Commercial Loans and Fun Blog

Just Learned an Interesting New Term of Art - Lien Clearing

As a hard money commercial lender, Blackburne & Brown has to foreclose on about ten to fifteen commercial properties every year. Contrary to what you may think, we never make money when we foreclose on property - never. I wish we didn't have to do it, but it's a necessary evil in this industry.

After foreclosing on ten to fifteen properties every year for the past twenty-five years, I have noticed an interesting fact. Hardly no one ever bids at commercial foreclosure sales. We have sold a commercial property at a foreclosure sale just once in twenty-five years.

Therefore, if you are the holder of a junior lien on a commercial property that goes to a foreclosure sale by the first mortgage ... well, you're toast. No one is going to over-bid the amount of the first mortgage. You will almost surely be wiped out by the foreclosure.

This week we foreclosed on an office in the foothills of the Sierras. It's a beautiful building. There was a $2 million second mortgage behind our $3.3 million first mortgage, and this second mortgage loan was completely wiped out.

We also wiped out a $350,000 mechanics lien that was junior to our loan.

As we prepared for the foreclosure, one of our attorneys used an interesting term: lien-clearing. Our successful foreclosure cleared off the title to the property and left us owning the property free and clear of any competing claims for the property.

The junior lienholders, in my opinion, made a fatal error when they failed to cure our senior loan. The second mortgage holder and the mechanics lien holder should have banded together and each chipped in enough dough to payoff our first mortgage.

Instead, they went to the foreclosure sale hoping that someone would over-bid our first mortgage. In real life, this never happens.

The Rent Might Not Be What the Borrower is Representing

Suppose you're a commercial lender, and you foreclose on commercial building. The good news is that the building still has a tenant. According to the lease in your commercial loan file, the tenant is obligated to pay $10,000 per month. Hooray.

Now the bad news. The tenant advises you that the lease in your commercial loan file is fraudulent. In order to obtain commercial financing, the borrower submitted a dummy lease. The tenant's signature on the dummy lease was forged. The real rent is only $2,700 per month! Ouch.

Okay, what did the lender do wrong? The commercial lender should have obtained an estoppel agreement from the tenant before making his loan.

What on earth does estoppel mean anyway? Estoppel is a a rule of evidence whereby a person is barred from denying the truth of a fact that has already been settled. To understand this definition, let's take a look at our current situation.

Suppose we had sent an Estoppel Agreement to the tenant that said that the rent was $10,000 per month, the lease was still in force, the lease still had ten years to run, and the landlord had performed all of his required duties under the lease. If the tenant had signed the Estoppel Agreement, agreeing that the lease terms described in the Estoppel Agreement were the actual lease terms, then the tenant would have been bound by the fraudulent lease terms, rather than the terms of the true lease.

The lack of prepaid rent is another item that needs to be addressed in the estoppel agreement. Suppose the tenant recorded his lease, so the lease was senior to the mortgage. Right before the commercial property owner loses the property in foreclosure, the owner approaches the tenant and say, "Say, I'm in a cash crunch.  You owe me $100,000 in rent for the rest of the year. I will reduce my rent to just $60,000 if you prepay it now." The tenant would be sorely tempted to accept that offer.

If the commercial lender then foreclosed, the commercial lender would be forced to honor the deal made by the prior owner, even if the former commercial property owner took the $60,000 and spent it on cocaine for his trashy girlfriend.

This is one of the reasons why commercial lenders do not like to be subordinate to recorded commercial leases.

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A Broken Condo is a Project That Didn't Sell Out

Commercial loan brokers should be on the look-out for broken condo projects. There is a good chance to make a nice commercial loan brokerage commission.

A broken condo project is a residential condominium project that didn't sell out. The unsold units are usually converted back to multifamily rental housing.

I spoke with a major commercial loan officer at a large bank today. This bank makes portfolio apartment loans. I asked him if it is possible to finance broken condo's.

His reply surprised me. He indicated that, of course, that if none of the condo units were sold, that a normal apartment loan is a no-brainer.

