is possible.

Please click here for more information on first trust deed investments.

Any Refinance Has to Rely on an Appraisal

All else being equal, a good argument can be made that purchase money first trust deed investments are often less risky than refinances. A purchase money loan is one where the loan is being used to buy the property. In a purchase money deal, the value of the property is usually established in the open market, where knowledgeable buyers and sellers, neither under any undue pressure, negotiate back and forth to arrive at the agreed sales price.

In contrast, any refinance must be based on an appraisal. Unfortunately, real estate appraisers - even the honest ones - are quite often wrong. Appraisers are often wrong for a number of reasons. Sometimes they are just plain incompetent. Fortunately, the states now test and license both residential and commercial appraisers. Commercial real estate appraisers must enjoy the General Certified Appraiser designation, which indicates that they have taken formal classes in commercial real estate appraisal and have passed exhaustive tests. Therefore the competence of the appraiser today is less of an issue than in years past.

However, it has been my observation that appraisers often fall in love with the borrower. Since appraising is a subjective process, there is usually a 20% swing in the valuation that an appraiser can justify either way. The valuation of a $400,000 building might easily be justified as low as $320,000 or as high as $480,000. If the appraiser likes the borrower, he might be tempted to bring in the appraisal at $480,000.

There are other reasons why appraisers are so often wrong. Some charismatic borrowers can make persuasive boasts about the value of the property or the demand for the space. "Tenants are beating down my door to lease this space." Such charismatic borrowers can dramatically influence the opinion of a human and fallible appraiser.

Sometimes good sales and leasing data is either outdated or unavailable. The appraiser then has to take data from different locations and make some sort of subjective adjustment because the subject property is either better or worse. These adjustments are little more than guesses.

Then, of course, there is outright appraisal fraud.

Bottom line: If you are looking at two different first trust deed investments, the purchase money loan may often be the less risky investment because you do not have to reply solely on some appraisal.

This is not an offer to sell first mortgage investments. An offer is made only through an Offering Circular. Investing in first trust deeds and first mortgages involves substantial risk. Please be sure to carefully review the Risk Factors section of the Offering Circular before investing. A substantial and prolonged decline in real estate value is possible.

Please click here for more information on first trust deed investments.