Commercial Loans and Fun Blog

This may be the most instructive training article that I have written in several years, so I strongly encourage you to study it.  (Note: This is NOT the subject vet clinic.)

Sometimes in the commercial loan business, you have to value a property based strictly on a capitalization rate ("cap rate").

Several years ago, I took on a commercial loan on an owner-occupied veterinary clinic.  The vet had gone through a divorce, and he had been forced to file for bankruptcy three years earlier.  He could therefore not qualify for a SBA loan.

The property was located in a town of over 75,000 people, so he could not qualify for a USDA business and industry loan either.  USDA B&I loans are very similar to SBA loans; but they are designed for rural areas.  Any town with a population of 50,000+ people is not considered sufficiently rural.

The loan had to go to a bank or credit union, so I was forced, absent an appraisal (always let the bank order the appraisal), to somehow create a pro forma operating statement on an owner-occupied veterinary clinic.  Hmmm.  How could I do that without having any idea of the market rent of a vet clinic?  Here is what I came up with, and I must say, it was brilliant.

I knew that the vet had bought the facility for $500,000 two years earlier.  To add in some property appreciation over the past two years, I multiplied $500,000 by 103%, which assumed a 3% annual appreciation rate.  To get the second year's value, after more appreciation, I multiplied the result by 103% again, producing a value after two years of $530,450.

Then I pulled a cap rate of 8.5% out of thin air.  Poof.  Remember, I am trying to get my client a commercial loan here, and any commercial broker (a commercial real estate salesman who specializes in selling commercial-investment real estate) will tell you that my cap rate assumption was probably about right.  I might have used 5.5% for a nice apartment building and 6.5% to 7.5% for a retail or industrial property.

You are reminded that a cap rate is just the return on his money that an investor would earn if he paid all cash for the property, assuming you built in a replacement reserve of around 3% of the Effective Gross Income.  The Effective Gross Income is the number you get after taking off 5% for vacancy and collection loss.

Now please remember where we are going.  We are trying a create a believable pro forma operating statement on an owner-occupied vet clinic, when rental comp's cannot be found.  You could look for a week and not find another vet clinic within 50 miles that was simply rented from some passive investor.  

You will recall that a pro forma operating statement is just an operating budget for the upcoming year, assuming you built in a replacement reserve to eventually replace the roof and the HVAC unit.

Quick Joke:

My wife and I had just finished a meal at one of our local restaurants when I realized I'd left my wallet at home. As the wife headed to the door to retrieve her purse from the car, she told the waitress what had happened, adding, "But don't worry, I'm leaving my husband for collateral." The waitress took one look at me and asked her, "What else you got?"

If you are not working towards building your own loan servicing
portfolio, get out of the business.  The money is in servicing.

Back to the Lesson:

Even though we have absolutely no rental rate comparable's, we can now compute the net operating income ("NOI") on the vet clinic.  We simply multiply the value of the building ($530,450) times the cap rate (8.5%) to arrive at the NOI ($45,088).

Confused?

 To value any commercial-investment
property using the income approach, we
simply divide the NOI by the cap rate.  

For example, if an apartment building had a net operating income of $300,000; and we knew that apartment buildings in the area were selling at 5.5% cap rates, we would simply divide $300,000 by 5.5% to arrive at a value of the apartment building of $5.45 million.

To value a commercial property -

Value = Net Operating Income / Cap Rate

Now let's get back to our veterinary clinic.  We are trying to build a pro forma operating statement, while hampered by the fact that we have no rental comp's.  

To get a net operating income, we simply move the formula around -

NOI = Value of the Property x Cap Rate

NOI = $530,450 x 8.5%

NOI = $45,088

We're getting there!  But your commercial lender will want to see a Gross Income, a 5% Reserve for Vacancy and Collection Loss, some expenses, including a management fee, and a 3% Reserve for Replacement.

The expenses are easy.  We just assume that the property is leased on a triple net basis ("NNN")!  The tenant (our vet) pays the taxes, the insurance, the repairs, the utilities, etc.   Poof.  Suddenly we have no expenses to worry about.  Am I good or what?  Haha!

But your commercial lender will still want to see you taking off 5% for Vacancy & Collection Loss.  He will want to see you taking off 3% for Management and another 3% for Reserves for Replacement.

We know that the NOI is just 94% of the Effective Gross Income, after taking off 3% for Management and 3% for Reserves.  Therefore to get the Effective Gross Income, we simply divide the NOI by 94%.

To get the Gross Income, we start by knowing that the Effective Gross Income is 95% of the Gross Income, because we have to take off 5% for Vacancy and Collection Loss.  Therefore we simply divide the Effective Gross Income by 95%.  Voila!  We've done it.

PRO FORMA OPERATING STATEMENT

Gross Income:                                         $50,364
Less 5% Reserve for Vacancy:                $ 2,398
Effective Gross Income:                          $47,966

Less 3% For Management:                     $ 1,439
Less 3% Replacement Reserves:           $ 1,439

Net Operating Income:                            $45,088

Take pride in your understanding of today's lesson.

Did I lose you?  Remember, I had to create a pro forma operating statement, so the lender could compute the debt service coverage ratio on your commercial loan request.  

The problem was that there were only about twenty veterinary clinics within 50 miles of the subject property, and all of them were owner-occupied.  There were no rental comparable's, so I couldn't just say, "Steve's Vet Clinic is leased for $3.00 sf, so the market rent of the the subject property must be $3.00 sf as well."

By assuming a reasonable and believable cap rate, we were able to work backwards to create a reasonable pro forma operating statement.

By the way, this commercial loan successfully (and easily) closed with a credit union, despite the recent bankruptcy.  Hoorah!

This is the perfect time to talk about the "quality" of income.  Real estate crashes seem to strike about every ten to fourteen years, and it has been thirteen years since the Great Recession.  If we were to have another commercial real estate crash, would you rather own a building leased to Betty's Gift Shop or one leased to Amazon.com?

The quality of income refers to the likelihood that you are going to receive it.  All money is green, whether it comes from the headquarters of the Catholic Church in America or from Boom-Boom's Place, LLC, a chain of gentlemen's clubs in southern Louisiana.

But is it likely that Boom-Boom's Place may have a little trouble making its rent payments or its mortgage loan payments if the economy completely tanks?  Guys are less likely to be drinking five beers a night and spending $30 on tips to the dancers if they are out of work.

Okay, obviously, we would rather be on the receiving end of $7,000 per month from Amazon.com than from Betty's Gift Shop; but in order to win that deal, we have to make some sacrifices.

Amazon.com, Inc. signs a lease for a small industrial building, perhaps used to repair its delivery trucks.  Upon the execution (signing) of the lease, the owners of the little industrial building offers the property for sale.

Now normal industrial buildings in Portland are selling at, say, 6.5% cap rates.  In other words, if an investor paid all cash for a garden-vareity industrial building in Portland, he could expect to earn, after paying all expenses and setting aside a little money every year to eventually replace the roof and the HVAC system in 12 years, a return on his money of around 6.5%.