But he also indicated that if only a handful of the units were sold that a portfolio loan on the rental units would be possible.

However, he stressed that if too many of the units were sold as condo's that such a deal would be impossible. How many is too many? Certainly if 25% of the condo units had been sold, the deal would be difficult to finance. I was left with the clear impression that if only 10% to 15% of the condo's had been sold that his bank would definitely consider financing the apartments.

Need a commercial or multifamily loan? You can apply to hundreds of commercial lenders in just four minutes using C-Loans.  And C-Loans.com is free!

It's Getting More Difficult for Hard Money Lenders to Raise Lending Capital

If you are commercial mortgage broker, you should not be trying to place large, hard money, commercial loans. Large commercial loans just aren't closing these days.

One of the reasons why is because hard money commercial lenders are having a difficult time raising money. Before the real estate crash of 2007, most hard money commercial loan brokers raised their money using mortgage funds. When the markets crashed, all of their depositors try to pull their money out of these funds. The situation has not improved since October of 2007.

Therefore very few hard money commercial lenders still have mortgage funds with which to make large commercial loans. Instead, if a hard money commercial lender wants to fund a commercial loan today, he has to syndicate a fresh group of private mortgage investors. This is a whole lot of work.

Therefore very few hard money commercial lenders are making commercial loans larger than $3 million today.

Need a commercial loan? You can apply to 750 different banks and hard money commercial lenders in just four minutes using C-Loans.

Cap Rate is Short for Capitalization Rate

You have probably heard the term cap rate many times, but what does it mean? Here's an easy way to understand the concept as it applies to commercial real estate. A cap rate is simply the return on your investment if you bought a commercial property for all cash.

For example, let's suppose that you buy for $1 million an office building that is leased out to an insurance broker. The insurance broker pays you $9,000 per month in rent, but there are also expenses, like real estate taxes, insurance, property management and a small reserve where you set aside money every year to eventually replace the roof and the HVAC system. Let's assume your net operating income (NOI) is $77,000 per year.

To compute the cap rate at which you bought the building, you merely divide your anticipated NOI by your purchase price.  In this case, $77,000 divided by $1,000,000 is 0.077. To express this cap rate as a percentage, we merely multiply 0.077 by 100% to produce a cap rate of 7.70%.

In plain English, a 7.70% cap rate means that you - as a passive commercial real estate investor - will earn a 7.7% annual return on your $1 million investment in this commercial property. Please also remember that for the purposes of computing a cap rate that you should assume that the buyer did not use a commercial real estate loan to finance the property.

You can't use the same cap for every commercial property. Some commercial properties are far more desirable than others. For example, let's suppose that Microsoft Corporation was the tenant on this property, and they signed a lease for 20 years. Arguably Microsoft is one the strongest credit tenants in America. If you - as the owner of the commercial property - had a lease with a strong, credit tenant, other investors would be very envious of you. In fact, they would offer you a lot of money for this property, perhaps as much as $1,800,000.

Now remember, the net operating income is still just $77,000 per year. If you sold the commercial building to another commercial real estate investor, who wanted a very reliable income stream, for a whopping $1,800,000 - he would be buying this same commercial property for just a 4.3% cap rate. Would someone really buy a piece of commercial real estate with a cap rate of just 4.3%? Maybe ... if indeed the property was leased to a major credit tenant for twenty years. By the way, a credit tenant is usually publicly traded or a large private entity with a strong S&P rating.

On the other hand, suppose you owned an old industrial building in a seedy part of town that was leased to an auto parts manufacturer. Suppose this auto parts manufacturer sold its parts mainly to General Motors, and the auto parts company wasn't making a lot of money. Let's further suppose that the neighborhood immediately surrounding your property was filled with prostitutes and drug dealers.

Even if this property was generating the same $77,000 in net operating income, you might not be able to sell the property for very much money. Any potential buyer might think to himself, "Geesh, if I drive over to collect the rents or to check on the condition of my property, I'm putting my life in danger. Yuck." This investor might not be willing to buy the property for less than a 12% cap rate.  Seventy-seven thousand dollars divided by 12% is just $641,000.

