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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What on Earth Does Attornment Mean?

Suppose ABC Rent-a-Car wants to build a commercial building on a specific, high-traffic-count lot in the City.  ABC Rent-a-Car offers to buy the land from the property owner, but the commercial property owner wants to leave this valuable commercial lot to his grandchildren and great-grandchildren. He refuses to sell.

The commercial property owner, however, is willing to lease the land to ABC Rent-a-Car on a long term basis. ABC Rent-a-Car tries to negotiate a lease of the land for 99 years, the longest term allowed by law. Had the commercial property owner unwisely leased the land to the car rental company for 100 years, the courts would have ruled that this lease was in fact an installment sale! Title to the property would pass to the car rental company. The maximum term of a land lease is 99 years.

The old man, however, refuses to lease the bare commercial land for longer than 75 years, which the car rental company decides is sufficient. The parties execute a land lease for 75 years at an amount that pays the old man a return of about 8% annually on the value of the land, with a cost of living escalator every five years. This would be a very typical deal.

The rental car company, however, insists on a land lease clause requiring any future lender to sign a Subordination, Non-Disturbance and Attornment Agreement. After all, it's only fair. The rental car company is going to spend $800,000 constructing a building on the property at the rental car company's own expense.

What a deal! The property owner gets $40,000 a year triple-net rent on his land lease AND when the lease expires, both the land and the building revert back to his heirs. (I recently ran across a wealthy family trust that has the land lease on an entire city block on Michigan Avenue - the hottest shopping strip - in Chicago. The land lessees built skyscrapers all along that block, and these skyscapers are poised to revert back to the grandchildren of the trust settlor after 99 years. Holy Smackeral! We're talking about a billion dollars worth of buildings!)

Okay, let's scroll forward about ten years. Suddenly the old man is in need of some dough. Maybe he just got a young, new wife. He takes his land lease to the bank and pledges it to the bank for a $500,000 loan. When the bank pulls a title commitment (preliminary report), they find out that ABC Rent-a-Car has recorded their land lease against the title. The bank contacts the attorney for the rental car company and says, "Hey, we want to record our mortgage against the property, and we have to be in first position. We please need for you to subordinate your land lease to our mortgage."

Counsel for the car rental company then responds, "Okay, we'll agree to subordinate, as long as you sign our Subordination, Non-Disturbance and Attornment Agreement." The attorney exchange documents and cut a deal. The new first mortgage is recorded, and the car rental company subordinates it's land lease.

The old man's new wife ends up being a spendthrift and drives him into bankruptcy. The bank forecloses on the property, which is now improved with a gleaming, modern automotive center. The REO property manager for the bank contacts ABC Rent-a-Car and tells them, "Hey, our foreclosure just cut off your lease. You were paying only $40,000 per year for this beautiful facility, but the fair market rent for the property is now at least $100,000 per year. You'll have to start paying us $100,000 per year if you want to continue to rent the property."

"Not so fast, Bucko," replies the attorney for the car rental company. Please check the Subordination, Non-Disturbance and Attornment Agreement that your bank executed. Under the terms of that agreement, your bank promised not to disturb our existing lease if you foreclosed. Now that you have completed the foreclosure, we certainly agree to attorn. Attornment is a word from feudal times that means acknowledging a new lord. In this case, the rental car company acknowledges that all future rent is owned to the new landlord, in this case the bank.

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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.

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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.

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 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.

I Had a Long Conversation With a Veteran SBA Originator

I have a buddy who has been originating SBA loans exclusively for over a decade. Yesterday we spoke about SBA lending for almost 40 minutes. Here are some of the highlights:

SBA lenders rely on selling the insured portion of their SBA 7a loans to bond investors in order to get their principal back with which to make new loans. During the nadir (lowest point) of the financial crisis last year, these bond buyers completely disappeared.

As a result, the huge finance company for which my buddy worked completely stopped making SBA loans for three months. Many other SBA lenders dropped out of the market as well. The only SBA lenders left in the market at the time were a few banks who had the luxury of holding newly-originated SBA loans in inventory.

Recently, however, my buddy's huge finance company converted to a bank and received over $2 billion in TARP money. As a result, his company is now aggressively back in the market to make both 7a and 504 SBA loans.

The SBA will not insure loans on apartment buildings and self-storage properties. These properties earn their cash flow from relatively long-term rentals. As a result, they do not create a lot of jobs and are therefore not eligible to be insured.

Hotel and motels, as my buddy pointed out, are suffering greatly as a result of the financial crisis. Few SBA lenders will make loans on hotels and motels right now.

My buddy's company will not consider gas stations as well right now. His company made a lot of bad gas station loans and lost tens of millions of dollars. Apparently few other SBA lenders will consider gas station loans right now because my own hard money shop, Blackburne & Brown, is seeing a ton of gas station deals.