A cap rate is just the return on your money if you paid all cash for a commercial building.

Wake up, folks!  The money
in this industry is in loan servicing fees!

Before computing that return on your money, always remember that you need to set aside a little money every year to replace the roof and the HVAC system.  This is called the replacement reserve.

Okay, so the seller has a building leased to Amazon.com for $7,000 per month.  Your accountant tells you that you need to set aside $850 per month to eventually replace the roof, repave the parking lot, and replace the HVAC system.  So the investment is scheduled to yield $6,150 per month.

Since industrial buildings in Portland typically sell at a 6.5% cap rate, you compute the value as follows:  Six-thousand-one-hundred-fifty dollars per month times twelve months suggests an annual net operating income ("NOI") of $73,800.

If you divide the annual net operating income (NOI) by the proper cap rate (expressed as a decimal), you get its value.

Okay, so $73,800 divided by .065 (6.5% expressed as decimal) equals a value $1.14 million.  Therefore you submit your offer of $1.14 million.  The selling broker falls out of his chair laughing.  What the heck?

"George," he says, "Betty's Gift Shop might sell for $1.14 million (a 6.5% cap rate), but this is Amazon.com!  The world could be in complete chaos, yet a buyer could absolutely depend on Amazon making its rent payments.  There are investors out there who need the security of predictable payments, and they will pay far extra to buy that stream of predictable payments."

"George, I have offers on this building of $1.5 million, $1.72 million, and finally $1.85 million.  That works out to a 4% cap rate."

When a real estate and stock market crash is coming, it's all about the quality of the income.

The date was around 50 years before the birth of Christ.  The Roman Republic had wonderfully prospered under a truly republican form of government for almost 400 years.  At the time, there were no kings, no emperors, no dictators, or no Caesars in Rome.  The Senate alone ruled the city-state.

In 49 B.C., Julius Caesar was then the governor of Gaul.  Gaul consisted about a dozen smaller kingdoms, which combined would eventually become France.  Caesar had conquered each kingdom and province in turn.  As he moved from province to province, he sold the captured people of Gaul into slavery.  Caesar made an immense amount of money in the process.

In terms of relative wealth, Caesar was the Bill Gates of his era.  He was not the single richest man in Rome, but he was definitely one of the top three or four.  

Caesar had also raised and paid for EIGHT of his own legions, and he did so without the Senate's permission.  "Aye, there's the rub."  (Hamlet, Act 3, Scene 1.)  Eight legions were a lot in those days.  The Senate had only given its quasi-permission to raise one legion.  The Senate controlled only 12 or 13 legions, and they were scattered all over the Roman Empire.  The Senators of Rome were genuinely scared.

Two more bits of background before Caesar crosses the Rubicon.  First of all, the Roman judicial system was totally and completely corrupt.  The judges all took bribes, and sometimes they even had the parties bid against each to see who would pay the largest bribe.  Justice in Rome could not be found in the courts.  The ruling of the Judge was already decided before most trials even started.

Now the last bit of background.  Rome had already suffered several bloody civil wars, so the Senate had passed an inviolate law.  Any Roman general who brought a legion across the Rubicon River in northeastern Italy was immediately declared an outlaw and an enemy of the state.  It became the duty of every Roman citizen to kill him.

Okay, so Caesar is in Gaul, putting down the occasional uprising, collecting even more slaves, and getting even richer in the process.  But Caesar had enemies in Rome.  Many rich and powerful political families had their own gang of thugs, including Caesar.  These gangs would all use clubs to crush the skulls of any political enemies caught walking the streets of Rome.  Swords were strictly forbidden.  To carry a sword in the city limits was an automatic death sentence.

As the body count grew, lawsuits were filed against Caesar.  The suits weren't just about money.  Many of these lawsuits were quasi-criminal in nature, and if Caesar was ever brought to trial, he could expect to be murdered in jail on his very first night.

The good news was that Caesar was immune from civil litigation as long as he was the Governor of Gaul.  The bad news was that Caesar's (five year?) term as Governor was about to expire.  The Roman Senate ordered him back to Rome to stand trial. Remember, the trials were all fixed, and the order from the Senate was effectively a death sentence.

So what does a general with EIGHT legions do?  Caesar marched his most loyal legion across the Rubicon (really just a large stream) and headed for Rome.  Oops.  The Senate looked around and realized that the forces they had to face the most brilliant general since Alexander the Great were pathetic.

The Senate and the Roman Army therefore fled Rome to Greece, and the Roman Civil War ensued.  The Senate eventually raised seven legions in Greece to Caesar's four, but in the big showdown - a fierce battle in Greece that pitted Roman versus Roman - Caesar pulled off a brilliant battlefield move.  Together with the fact that his troops absolutely adored him and the fact that his troops were all seasoned veterans, Caesar's forces routed the young, inexperienced troops of the Senate.

The Roman Republic was dead.  Never again in history was the Roman Senate anything more than just a figurehead.  The real power always rested thereafter in whoever was Caesar.

Let me put this differently.  The Roman Senate brought a bull-pucky legal suit against Caesar, and they lost the Republic.

Have you figured out yet why I am writing about Caesar and the Rubicon today?  The undeniably blue State of New York brought criminal charges this week against the Trump Organization, citing a scheme to defraud, conspiracy, grand larceny and falsifying business records. 

Now folks, I am not saying that an army of Trump supporters is going to descend from the hills and overthrow the American Republic.  C'mon, guys, get real.  

But I do believe it is historically ignorant for the State of New York to set the insanely dangerous precedent that any American president who loses power will be instantly exposed to, and assailed with, charges from the states controlled by the opposite party.  Think about President Duarte in the Philippines, who instructed his army, the police, and his own hit squads to instantly shoot 6,000 (20,000?) drug dealers.  Why would I bet that Duarte will declare marshal law and extend his own term?

Let me be clear and not beat around the bush.  Those New York State prosecutors are so historically ignorant that they should not be allowed to have children.  (Don't hold back, George, tell us what you really think.  Hahahaha!)  C'mon, you New York prosecutors.  You are attorneys.  You all studied history.  You should know better than to set such a dangerous precedent.

For God's sake, the single most important thing about America is that political leaders and parties can change power in America peacefully.  If you make an outgoing President or a political party fear for their freedom or their own physical safety when they step down from power, how long will it be before America is no longer a republic?

Imagine the following scenario:  Admiral Smith anticipates a Chinese invasion of Taiwan, and through the use of a distributed defense, where missile launchers are spread out over 50 different islands, ships scattered in the South China Sea, and 60 rusting old trawlers pressed into service as missile ships, we sink the entire invading Chinese fleet.

Admiral Smith retires from the Navy, greatly adored by servicemen from all five  branches of the service.  Don't forget that we now have the Space Force, who surely played a huge role in the First Chinese War.