Remember, the more desirable the commercial property, the lower the cap rate a buyer will require before he buys it.

Scanners With Document Feeders Are Becoming Essential

Commercial mortgage loan brokers now only really need three pieces of equipment - a reliable cell phone, a laptop computer, and a combination copier / fax machine / scanner.

The need of a commercial loan broker of a good cell phone is obvious; but have you ever considered whose phone number you are promoting? Let's suppose that you send a thousand mail pieces and 3,000 emails every month for two years. Further suppose your marketing pieces encourage your clients to call the main office number for your broker.

Now suppose your broker goes belly-up. Oops! All of those clients and referral sources will be calling a disconnected phone number. Yikes.

Or suppose a commercial real estate agent really needs a commercial mortgage loan for his client. He calls your office and asks for you, but you're out of the office. "Is there another commercial loan agent there with whom I could speak?" You've just lost a commercial loan and potentially a good commercial real estate agent.

The moral of the story is this: Promote your personal cell phone number, not the office number of your broker.

Let's talk about laptop computers. I recently converted to an Apple MacBook, and I absolutely love it. No longer do you have to spend hours updating your virus protection software and malware protection software. Sure, an Apple MacBook costs an extra $600; but the machine so worth it.

Don't worry about software. Microsoft makes Office software for the Mac. This means that I can still use the fabulous Apple OSX software and still communicate with my office. There is Word, Excel and PowerPoint for the Mac, and my staff at our commercial loan office can easily open with their PC's any file I create on my Mac. It's heavenly.

But the machine that gets me hot and sweaty is my new, combination copier / fax machine / scanner with autofeeder. The other day a broker faxed a commercial loan package to me. Because the original commercial loan package had been faxed to him, I was working with a second generation fax. The copy quality was starting to decline.

I printed out the commercial loan package and then scanned it using the autofeeder. I then clicked a few times on my laptop and created a PDF, which I simply emailed to my office. The quality did not degrade, and my commercial loan officer at Blackburne & Brown was able to issue a loan approval letter the same day.

This combination machine was not expensive. It was less than $300 and I absolutely love it. It's a Canon MX700 and I even bought it using the reward points on my credit card.

The Latest Skinny on SBA Loans and SBA Lenders

A buddy of mine in the SBA loan business called me today, and we chatted about a number of very important changes to the SBA loan program. The Federal government is trying to get credit flowing again to the economy, so they have made SBA loans much more attractive.

First of all, until the end of the year or until money runs out, the SBA is now waiving its guarantee fees (points) on 7a loans and on the debenture portion (the second mortgage portion) of 504 loans. You will recall that the 504 loan program involves a conventional first mortgage loan from a bank up to 50% loan-to-value and a piggy-back second mortgage loan from a certified development corporation up to 90% loan-to-value.

The second thing the Federal government has done to make SBA lending more attractive is that the SBA has increased its guarantee of SBA loans from 75% of the loan amount to 90% of the loan amount. This should encourage SBA lenders to start approving more deals.

The third incentive is the SBA has effectively extended the repayment term of its loans. In the past, the real estate portion of an SBA loan had a term of 25 years, but that portion of the loan used to finance the acquisition of machinery or equipment had a term of just 10 years. If the borrower also wanted some working capital, the repayment of this portion of the loan had to be amortized over just 7 years. A weighted-average loan term was used. Now, if more than 50% of the loan is being used to acquire real estate, the entire SBA loan can be amortized over 25 years.

The SBA also announced two weeks ago that 504 loans can now be used for refinances, as opposed to just the purchase, of real estate and/or equipment. The announcement was somewhat unclear, however, and further clarification is expected from the SBA.

In general, the volume of SBA lending is way down. CIT Financial, the largest SBA lender in the country, is back in the market. CIT is now a national bank with one branch in Utah. More importantly, CIT, as a bank, now has access to the discount window at the Fed.

Banco Popular, the second largest SBA lender, has severely trimmed its SBA lending infrastructure. While the bank is still in the market for SBA loans, their SBA loan volume is down by more than half. So is the SBA loan volume of Bank of America and JP Morgan Chase.