To my surprise, my buddy told me that the SBA will make loans on mixed use properties. A mixed used property is one where there is both commercial space and residential income space (apartments). Being from New Jersey, he sees a lot of mixed use properties in downtown areas where there is an apartment upstairs and a commercial unit (storefront) downstairs. The only restriction is that the owner-used commercial space must be larger than the apartment space; however, since most of these properties have basements used by the owner of the commercial space, this condition is usually satisfied.

He also surprised me by saying that an SBA loan borrower does not have to have good credit. If the borrower's credit problems were a result of some situation that has subsequently been resolved (divorce, medical problem, etc.), the borrower will still qualify for an SBA loan. He just can't have a lot of delinquencies at the time of the application.

The biggest issue is that the borrower must be able to demonstrate from his tax returns that he has the ability to make the proposed payments. Of course he gets to add back any depreciation and interest payments on any loans that will be paid off from the proceeds of the SBA loan.

My buddy's company has plans to make between $400 million and $600 million in SBA loans this year; however, there has been a fundamental shift in the type of deals they will make.  No longer will they make loans where the underlying commercial real estate constitutes less than 50% of the size of the loan.

Prior to the financial crisis, SBA lenders were regularly making SBA loans with no commercial real estate as collateral at all. They would often finance the purchases of franchises and professional practices, for example. His own company will no longer make SBA loans without some commercial real estate as collateral.

I was surprised at the leverage that SBA lenders can achieve. Using the SBA 7a loan program, SBA lenders can finance not only the purchase of commercial real estate, but also furniture and equipment to use in the property. They can often finance up to 150% of the value of the commercial real estate!

Did you know that if an SBA loan goes delinquent for four months that the SBA lender can present the loan to the SBA, and the SBA will immediately return 75% of the SBA lender's original principal? The SBA lender is still responsible for foreclosing on the collateral and selling the property. Whatever the SBA lender recovers, it must give 75% back to the SBA; but it still gets to keep the remaining 25%.

Let's suppose a SBA lender makes a $1,000,000 loan. When the loan goes delinquent by four months, the SBA lender presents the loan to the SBA, and the SBA immediately gives the lender $750,000 (75%). If the property is later sold at foreclosure for a net sales price of $800,000; the SBA lender gives $600,000 to the SBA (75%) and keeps $200,000. The SBA lender therefore recovered $750,000 plus $200,000 on a $1 million loan, for a loss of only $50,000. This is a good deal.

Based on my buddy's comments, it appears that SBA lenders are likely to loosen up and make some loans this year.

Do you need an SBA loan? You can submit your 51% owner-used commercial property loan to scores of different SBA lenders in just four minutes using C-Loans.com. Ad C-Loans is free!

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.

Where to Invest Your Money for the Next Upturn in Commercial Real Estate

The Urban Land Institute recently asked 700 real estate professionals to name the best (and worst) places to invest in commercial real estate in the coming year. Those surveyed included private developers, real estate brokers and Real Estate Investment Trust (REIT) executives. Their answers also apply to the residential market, since the single-family-home sector typically follows the economy. As wages go up and there are more jobs, more people can buy homes, pushing prices up.

The best cities in which to invest are those that are considered gateways to international investment, have vital downtowns where people can forgo cars, and don't have a glut of condos or office space.

According to this survey, the number one place to invest in commercial real estate right now is Seattle. Seattle is a diversified market, has a good base of business and is becoming a 24-hour city.

Although the city is suffering from the loss of Washington Mutual and the downsizing of Starbucks, Boeing and Microsoft are still relatively strong. Apartment vacancies are low and there aren't too many new buildings going up, meaning the market won't be oversupplied. The same is true in the retail space.

San Francisco comes in second in the survey as the best location to invest in commercial real estate.  San Francisco learned from the tech crash of 2001 not to overbuild. There is a reasonable supply of office and apartment space, which should limit vacancies. San Francisco's port is also expected to help the city during the downturn as Americans continue to rely on Asian imports.

Washington, D.C., New York and Los Angeles round out the top five.

The least attractive major city in America to commercial real estate investment is Detroit, Michigan. Detroit has been reliant on the car industry, which is rapidly shrinking. Other businesses are unlikely to fill the void in the next few years, which means the city will be hit hard by further economic struggles.

The second worst city was New Orleans. The city has been losing businesses to Houston, Dallas and Atlanta since Hurricane Katrina hit in 2005.

The other cities at the bottom of the list — Columbus, Ohio, Milwaukee, Wis., and Cleveland — suffer from dying industries and lack of tourist appeal.

Do you need a commercial real estate loan right now? You can apply to 750 different commercial real estate lenders in just four minutes for free using C-Loans.com.