Admiral Smith runs for President, and he wins in a landslide.  But a great many Americans grow to hate him.  He has raised taxes, and he used the additional income to build more underground missile plants and to build new American shipyards in Mexico and Canada.

The American economy has been on a war footing for too long, and it has suffered.  Inflation stands at 12% annually, and good-paying, non-military jobs are scare.  Millions of Americans come to hate Admiral Smith, even though he keeps warning them that China will soon attack again.

The State of Utah then files criminal charges against Admiral Smith for having only two wives.  C'mon, guys, I am just having some fun here; but my point is that the State of Utah files some bull-pucky charges that carry a life sentence.  Yikes.

So Admiral Smith appeals to the military, who absolutely love him and agrees with all of his warnings and preparations for the next Chinese war.  Congress is "temporarily" closed, as Admiral Smith declares marshal law and extends his own term.  "I have no choice but to protect America from China."

So to the prosecutors in New York, I call you historically ignorant.  You have set an insanely dangerous precedent, and you may have just cost us the American Republic.

"Those who cannot remember the past are condemned to repeat it." -- George Santayana

The Big Boys, the ladies and men who make and arrange the really huge commercial real estate loans, have their own specialized language.  You can think of it as advanced commercial mortgage-ese.  Today we'll discuss one of their underwriting terms, mark-to-market (MTM) accounting in real estate.

Mark-to-market accounting assigns a value to real estate assets based on what the property could command on the market if it were sold today.  This often means assigning a value based on the current market rents for the building, as opposed to the actual rent being generated from existing tenants.

Now let's use mark-to-market accounting is some real life deals: 

When Boston Properties acquired the General Motors building for a record $2.8 billion in June of 2008, it internally assigned a value based on the current market rents for the building, as opposed to the actual rent being generated from existing tenants.  The company noted that the average rent being paid at the GM building was $90 a square foot, which it said was half the current market rent of $180 per square foot.  This MTM analysis played a significant part on its decision to buy the property.

Here is another one, which I pulled from a closing tombstone in FinFacts, the bi-monthly newsletter of George Smith Partners, one of the largest commercial mortgage banking firms in the country.

Pop Quiz:

What's the difference the a commercial mortgage banker and a commercial mortgage broker?  Commercial mortgage bankers retain the servicing on the commercial real estate loans that they originate for life companies and the Agencies.  The Agencies include Fannie Mae, Freddie Mac, HUD, and Ginnie Mae.

And what have I been preaching to you for decades?  The real money in commercial real estate finance is in loan servicing fees.  A commercial mortgage broker is often a poor person.  A commercial mortgage banker is usually a rich person.

Okay, so here is the MTM language from FinFacts:

"George Smith Partners secured a $4,500,000 refinance for a 13,051 SF mixed-use property in West Hollywood. The loan is fixed at a rate of 3.92% for a 5-year term.  At close, the Property had four month-to-month leases in place, plus two cell tower leases.  This was problematic since some lenders would not include MTM income or cell tower income in their underwritten cash flow.  Although several lenders offered a competitive interest rate, they used a high stress rate when applying their debt coverage ratio constraint.  As a result, most lenders quoted proceeds of less than 45% LTV."

"The selected lender was able to mitigate the impact of these challenges by using a lower stress rate, giving full credit for MTM leases and including the cell tower income. As a result, they were able to provide proceeds of 50% LTV at a fixed rate under 4%."

Sadly My Predictions of Stock Market Doom Were Accurate:

On Sunday I wrote:

"Even if COVID-19 never gets out of control in the U.S., hundreds of thousands of small businesses in China are in serious trouble, especially with tens of millions of their workers confined to their homes. The owners of most small businesses in China have no more than four months worth of operating expenses in savings, and small businesses employ 60% of China's workers."

"And the thing is, many of these small Chinese companies manufacture parts for American companies. As a result, the worldwide supply chain has been shaken. We can't manufacture our own high-value goods without many essential parts coming from China. Container ships coming in from China are coming back only 25% full."

"...A worldwide pandemic is a virtual certainty.  I am writing this article on Sunday afternoon. It will be interesting to see if the U.S. stock market gets hammered on Monday."

Unfortunately, the stock market lost more than 1,000 points on Monday, and it has been getting hammered ever since.  

You guys are my buddies, and I am trying to warn you.  The consequences of this virus are far, far greater than the precious lives that the world will lose.  Small business owners in China have been traumatized.  They are NOT going to be borrowing more money from their banks.

Grasp the concept that the multiplier effect, in a world of fractional banking, can work in reverse at the rate of 20:1.  If a Chinese bank takes in a $1,000 monthly loan payment, and it does not immediately recycle that payment into a new loan, a whopping $20,000 gets sucked out of the Chinese money supply.

Now get your mind around the shocking reality that Chinese banks rake in on the order of US$4 billion per month in loan payments.  If these banks have no willing borrowers to whom to lend, the unfathomable sum of US$1 trillion will disappear every year from the Chinese money supply.  

Money is going to be destroyed in China like it is being sucked into a black hole.  A tidal wave of deflation is likely to sweep over the world.  Your $1 million home might be worth just $550,000 in 20 months, even if the authorities can mass-produce a vaccine before the end of the year.  

Borrowers have been traumatized, and traumatized borrowers seldom borrow.  The government cannot force companies and people to borrow, so the world's money supply is headed down a giant drain.  You will see deflation everywhere because no one will have any money.

Think 'ole George is crazy?  Think back to the depths of the Great Recession, when Fed Chairman Ben Bernanke injected a whopping $4 trillion into the U.S. money supply.  (Remember all of that talk about the Fed's big balance sheet?) Why didn't we have runaway hyperinflation?  Because the Fed was merely replacing the $4 trillion worth of money that was destroyed when banks stopped lending and borrowers stopped borrowing during the Great Recession.

I sold all of my stocks and invested in a short fund eight days ago.  As my golf buddies would say, when I occasionally sink a long putt, "Even a blind squirrel finds a nut on occasion."  Haha!  

Or maybe I am one of a small handful of folks who understand that the multiplier effect can work in reverse.  I remember reading a wonderful economics book, by James Dale Davidson, entitled The Great Reckoning, in the mid-1990's.  In about the middle of the book, in the middle of some chapter, he briefly mentioned, "that under some circumstances, the multiplier effect can actually work in reverse."  I remember the blood suddenly rushing to my head, and tiny pins and needles suddenly sweeping all over my body.  "Oh, my God!"

So in 2007, a year before the Great Recession, I wrote the financial novel, The Reverse Multiplier Effect, When Crushing Deflation Destroys America.  At the time, the concept of deflation was unfathomable, even to most investment advisors.  My book prescient.  During the Great Recession, trillions of dollars were destroyed, as banks took in loan payments and did not recycle them.  Only the heroism and determination of Helicopter Ben Bernanke and his injection of $4 trillion saved this country.  

Deflation is coming.

I have not included many funny memes today.  Instead, I need for you to appreciate just how deserted are the streets of Shanghai, a city of 24 million.  Guys, these pictures are NOT of Wuhan.  They're pictures of Shanghai, the biggest city in China!