Former giants in the SBA lending market - Temecula Valley Bank, UPS Financial, Small Business Loan Source, and Business Lenders - have all closed down their SBA lending divisions.

The secondary market for the conventional portions of 504 loans has completely dried up. These attractive first mortgage loans used to sell for 6 to 15 point premiums because of the implicit guarantee of having the SBA in a second mortgage position. The good news is that the Obama administration has earmarked a sizable amount of money aimed at buying up these 504 first mortgages in hopes of jump-starting this market.

The second mortgage portion of 504 loans are being written at a fixed rate of 5.67% today (3/31/09) for 20 years. The underlying first mortgages are typically written at an interest rate that is 1% to 1.5% higher than the 504 second mortgages. Wait a minute? Higher than the second mortgage? Yes, because unlike the second mortgages, these first mortgages are not credit-enhanced by the SBA.

I learned today that SBA 7a loans have a modest prepayment penalty during the first three years. It's a declining prepayment penalty of 5% in year one, 3% in year two, 1% in year three, and no prepayment penalty thereafter.

The SBA 504 program has a stiffer prepayment penalty. The bank making the underlying first mortgage is not allowed to charge a prepayment penalty. The second mortgage, however, has quite a stiff prepayment penalty - 10% in year 1, 9% in year 2, 8% in year 3, and so on. There is no prepayment penalty on the second mortgage after 10 years.

Gas station loans are still not being guaranteed by the SBA.  (Blackburne & Brown is happy to finance gas stations right now.)

While the SBA will still guarantee hotel loans, very few SBA hotel loans are being made by SBA lenders. SBA lenders are worried about declining trends. In other words, they are comparing this year's revenues to last year's revenue - and the trend is usually too negative. The expression - declining trends - is the hot, new buzzword in SBA lending.

If an SBA lender were to finance a hotel today, it would probably be a hotel highly visible from a busy highway. Many more business travelers are driving rather than flying because of the recession. The hotel lucky enough to get SBA financing would probably be a limited service hotel, typically without a restaurant and with far lower nightly rates. It would probably have less than 100 units.

The more expensive full service hotels, typically close to airports, are suffering far worse than the cheaper limited service hotels off of busy highways. These full service hotels would also require large loans, and lenders are loathe to make large hotel loans today.

Finally, if an SBA lender were to finance a hotel today, it would probably be a hotel with interior corridors. Older hotels and motels usually have exterior corridors, and women traveling on business today are likely to avoid such hotels due to security concerns.

The maximum SBA 7a loan is $2 million. Therefore, if a borrower wanted more than $2 million or if he wanted a fixed rate loan, the SBA 504 program would be the right program.

C-Loans recently received a loan that otherwise would have been perfect for the SBA; however, the borrower was a non-profit organization.  The SBA will not guarantee loans to non-profit organizations.

Conventional commercial real estate lending is down by more than 80% from early last year. SBA lending is also down by 60% or more. The Federal government's efforts to increase SBA lending is a noble effort. Let's hope it works.

Need an SBA loan? You can apply to dozens of different SBA lenders in just four minutes using C-Loans. And C-Loans is free!

When Money is Tight, Wraparound Loans Get the Job Done

A good way to understand wraparound mortgages ("wraps") is to follow a little story. Once upon a time Ida Investor bought an office building. The cost of the office building was $1,400,000 and she put down $350,000 (25%) in cash. Hometown Bank made a $1,025,000 new first mortgage for ten years at 6.25% interest.

Ida Investor made a shrewd investment. The City of Hometown started to boom. The value of her office building skyrocketed, and just four years later Bobby Buyer offered to purchase the property was a whopping $2 million.

The problem was that commercial loans had dried up. Neither Hometown Bank, nor any of the other banks near Hometown, Montana, were making any new commercial loans.

Fortunately Ricky Realtor, Ida's real estate broker, had a solution. Bobby Buyer would give Ida Investor $400,000 in cash (20%) as a down payment.

