Commercial Loans and Fun Blog

Why the Recovery Will Take So Long

In a recent excellent blog article entitled The Death of Real Estate Investing, Susan Lassiter-Lyons pointed out that mortgage financing for investors and real estate speculators is drying up.

Investors are being forced to pay all cash to buy up foreclosures, which greatly curtails the number of investors bidding on these properties. The fewer the number of investors competing to buy these REO (Real Estate Owned; i.e., bank foreclosures), the lower the price these REO's will fetch.

I then wrote a blog article with the same title that expanded on Susan's insightful theme. A reader asks:

Where can I get a copy of your (my) book?

My blog article raised the spectre of crushing deflation and referred to my new book, The Reverse Multiplier Effect - When Crushing Deflation Destroys America. You can order a copy here.

Why will the current depression last so long?

Japan's deflationary depression has already lasted 18 years, and the Japanese people entered their depression with large amounts of savings. The magnitude of any depression is proportional to the size of the credit creation binge preceeding it. Our debt creation bubble was a whopper. It may takes decades to liquidate all of this debt.

What is the outlook for the commercial real estate finance industry?

As short as one year ago, the conduits were making more than 50% of all new commercial real estate loans. Now this industry is just a shell of its former self.

The money center banks were all involved in the securitization game, so when the secondary market for CMBS loans died overnight, they were left holding far more commercial real estate loans than they wished. For the time being, most of the big banks will be originating just a few very clean deals.

The small banks - the ones not hurt when the CMBS market dried up - are still lending. But they only have so much money.

Lehman Brothers, which has a portfolio of $200 billion of subprime commercial loans, stopped originating new deals this month. Bayview Financial, another huge institutional originator of subprime commercial loans, has cut its lending volume by at least 70%.

Subprime and even prime commercial loans are now flowing to the hard money lenders. Unfortunately many hard money commercial lenders are stuck with huge portfolios of non-performing construction and land loans.

Fortunately my own hard money shop, Blackburne & Brown, never made any construction loans, and we made very few land loans. We are still actively arranging loans.

But the bottom line is that the entire commercial real estate finance industry is severely depressed. And if commercial lenders aren't lending, this will depress the value of commercial real estate. I expanded on this in my other blog today.

The commercial loans securing most commercial mortgage-backed securities are performing quite well. The delinquency rate is less than 1.5%. Why is the CMBS market getting so badly slammed when the main problem is in the subprime residential loan sector?

The issue is one of confidence in the rating agencies. The rating agencies issued some wildly over-optimistic ratings on residential mortgage-backed securities. Investors in these residential bonds are now getting slaughtered. Commercial mortgage-backed securities are guilty by association.

But there is another issue. The collapse of residential real estate has triggered a recession that will probably lead to a deflationary depression. All real estate could get clobbered in this depression, even if commercial real estate fares far better than residential real estate.

Some final comments:

There is one asset class about which I am very bullish - farm land. But I am very bearish on all other classes of real estate.

I debated selling my little mortgage company office building here in Indiana in anticipation of the real estate bear market; but I decided that there is always a chance that the Fed could drop trillions from helicopters. My advice to you is to only buy real estate that you're going to use. As explained in my book, the deflationary forces on all real estate are far more prodigous than most investors would imagine.

Some Follow-Up Comments to a Brilliant Blog Post By Susan Lassiter-Lyons

Attention Ben Bernanke and the U.S. Treasury: In a recent blog post called The Death of Real Estate Investing, Susan Lassiter-Lyons has brought up a very important issue.

Unless the Fed and the Treasury develops some sort of financing mechanism to help investors and speculators buy real estate using high-leverage mortgage financing at favorable rates, this meltdown in real estate values is going to continue. And its not inflation that keeps Ben Bernanke up at night ... its crushing deflation.

In my recent book, The Reverse Multiplier Effect - When Crushing Deflation Destroys America, our banks get scared and stop lending. Over a trillion dollars in annual payments on existing loans kept flowing back to the banks, but the banks stopped rolling over their interest receipts into new loans.

Since the multiplier effect today is around 20, and since the multiplier effect works in reverse, the money supply of the United States started to disappear. Homes fell over 70% in value, and the banks started foreclosing on most of the homes in the United States.

Well, folks, I fear the scenario that I described in my book may be coming true. The book was written in early 2007, when gas prices were $2 per gallon. I predicted $6 gas and a complete real estate estate meltdown, even more dire than that of today, by the year 2010.

Fortunately Ben Bernanke and the Fed are very aware of the dangers of deflation. By propping up Citibank, Countrywide, Bear Stearns, and now Fannie Mae and Freddie Mac, Ben Bernanke has done a masterful job of preserving our institutions. We are probably in a great depression right now, and Americans will probably have to endure a precipitous decline in their standard of living over the next 15 years. Ben Bernanke can only do so much.

But Mr. Bernanke, if you're out there, please pay attention to Susan Lassiter-Lyons brilliant blog post.If you want to save your banks by stopping the decline in real estate values, the country will need non-owner and commercial financing. It's wealthy investors who have the incentive and the courage to buy foreclosed properties in a declining market. It is these wealthy investors who have the dough to make timely payments on these new mortgages. They just need some leverage and a reasonable interest rate.

Condo and Housing Projects Have the "Coodies"

If you're a commercial real estate loan broker, you shouldn't waste even five minutes working on a construction loan request for a residential subdivision or a residential condominium subdivision right now. These deals are almost impossible to finance in today's market. In the minds of most commercial real estate lenders, such constructions loans have the black plague or the coodies right now.

If you're a real estate developer, and you are the sponsor of a broken residential condo project or a stalled residential subdivision, you are going to need more equity. You only have a few more months before the last of your interest reserve is consumed. Don't waste time trying to find some commercial construction lender foolish enough to add another 50 homes to the current glut of unsold homes.

Instead, focus your energy on finding some wealthy private investors to help you de-leverage your land. Maybe you could cut a deal with the bank that has the existing first mortgage. "I'll reduce your loan balance, Mr. Banker, by 50% if you discount your total loan by 25%." Then you could use this discount to attract a new equity partner.

Your sales pitch to a new equity investor might be: "If you bring in $250,000 in equity, Mr. Investor, the bank will reduce it's current loan of $625,000 to just $500,000 - and we'll pay down that $500,000 to just $250,000.  Then my development company will pay you a preferred annual return of 14% in three years when the land is once again ripe for development."

So where does a developer find a private investor to help him carry a stalled residential housing project. You should try advertising on LoopNet.com.  Call their advertising department and tell them what you're looking to do.

Do you have a residential subdivision construction loan that still makes sense in today's market?  If so, you can submit it to hundreds of commercial construction lenders by using C-Loans.com. And C-Loans is free!