Obviously, if the coronavirus gets loose in the United States like its already loose in China, the U.S. economy is going to crumble.  A lot of people - especially old 'gomers like me with a bad heart or with bad lungs - will be too afraid to go outside.

Please pay attention!  

If your father and mother are over the age of 55, and they have a fairly serious pre-existing health condition, you may have to ground them for three or four months.  "Go to your room!"  This disease is killing well over 35% (50%?) of these older folks with pre-existing health problems.

This disease starts in the lungs, where it starts killing the cilia - the active little hairs in your lungs that work like oars to stir and to clean out the good mucous that protects your lungs.

In response, the immune system over-reacts (called an Immune System Storm) and floods the lungs with white blood cells.  The patient starts to drown from his own immune system response, and breathing becoming increasingly difficult.

In many cases, the coronavirus also attacks the walls of the blood vessels in the lungs, and blood starts to seep out from the arteries and veins into the lungs, further drowning the patient.

In about twenty percent of cases, this evil virus moves on to attack the liver, and it interrupts the blood cleansing process.  Not good.  Seriously not good.  And if the disease moves on to your father's or mother's kidneys, the fatality rate is over 91%.

The good news is that younger adults seem to survive the infection.  I read today that in China, doctors are collecting plasma from young adult survivors and giving it to the very sick.  It seems to help.  Your own children?  Don't be reckless, but very few young kids are getting the serious version of this disease.  Thank God for that.  Thank you, sir.  Source for all this medical stuff:  Article in the National Geographic.

So, of course, if the coronavirus runs rampant through the United States, the economy is toast; but today I am going to make the argument that even if the coronavirus stays predominantly in China, the U.S. may still suffer another Great Recession.

Pop Quiz:  

Q:  What's the difference between a Great Recession and an outright economic depression?

A:  In a Great Recession, the Fed intervenes and keeps the banks from failing.  That was the huge mistake that bank regulators made in the 1930's.  We let 9,000 banks fail during the Great Depression - 4,000 in just 1933 alone.

Okay, so why would an economic slowdown in China crush the United States?  Once again, it involves the multiplier effect kicking into reverse.  You will recall from earlier articles that the multiplier effect is that virtuous cycle whereby a $100 deposit into a bank increases the country's money supply by a whopping $2,000.

In a world of fractional banking, a bank only has to keep a fraction of its deposits on hand in the form of cash, and it is allowed to lend out the rest.  Therefore, if Bank A takes in a $100 deposit, it only has to keep $5 in reserve.  It can lend out the remaining $95 at a profitable interest rate.

The proceeds of this $95 loan end up eventually as a deposit in Bank B.  Bank B keeps $4.75 in reserve (5%), and lends out $90.25.  This money eventually ends up in Bank C, which keeps 5% in reserve and lends out the rest.  And so on.

The end result is that a whopping $2,000 in new money is created from that single deposit of $100.  Twenty-to-one.  One divided by the Reserve Ratio demanded by the regulators.  1 / .05 = 20.  

Wow.  Pretty cool, huh.  But here's the problem.  The multiplier effect can sometimes work in reverse, thereby destroying vast amounts of a nation's money supply.  

Money then becomes tight, businesses fail, workers are laid off, resulting in fewer consumers, reducing demand, lowering prices as companies desperately try to sell their products at some price.  Lower prices means lower profits, squeezing the budgets of the surviving companies, resulting in more company failures, more layoff's, and a general circling down the economic drain.

Now let's jump to China.  Wong Chiang builds and sells parts for electric scooters.  Fearing an economic slowdown due to the coronavirus, Mr. Wong decides not to replace much of his inventory of scooter parts (they might just collect dust on the shelf), so as existing scooter parts sell out, Mr. Wong stops borrowing more money on his inventory line of credit from the bank.  In fact, he starts to substantially pay down his line of credit.

Shanghai Bank, his bank, receives  a series of loan pay-downs from Mr. Wong totaling $100,000.  Since Mr. Wong refuses to borrow more money, Shanghai Bank looks around for some other borrowers to whom it might lend; but it has no takers.  Every other business owner in the Shanghai area is equally freaked out about taking on new debt.

Guess what happens?  Since the reverse multiplier effect also works at 20:1, Mr. Wong's $100,000 loan pay-down results in the Chinese money supply shrinking by a whopping $2,000,000!

And other Chinese businessmen are also probably paying down their debt right now in anticipation of a recession.  The Chinese money supply has to be contracting right now like the tailpipe of a man about to get a prostate exam.  Hahahaha!  In order to convince older men to get prostate cancer exams, there was once a terrific commercial showing a doctor wearing one rubber glove.  "I have performed 2,332 and a half prostate exams."  Some poor guy apparently ran out screaming from the exam room.  [Oh, my goodness, laughing my tush off.]  

With billions of yuan also flowing back to Chinese banks in the form of normal monthly loan payments, the Chinese money supply must be contracting severely right now (20:1).  This is extremely deflationary.  

Could we see U.S. commercial real estate fall by 45% again?  If this epidemic drags on more than a few more months, then the answer is yes.  

But wait, why does a contracting Chinese economy mean that the U.S. will soon go into a deflationary recession as well?  Think about all of the products that we sell to China.  Our exports to China will definitely be declining. 

And let's talk about U.S. manufacturing.  Parts.  Our factories will not be able to get all of the Chinese parts they need to manufacture their own products.

Millions of Chinese are still not back to work after their Chinese New Year vacation.  The Chinese Communist Party has closed thousands of factories in order to slow the spread of the virus.  Over 50 million Chinese are effectively in quarantine in their own homes.  Travel by private car in Wuhan was just banned today.

Is there any hope?  The coronavirus does not like heat, humidity, or sunlight.  There is some hope that the disease may burn itself out in the Spring; but there is no guarantee.

What can you do?  Avoid taking on new debt.  Stay liquid, including keeping some extra cash at home.  Build up a supply of food.  People are starting to go hungry in Wuhan.  There were food riots at the supermarkets in Shanghai this week, hundreds and hundreds of miles away from Wuhan.  Got a gun?  Should you buy another one for your wife, each of your older kids, and your dog?  I think so.  

Dog and cat food.  Some desperate Chinese people have been forced to hurl their sweet dogs and cats from twenty-story buildings because they were competing for the family's dwindling supply of food (and there was unfortunately an erroneous rumor that dogs and cats were acting as a reservoir of the virus).

Toilet paper.  I kid you not; there was an armed robbery in China yesterday where the perpetrators stole a huge shipment of toilet paper.  "Hey, man, did you get the goods?  Yes, we got ten pallets of toilet paper."

But here is some good news.  I no longer think the Chinese will be starting a war against us in less than four years.  This epidemic must be traumatizing the Chinese people.