Ida Investor would then carry back an all-inclusive mortgage (wraparound) in the amount of $1,600,000 at 7.25%.

Bobby Buyer would pay Ida Investor one payment every month, an amount sufficient to amortize a mortgage of $1,600,000 at 7.25% over 25 years. It would then be Ida Investor's responsibility to make the payment on the existing first mortgage, which had been paid down from $1,025,000 to just $1,000,000.

Since Ida Investor's existing first mortgage balloons in just six years, the all-inclusive mortgage (wraparound mortgage) would have a similar due date. These two mortgages would be coterminous; i.e., they have identical maturity dates.

Why bother with the wraparound structure?  The reason is because Ida Investor really wanted all cash on the sale. She didn't want to carry back a garden-variety second mortgage at a lousy 7.25% interest. Bobby Buyer, however, would never agree to pay Ida Investor 9% interest on the second mortgage.  He was way too stubborn.

The wraparound structure solved the problem. How? Remember, Ida Investor's old first mortgage had an interest rate of just 6.25%. The amount of the old money - wrapanese for the existing mortgage being wrapped - was $1,000,000.

The amount of the new money - wrapanese for the amount of the equity inside Ida Investor's new all-inclusive mortgage - is $600,000. Remember, the gross wrap was for $1,600,000 and the existing mortgage was $1,000,000. Therefore Ida Investor's equity in the wrap is $600,000.

Now let's get back to Ida Investor's return on her equity in the wrap. She's earning the wraparound interest rate of 7.25% on her $600,000 equity inside the wrap, which works out to be $43,500 per year in interest income.

But Ida is also earning 1% interest - the difference between 7.25% and 6.25% - on the existing $1,000,000 first mortgage that is being wrapped. This is an extra $10,000 per year in interest. If you add $10,000 to $43,500 you get $53,500 in annual interest income on Ida Investor's $600,000 equity in her wrap, or an annual interest return of almost 9%.

Look for more wraparound mortgages to be made on commercial properties in the coming years, as the banks remain tight-fisted about making commercial loans.

Need a commercial loan?  You can apply to 750 different commercial lenders in just four minutes using the same mini-app by using C-Loans.com. C-Loans is the internet's most popular commercial mortgage portal. And C-Loans.com is free.

The Banks Don't Have Any Money

Every commercial loan broker will tell you that the banks are not making a whole lot of commercial loans these days. Surprisingly, the reason why isn't just because they are afraid to make new commercial loans.

Another important reason is that many banks are fully-invested. In plain English, they don't have the money to make new commercial loans.

This lack of liquidity is not the result of loan losses associated with the subprime meltdown. Few small banks were involved in the deal-flow of subprime loans. When the music suddenly stopped, the small banks were not left holding a huge volume of unsold subprime residential loans. It is easy, therefore, to assume that the small banks have plenty of money to lend.

In fact, the opposite is true. Banks have always preferred to make short term loans, like construction loans and bridge loans. This way they constantly have a few outstanding loans paying off every month, giving them the liquidity to make new short term loans. Unfortunately, ever since the financial crisis began, their outstanding loans have not been paying off. Borrowers with construction loans and bridge loans have been unable to refinance their loans with long-term lenders. The banks have been forced to extend these short term loans into longer term mini-perms.

To make matters worse, most small banks had a great many lines of credit extended to businesses that they served. Most of these businesses are now losing money, so the businesses are drawing down on their credit lines.  This has further drained liquidity from the banks.

Lastly, this is a very difficult time for banks to attract new deposits. The prime rate is a rock-bottom 3.25% right now. The 11th District Cost of Funds Index, a fair proxy for the typical bank's cost of funds, is a whopping 2.75%. Twenty years ago a small bank could not survive on a gross interest margin of less than 6%. With sophisticated new software and ATM's, a small bank can modernly make a profit on a gross interest margin of 4%. Helloooo? Small banks are being forced to survive right now on a gross interest margin of just 50 basis points. They certainly cannot raise interest rates to compete for more deposits.