The year was 541 A.D.  The Western Roman Empire had already fallen to the Visigoths; but the Eastern Roman Empire, headquartered in Constantinople (modern day Turkey), would survive for another 850 years.  The Bubonic Plague, carried by fleas, was a pandemic that wiped out much of the population of the Byzantine (Eastern Roman) Empire, as well as that of the Persian Empire.

What I never knew until yesterday was that a horrible economic depression followed the Plague of Justinian (the Roman Emperor in 541).  Just sayin'.

We may soon be going through an economic poop storm, and if we do, the banks will quickly exit the market.  Please remember that Blackburne & Sons is NOT a mortgage fund.  If you are invested in a hard money mortgage fund right now, get the heck out immediately.  There is nothing worse than being invested in a hard money fund when the sponsor fails.  You'll be lucky to recover 25 cents on the dollar.  

Instead, Blackburne & Sons quickly assembles a new and different syndicate to fund every deal.  There are always private investors willing to fund a good loan, even when blood is running in the streets.  It's simply a matter of interest rate.

Blackburne & Sons was in the market, making commercial loans, every single day of the S&L Crisis, the Dot-Com Meltdown, and the Great Recession.  

Commercial lending is all about relationships.  Were you smart?  When the everything was peachy keen, did you bring your good hard money deals to Blackburne & Sons, or did you foolishly try to establish a relationship with some hard money mortgage fund that will be out of business in the next nine months?  

Most hard money mortgage funds are Ponzi Schemes.  When new deposits stop flowing into the fund, and the sponsors lack the dough to make new loans and earn new loan fees, hard money mortgage funds fold like a cheap suit.  But Blackburne & Sons will still make you a commercial real estate loan - every single day of the Coronavirus Crisis.  We are always in the market.

Why do almost all gas stations now have convenience stores?  Answer:  A convenience store is an extra profit center.  The gas pumps pull in the customers, and while they are waiting for their tanks to fill, the convenience store sell them sodas, snacks, lotto tickets, and hot dogs.

Right now your real estate web site is like a gas station without a convenience store.  You are leaving all kinds of dough on the table.  Over the next five to six years, C-Loans.com could pay you enough dough to pay for a year of college for one of your kids.

But what I am asking you to do is a lot of hard work.  You might have to spend up to... gasp... two whole minutes on this project.  It's exhausting work earning that kind of money.  Phew.

Just send an email to your web site guru.  "Hey [Steve], please create three new hyperlinks on my home page.  Please find a place to put one at the top, one in the middle, and one at the bottom.  The top link should say, 'Commercial Loans'.  The middle link should say, 'Commercial Real Estate Loans'.  The bottom link should say, 'Commercial Financing'.  Please point all three links to https://www.c-loans.com."

Just cut and paste the above paragraph and send it to your webmaster.  Voila.  You're done.  You've just added a convenience store to your gas station - a new profit center.

Now here is what happens:  C-Loans is programmed to automatically capture the URL of the referring site and print it at the bottom of our loan application.  It's automatic.  We don't have to think.  Bam!  Right there at the bottom of our loan application are the words, "This loan was referred by billsmithrealty.com."

When the deal closes, we look up the owner of Bill Smith Realty and send him a check for 12.5 basis points.  That's what happened a few years ago with Alan Dunn, the owner of a site named SpyderCube.  We ended up closing a $17 million commercial loan for Alan's customer, so we sent Alan a check for a whopping $21,250.

Alan was even asleep when he made that $21,250.  The deal came in late at night.  Can you imagine the thrill of getting a call, "Hey, Alan, I have some good news for you."  Hot snot, I'll bet that we made his whole day.

And here's the thing.  That potential borrower is your referral forever.  Maybe the first deal falls out, but the borrower comes back and applies for a different loan two years later.  You still get paid.  He's your guy.

Here is another wonderful thing.  C-Loans is not a commercial real estate lender, limited to its own lending programs.  C-Loans does not make loans.  C-Loans.com is merely a  commercial mortgage portal where borrowers can submit their deals to 750 different lenders.  We have life companies, conduits, banks, credit unions, savings banks (S&L's), REIT's, hard money lenders, SBA lenders and USDA business and industry specialty lenders.

C-Loans lenders will make permanent loans, construction loans, bridge loans, SBA loans, USDA B&I loans, mezzanine loans, preferred equity investments, SBA construction loans, and USDA construction loans.  A link to C-Loans gives you a chance to earn a big referral fee on ANY kind and size of commercial real estate loan, from $100,000 to $500 million.  Yes, our conduit lenders have made loans of this size on chains of major hotel franchises or portfolios of office buildings.

Important note:  C-Loans usually earns at least 37.5 bps. per closing, so we can afford to pay you 12.5 bps.  On deals of greater than $5 million, our best-rate lenders only pay us 25 bps., so your referral fee would be 8.33 bps.

"Gee, George, this all sounds great and everything, but how do I know that you won't cheat me?"  For one thing, we didn't cheat Alan Dunn, and there was no way he would have known that we had closed that big deal.  I am also an attorney, licensed in both California and Indiana.

Lastly, my hard money commercial lending shop, Blackburne & Sons, has been in business for 40 years now.  The average daily balance in our trust accounts is $400,000; and after a loan payoff, there could be several million dollars in that account.  If I ever decide to go bad, I am gonna steal the millions in that trust account, not your stinky 'ole referral fee.  :-)  Fortunately, I have managed to resist the temptation for 40 years.  I am proud to say that both of my sons and I are Eagle Scouts.  There was a time when that mattered.

But hey, while 100,000 people in this industry may know me, I might be a complete stranger to you.  Trust but verify, some would say.  So here is my proposition:  If you create five or more commercial financing links across your real estate web site, we will create for you a special partner link.  With a special partner link, you will get a copy of every deal that comes from your site.  Just create the five (or fifteen) commercial loans links on your real estate website, and we will create this special partner link for you.  It takes us about 30 minutes to create such as a partner link, so we obviously don't want to have to create the link unless we are getting some really good visibility.

Now back to the good stuff.  After awhile, you are going to have several hundred of your loan clients registered on C-Loans as your guys, and you are likely to close two or three deals every year going forward.  Every year going forward - think about that.  You will have your old referrals and then you will add to that base of potential referral fees even more clients every year.

And if you create at least five links on your website to C-Loans, you can also use your partner link to imbed commercial real estate loan links in your regular newsletters to your clients.  Remember, with a partner link, you get a copy of every commercial loan application generated by your site or one of your newsletters.  

I could see a time when one of your clients applies for a purchase money loan using C-Loans, and you suddenly realize that he is looking to buy another apartment building.  (Please read that last sentence again.)

Important note:  We cannot track links inside of newsletters because there is no referring URL.  To imbed commercial financing links in your newsletters, you will need for us to prepare a partner link for you.  Therefore, please create your five referral links to C-Loans.com right away and then contact Tom Blackburne at 574-210-6686.

Now some real estate brokers only like a little bit of referral income, so they only create one Commercial Loans link to C-Loans.com on their home page.  Smarter real estate brokers like to make a TON of referral fee income, so they put three links to C-Loans on every one of their interior web pages.  

The way you can easily do this is to have your website guru edit the template of your pages to add these three links.  Then, whenever your webmaster creates a new web page for you, the links automatically appear on the new page, without anyone having to think about adding them.  The more links to C-Loans, the more chances you have have of earning a $21,250 referral fee.

In conclusion, I urge you to add a convenience store to your gas station.  Just cut and paste the following message into an email to your webmaster:

"Hey, [Steve], please create three new hyperlinks on my home page. Please find a place to put a link at the top, one in the middle, and one at the bottom. The top link should say, 'Commercial Loans'.  The middle link should say, 'Commercial Real Estate Loans'.  The bottom link should say, 'Commercial Financing'.  Please point all three links to C-Loans.com."

Now, the really, really smart guys will add the following:

"In addition, [Steve], would you please edit the template you use to create new web pages for our site to add these three links (top, middle, bottom)?  This way, the next time you create a new web page for us, the new page will automatically contain these three links."

Voila!  You have now added a convenience store to your gas station.  I said it would take a whopping two minutes, and you did it in just 97 seconds.  :-)

Questions:  Call Tom Blackburne at 574-210-6686.

Now that I have mentioned it, you will start to hear the term, Modern Monetary Theory, all of time.  The commentators use it a lot on Bloomberg, CNBC, and Fox Business.  The financial commentators will often just use the acronym, "MMT".  

According to Wikipedia, Modern Monetary Theory (MMT) is a macroeconomic framework that says monetarily sovereign governments should sustain higher deficits and print as much money as needed because they do not need to worry about insolvency, and inflation is a distant possibility.

The key to MMT is that the sovereign government borrows in its own currency, pays it back in its own currency, and controls the printing press to print more of its own currency.  Countries in the European Union - France, Spain, Italy, and Greece - are examples of sovereign governments that do NOT have this option.  They use the Euro, which is a currency that they don't control.

Interesting note:

Since I started this article, Boris Johnson and his conservatives won a landslide victory in the United Kingdom.  The U.K. will be leaving the European Union (Brexit) on January 15th.  The pound has soared!  Apparently investors think that the Brits are going to do better financially without Europe.

The Japanese, in contrast to EU members, can borrow in yen and repay their debt in yen.  If the debt service on Japan's debt, denominated in yen, becomes unbearable, Japan can simply print hundreds of trillions of yen, buy back their own debt, and retire it permanently.

In other words, as long as inflation remains tame, the U.S. should go ahead and pass a $1.5 trillion infrastructure spending plan, even if the deficit soars to $2.5 trillion annually.  We spend the money to repair our bridges and upgrade our airports.  Then we take another look at inflation.  

If inflation is still tame, we could increase military spending by another $1 trillion and bolster our missile forces, bolster our missile defense forces, and greatly expand our Space Force.

I read a military journal article this morning where one of our leading air force generals (just forced into retirement) begged the country to prepare for war in space.  China is already working on a space mothership (think of it as an aircraft carrier in space - see the picture above) from which attack space ships will fly out to destroy our constellation of satellites.  "... and you don't believe we're on the Eve of Destruction?"  (Famous hippie song from the 1960's.)

So go ahead and spend that $1 trillion on defense and then take another look at the inflation rate.  Has inflation increased from 1.75% to 4.5%?   In that case, maybe the country dials back on any extra MMT spending.

Is it a good idea?  I am convinced that a world war is coming, so I am all for it.  If we can spend enough in space and on missiles, maybe China won't attack us.  I'll gladly live with some inflation, if that means that my precious kids (and now grandkids) get to live.

But absent a war, is it a good idea?  If Trump died and made me king, I would use the power of the printing press to buy up many of the nicest apartment buildings, office buildings, and shopping centers in Rio de Janeiro, Jakarta, Seoul, Ho Chi Min City, Bangkok, and Manilla.  I would intentionally devalue the dollar to make our manufacturing companies more competitive.  In the process, the rents from those trophy properties would be sweet.

But you know that's not what is going to happen.  Opportunists like Andrew Yang are going to promise to give away $1,000 per month to every American voter, in order to rise to power.  We are going to teach our people - instead of working hard to advance themselves - to stay home all day, take drugs, and play video games.

In the words of Alexander Fraser Tytler, the famous Scottish historian, in 1807:  

“A democracy cannot exist as a permanent form of government.  It can only exist until the voters discover that they can vote themselves largesse from the public treasury. From that moment on, the majority always votes for the candidates promising the most benefits from the public treasury with the result that a democracy always collapses over loose fiscal policy, always followed by a dictatorship.  The average age of the world's greatest civilizations has been 200 years.  These nations have progressed through this sequence:  From bondage to spiritual faith; From spiritual faith to great courage; From courage to liberty; From liberty to abundance; From abundance to selfishness; From selfishness to apathy; From apathy to dependence; From dependence back into bondage.”

He made this famous observation way back in 1807.  Our 200 years of power are long past.  Hail Chairman For Life, Xi Jinping!  It's important to get in good graces with our future rulers early.  Haha!

In my earlier posts about the Winds of War, I made the point that no country will ever use nukes again.  The resulting nuclear winter would end most life on earth.Need an example of a doomsday weapon not being used?  When the Russians rolled through East Prussia in their unstoppable march on Berlin, they were committing unspeakable atrocities against the East Prussian women.  (In defense of the Russians, they were merely giving the Germans a taste of their own medicine.)  The Germans had the option of using poison gas.  They didn't.  Nuclear weapons are no longer a deterrent.

This means there could now be a single, big winner of World War III.  The coming world war, I submit, will be quick, total, and economically profitable for the winner.  It will be a lightening war, much like the Six Day War in 1967.  You need to open your mind to the possibility that we will be playing the role of the Arabs.

Here is how I see this war playing out.   There are 1.4 billion people in China, and the Chinese are now ruled by a single man, President Xi Jinping.  In March of 2018, China approved the removal of the two-term limit on the presidency, effectively allowing Xi Jinping to remain in power for life.  Whatever Mr. Xi says, goes.

The Chinese people are terrified of their government, and whenever a populace lives in constant fear of their government, they hate it.  As long as President Xi improves their lives every year, however, the Chinese people will tolerate him.

But here's the thing.  The students in Hong Kong are thumbing their noses at Xi, making him appear weak.  These students are also showing the rest of China how to someday remove Xi from power - using mass protests and riots.  He cannot allow these protests to continue forever.  

If Xi rolls his tanks into Hong Kong, thereby reaffirming the fear that China is out to conquer the world, the world's backlash would be huge.  Crippling economic sanctions would likely be imposed on China by much of the world.  These worldwide sanctions would greatly reduce China's exports, greatly reduce their GDP, and greatly reduce the standard of living for the average Chinese citizen.

Uh-oh.  Remember,  Xi has to steadily improve the economic lives of the average Chinese worker; otherwise, he and the hated, semi-corrupt, Communist Party will be swept out of power.  