I feel like an early pioneer, whose wagon train is surrounded by angry Indians, and who learns that the cavalry detachment sent to relieve him is itself under siege by Indians.  The small banks were one of the last sources of lending that might save this faltering economy, and it now appears they too are under siege. Yikes.

Includes George's Famous Pooh-Pooh Soup Story

You're a commercial mortgage broker. You've just quoted a commercial real estate loan to a borrower over the phone. The borrower appears interested, and you want to convince the borrower to send his commercial real estate loan application to you, as opposed to a competing mortgage broker or bank.

The key thing to remember is the Theory of Momentum. A body at rest tends to stay at rest. A body in motion tends to stay in motion.  A potential commercial real estate borrower is therefore going to want to keep sitting on his hands.

To convince a potential commercial borrower to send his loan package to you, never ask for too many documents at one time.

If you ask for a huge checklist of documents, the borrower will surely procrastinate, during which time he'll speak with a competing commercial lender or mortgage broker, and you'll lose the deal. Instead, ask for just two or three documents at a time. Gather the six-inch-thick stack of required documents slowly over a period of weeks.

"But George, it will take months to close a commercial loan at that pace."

We've all heard the story about the young bull and the old bull standing at the top on the hill and looking down over a herd of beautiful heifers. The young bull turns to the old bull and says, "Hey, Pops, let's run down and kiss one of those cows." The wise old bull replies, "Son, let's walk down and kiss them all."

The point of the story is that if you rush things, your success rate is often much lower. If you ask for a huge checklist of documents, you'll only close one deal in fifty. If you gather the required documents in small, easy waves, you might be able to convince all fifty borrowers to send you a package.

But you have to give the borrower reassurance that his commercial loan application is looking good ... and this leads us to my famous Pooh-Pooh Soup Story:

Have you ever noticed that whenever you order anything to eat at an expensive French restaurant that the snooty waiter always says, "Ah, good choice. The duck a la orange is delicious!" And when you order dessert, "Wonderful choice, sir. The Crepes Suzette are
delicious!"

I've therefore often wondered that if I ever asked for Pooh-Pooh Soup (you guessed it, a log floating is broth ..... eeuuuuu!) whether the French waiter would say, "Ah, the Pooh-Pooh Soup is delicious!"

Now back to our training. We've pointed out that you absolutely need to ask for the documents in five or six waves of three or four easy documents to fetch. But the borrower will need reassurance, before fetching a whole new wave of documents, that at least so far his commercial real estate loan application looks good.

So when you get the first wave of documents - his current schedule of leases (rent roll) and his last year's actual operating expenses - quickly scribble out a pro forma operating statement and do a debt service coverage ratio calculation. Then, assuming the numbers look good, you can tell him, "I've crunched the numbers, and so far your deal looks very do-able!"  (The pooh-pooh soup is delicious!) "Now all I need is a financial statement and two years tax returns."

With these documents you can pull a credit report and report back to the borrower, "I've looked at your financial statement, tax returns and credit report, and everything continues to look very favorable!" (The pooh-pooh soup is delicious.") "Now all I need is a copy of the leases and a financial statement and two years' tax returns on the LLC that actually owns the property." And so on, being sure to reassure the borrower that his loan package looks good (the pooh-pooh soup is delicious) after receiving each wave of documents.

So, to summarize, the object of the game is to convert a telephone lead into a loan package. To get your commercial loan borrower finally moving in your direction, you must not ask for a huge checklist of documents. Instead, ask for a very short list of easy documents to gather. After receiving each wave of documents, be sure to tell the borrower that his deal looks great (the pooh-pooh soup is delicious!). It will take you slightly longer to close a commercial loan this way, but you'll close far, far more deals (you'll kiss them all!).

Do you need to place a commercial real estate loan right now? You can submit your commercial deal to 750 different commercial real estate lenders in just four minutes using C-Loans.com. And C-Loans is free!

Perhaps as many as 10% of all of the practicing commercial mortgage brokers in the industry are my former trainees. If you would like to really learn how to broker commercial real estate loans like a pro, please click here.