The movie, Midway, came out a few weeks ago.  It is a terrific movie, and the audience, when I took my wife, even clapped at the end of it.   The special effects were terrific, especially during the attack on Pearl Harbor.

Do you know why the Japanese attacked us on December 7th, 1941?  Do you know why they risked awakening a sleeping giant?  Admiral Isoroku Yamamoto, their most brilliant Naval strategist, made this famous quote, the morning after the Pearl Harbor attack, "I fear all we have done is to awaken a sleeping giant and fill him with a terrible resolve."

The answer is that America had imposed an oil embargo on Japan for attacking and occupying Manchuria and China.  At the time, Japan imported most of its oil from the United States and the Dutch East Indies (Indonesia).  After the American embargo, the Japanese had no choice but to invade Indonesia and seize its oil.  The same day, the Japanese attacked Pearl Harbor.

Interesting note:  I am married to a beautiful, exotic girl (for 37 years now), who was born in Indonesia to a Dutch father and a part-Indonesian mother.  Francisca's grandfather was the top executive for the Dutch Shell Oil Company in Indonesia, when the Japanese invaded.  Her grandfather bravely ordered that all of the oil wells in the country be set on fire.  The Japanese were not pleased.  They took her grandfather away in a  truck and shot him.  (See the picture at the top.)

Now if Xi rolls this tanks into Hong Kong, it will be the first domino in a long line to fall.  The crippling economic sanctions will force Xi to rail against the evil Americans and their stooges.  He will rally the people behind him by starting a war.  Tell me if you have heard this song before.

Under the the battle cry of, "Free the oppressed Taiwanese Chinese from the evil capitalists and imperialists," Xi will invade Taiwan.  The United States has a mutual defense treaty with Taiwan, so we will have no choice but to try to defend the country. Unfortunately, in the process, we will probably lose the 7th Fleet.

I recently saw a war games presentation of how the Chinese would likely destroy every ship in the 7th Fleet.  They would first swamp our fleet with drones and cheap missiles, and we would defend by using our arsenal of about 2,000 pieces of anti-missile and anti-drone ordnance.  When we are out of "bullets", they would send their carrier-killer hypersonic missiles far out to sea, to loop around behind our fleet and start taking out our largest ships. 

After taking Taiwan, the Chinese would next use its 300-ship Navy (13 more than ours today even before the massacre of our 7th Fleet) to start seizing islands to be used as missile bases.  Remember, the coming war will be a missile war, and even today's hypersonic missiles "only" have a range of 1,000 to 1,100 miles.  (Nuclear-powered hypersonic missiles, with an unlimited range, have yet to be perfected.)  

Less-expensive cruise missiles have a maximum range of about 550 miles.  The name of the game will therefore be island-hopping again.  If the Midway Islands are seized, GPS-directed Chinese missiles will be able to fly into specific windows of capital ships and important buildings at Pearl Harbor.

In the meantime, Chinese missile cruisers will be planting ship-launched cruise missiles into Boeing's missile and aircraft plants in Washington and into Lockheed missile and aircraft plants in California.  If the Chinese can also take out our shipyards in Long Beach and Oakland, with pinpoint missile accuracy, how long before we will be forced to sue for peace?  There will be no time to recreate our missile-making capability.  

The U.S. made a  number of fatal mistakes in the lead-up to this war.  Our first mistake was to fall so far behind China in our missile construction capability.  The second mistake was to waste scores of billions of dollars on aircraft carriers and their supporting ships.  They will be mere cannon-fodder in the coming missile war.  The Chinese, in contrast, had it right.  They built lots and lots of smaller ships.  You can even use an old, rust-bucket, Liberty Ship from World War II as a missile platform.

Will America win this war?  Will we survive long enough to catch up with our missile arsenal?  We're trying.  In one of my earlier articles about the Winds of War, I suggested that SpaceX's (Elon Musk's company) cluster of satellites, called Starlink, might allow the U.S. to pull its fleet back behind Midway Island, thereby increasing its survivability.  I was gratified and relieved to read that SpaceX is indeed now working with the military.

So could we win?  I don't think so.  I don't think that Xi will give us enough time to catch up to the Chinese in the missile production race.  A suburb of Indianapolis, located far from the West Coast, is looking like a decent place to try to survive World War III.  Am I serious?  Yes.  I tend to be early with my predictions, but I genuinely fear that we will fight and lose World War III in less than four years.

If Chinese tanks roll into Hong Kong, you need to start storing some long-term survival food.  After that, the dominoes may start to fall quickly - world economic sanctions on China, extreme economic distress in China, protest and riots against the rule of the Communists in China, the rallying of Chinese public opinion against America and its allies, the attack on the 7th Fleet, the invasion of Taiwan, the island hopping, the new island missile bases, the fall of Midway, the fall of Hawaii, the pinpoint destruction of our missile-making and ship-building capacity on the West Coast, and finally the capitulation and occupation of the United States.  

It's not as though China couldn't raise an extra two to three million soldiers to garrison the U.S.  Did you know that China has thirty million young men without wives?  Unmarried Chinese soldiers would make the perfect occupying force and a source of new husbands for our women citizens.  (Oh, goody.)  Sadly, too many Chinese parents left their baby girls out to die of exposure on some hillside 25-years ago during the One-Child Policy.  (In truth, most of these so-called abandoned baby girls were actually and thankfully snatched up and sent to relatives far away.)

With 350 million guns in the United States, we would be hard country to occupy; but  this thing about these extra thirty million young Chinese men without wives is a real phenomenon.  Yes, we could fight a guerrilla war, but the Chinese could also round up the population of entire states and put the people in concentration camps.  The British fought and won a guerrilla war in Malaya between 1948 to 1960.  It was one of the few victories against a guerrilla war.  They did it by rounding-up the population and holding the people in concentration camps.  Would the Chinese really land troops on American soil?  Geez, I hope not.  Reminds me of the Amazon Prime TV show, The Man in the High Castle.

Today's article contains great news for investors and brokers alike.

According to an important Bloomberg article published this week, the economic boom currently being enjoyed in America will probably not result in an extra big bust, according to the work done by the Nobel-prize-winning economist, Milton Friedman.

You may recall that Milton Friedman was a famous economics professor at the University of Chicago from 1947 to 1977.  Friedman was the foremost proponent of the Monetarist School of Economics, and once famously said, "Inflation is always and everywhere a monetary phenomenon..."  In everyday English, he meant that if a government creates a lot of new money, there is going to be a ton of painful inflation. "Inflation is taxation without legislation," was another one of Friedman's famous quotes.

In 1964, Milton Friedman developed an economic hypothesis called the Plucking Model.  The Plucking Model holds that the economy is like a string on a musical instrument — recessions are negative events that pull the string down, and after that it bounces back, like a guitar string.  But here's the thing:  When you pluck down on a guitar string, it only snaps back to its original position.  It doesn't go careening to the other side of the neck.

And just as a string snaps back faster if you pull it harder, the Plucking Model holds that the deeper the recession, the faster the recovery that follows.  But you can only pluck the economy in one direction; bigger expansions don’t lead to bigger recessions!

But is the Plucking Model true?  "Friedman proposed the idea in 1964 and argued that if he was right, future recessions would show a correlation between the depth of the bust and the speed of the recovery that followed.  He then waited 20 years to see if his predictions were borne out.  In 1993, he looked at the business cycles that had happened in the intervening years, and he concluded that he'd been right."

"Since then, others have found more evidence to support the plucking idea.  A 2005 paper by economist Tara Sinclair used advanced statistical techniques to confirm that, in the United States, bigger recessions are followed by faster recoveries — but not the other way around.  If you pull that guitar string really far - bam - it snaps back blazingly fast; but bigger recoveries don't produce faster recessions.  In other words, when a big expansion starts to end, an economy doesn't instantly plunge in a deep, dark recession."

After the Great Recession of 2007-2009, researchers looked at European countries and concluded that those that had it worse in the downturn ended up bouncing back faster.  In other words, those European countries which saw their GDP's fall the furthest were the first to recover.  

But there was no correlation between how well a country did before 2007 and how much it suffered afterward.  In other words, those countries which enjoyed the biggest increases in GDP did NOT suffer worse than the countries who fared only so-so in the preceding expansion.  All this evidence implies that recessions cause recoveries, but that booms don't cause busts.

But why does this happen?  The answer is that it's easy to give people raises, but it's hard to make them swallow pay cuts.

In good times, growth simply feeds into higher wages (as well as higher profits). But when a recession or other negative shock comes along that hurts corporate earnings, employers might like to cut wages, but they can’t.  Instead, they lay off workers.  The more workers who get laid off, the bigger a pool of unused labor there is, so the faster the economy can grow once the recovery takes hold.  Makes perfect sense, huh?

All of this is great news.  We can now forget about the Sword of Damocles hanging over our heads and truly enjoy this expansion.  Yes, we will eventually have another recession, but it will probably not be a horrible one.

Sword of Damocles

The famed “sword of Damocles” dates back to an ancient moral parable popularized by the Roman philosopher Cicero in his 45 B.C. book, “Tusculan Disputations.”

Cicero’s version of the tale centers on Dionysius II, a tyrannical king who once ruled over the Sicilian city of Syracuse during the fourth and fifth centuries B.C.  Though rich and powerful, Dionysius was supremely unhappy.  His iron-fisted rule had made him many enemies, and he was tormented by fears of assassination—so much so that he slept in a bedchamber surrounded by a moat and only trusted his daughters to shave his beard with a razor.

As Cicero tells it, the king’s dissatisfaction came to a head one day after a court flatterer named Damocles showered him with compliments and remarked how blissful his life must be.  “Since this life delights you,” an annoyed Dionysius replied, “do you wish to taste it yourself and make a trial of my good fortune?”

When Damocles agreed, Dionysius seated him on a golden couch and ordered a host of servants to wait on him.  He was treated to succulent cuts of meat and lavished with scented perfumes and ointments.

Damocles couldn’t believe his luck, but just as he was starting to enjoy the life of a king, he noticed that Dionysius had also hung a razor-sharp sword from the ceiling (see the picture at the top).  It was positioned over Damocles’ head, suspended only by a single strand of horsehair.  From then on, the courtier’s fear for his life made it impossible for him to savor the opulence of the feast or to enjoy the servants.  After casting several nervous glances at the blade dangling above him, he asked to be excused, saying he no longer wished to be so fortunate.

Haha!

A buddy of mine - an old veteran in the commercial loan business - sent me an email marketing flyer last week.  He had just closed a big commercial loan, and he was telling me about his special new program - a sort of fix-and-flip loan for large commercial properties.

Here is how my buddy described his new program in his marketing piece:

"Low-Cost Non-Recourse Gap Equity - We are under application on several opportunities to bring high octane capital to new construction and deep rehab projects at a coupon rate of starting in the 6's with no equity participation."

"Our investor funds his last dollar to 85 to 90% of cost on new construction and up to 100% of qualified renovation costs.  Our active pipeline includes multifamily, senior housing, and hotel projects."

Confused by his flyer, I wrote to my buddy and asked, "What on earth does last dollar mean?"   He wrote back:

"Let's assume the total capitalization of a renovation project is $10 million - with an $8 million purchase price and $2 million in the projected hard costs of renovations."

"Our investor funds up to 90% of the $8 million purchase price, or $7.2 million, and 100% of the hard renovation costs, or $2 million - for a total loan proceeds, based on cost, of $9.2 million."

"This assumes the property's After Renovation Value (ARV) is $13.2 million, since our lender limits loan proceeds to 70% of ARV."

"This gap equity program for commercial properties sounds terrific," I told my buddy, "but I still don't understand what last dollar means!"  My buddy must have thought that I was mentally-challenged.

Kneeling down and speaking very slowly to his slow-witted friend, my buddy explained:

"Last dollar refers to the highest loan-to-value reached when a lender loans his very last dollar.  (See the pic at the top squeezing out the last dollar.)  The term is used most often when mezzanine loans or preferred equity investments are stacked on top of very large permanent loans.  The permanent lender's last dollar is 60% LTV, the mezzanine lender's last dollar is 75% LTV, and the preferred equity provider's last dollar is 85% LTV."

At last the light bulb clicked on for me.

But wait a minute.  In trying to explain last dollar, my buddy described an incredible way to reach very high leverage on new construction deals and commercial renovation projects.  Eighty-five percent of cost for new construction?  Perhaps as high as 90% of cost?  Plus 100% of renovation costs?  This is fantastic! 

The program is also non-recourse.  The minimum loan amount is $3 million, and the maximum loan amount is  $200 million.  

This lender will make these high-leverage new construction loans and commercial renovation loans nationwide.  Acceptable property types include multifamily, senior housing, hotels, and several other standard property types.

Got a potential deal?  Please email me, George Blackburne III, no more than three sentences, along with your contact information.  Please type into the Subject line, "Gap Equity Program."  I'll make sure that the opportunity gets to my buddy.

You might even text me a message to 574-360-2486, "Just sent you a gap equity request."  I get an average of 1,350 email per day - every day - so its easy for me to miss emails.  Why don't I employ a junk mail filter?  I live in Indianapolis - a beautiful city, but a bit of a financial backwater.  Mortgage flyers are my window to the industry, and I don't want to miss a single one.  Add me to your newsletter list, so I can steal your jokes.  :-)

By the way, I had to look up the term, high-octane too. High-octane, in this context, means exciting and full of energy.  My buddy was specifically using the term high-octane to refer to a loan that is very high in terms of loan-to-cost.  

It's no fun being slow-witted; but it really helps when I teach.  Since I have to reduce difficult concepts to baby language in order to learn, I teach the same way.  Haha!