Commercial Loans Blog

Commercial Loans and the Value of Your Discounted Note

Posted by George Blackburne on Tue, Dec 11, 2018

Fix and flip-1Perhaps you sold a small commercial building, and you carried back a commercial loan; or perhaps you bought a run-down house, renovated it, and sold the house to a couple who had lost their home during the Great Recession.  Their poor credit is why you had to carry back a first mortgage or a contract of sale.

These private first mortgages and contracts of sale can be a wonderful source of wealth and cash flow.  Let's suppose you own a first mortgage note or a contract of sale.  How much is your note or contract of sale worth?

 

 

 

 

Please Click After Viewing   Earn Up to 12% Interest Video

 

bread-is-like-the-sun_th-1

 

First of all, is your contract of sale worth less than a regular first mortgage?  Naw.  The buyers of discounted notes are pretty sophisticated investors, and they are far more concerned about about the interest rate, the monthly payments, and the term of the note they are buying.  From a practical point of view, there is little difference between a mortgage and a contract of sale, assuming we are in a mortgage state.  (Trust deed foreclosures are much faster.)  

One of the first things that a note buyer is going to want to see is the closing statement.  What was the purchase price of the property?  How much did the buyer put down?  Obviously, the smaller the downpayment, the less the note is worth; however, if the note is several years old and the borrower has demonstrated a good payment history; i.e., the note is seasoned; the real estate recovery since the Great Recession may have created enough protective equity to satisfy the note buyer.

 

Submit Your Loan to 750 Commercial   Lenders Using C-Loans.com.  It's Free!

 

Bathroom Paint

 

Free List of 3,159 Commercial Lenders  Sort By Your Own Criteria

 

Now let's talk about how the terms of your note affect its value.  Obviously, the higher the interest rate on your note, the more valuable it is (within reason).  Would a note buyer actually pay a premium for a high-yield first mortgage note?  A premium is paid when a note or a bond has a higher-than-market interest rate, and the buyer pays more than the face value of the note or mortgage.  

Example:

Smart Sammy bought a foreclosure during the Great Recession, and he fixed up the home very nicely.  Bonnie Buyer and her husband, Dave, looked at the property, and Smart Sammy noticed that Bonnie, an attractive woman whom Dave obviously adored, was clearly in love with the property.  

 

Buy a List of 2,500 Commercial Lenders Freshly Updated in 2019

 

$50-1

 

Free Commercial Loan Placement Kit

 

Dave then confided to Sammy that he and Bonnie had lost their home in foreclosure during the Great Recession.  They therefore could not qualify for a conventional mortgage.  Would he, Sammy, carry back the first mortgage?

Now Sammy loved notes, and he would ordinarily carry them back at 11%; but Smart Sammy was convinced the pretty Bonnie desperately want this home, and Dave could never deny her.  "Yeah, I'll carry back a first mortgage for 85% of the purchase price, but because of the extra risk, I want a 14% interest rate."  The Buyers jumped at the offer.

 

Nine-Hour Video Training Course  How to Broker Commercial Loans

 

5-00 am

 

Become a Hard Money Lender.  Approve Your Own Deals!

 

Get Both Video Training   Programs For Just $849.

 

Later Smart Sammy needed cash, and the ideal note to sell was his $100,000 first mortgage at 14%.  Indira Investor, a note buyer, showed herself too willing, so Smart Sammy said, "Gee, Mrs. Investor, I hate to part with it.  After all, its yielding a whopping 14%.  Where else can you earn 14%.  I'll tell you what.  I'll sell you this $100,000 note for $105,000 - a $5,000 premium - because the note rate is so much higher than the market."

Indira Investor thinks to herself, "Hmmm, I'll earn an extra $3,000 per year in interest, and in a little longer than a year-and-half I will have recouped my $5,000 premium.  After that, I'm golden."  "Okay, Sammy, I'll buy your $100,000 note for $105,000."

 

Get Four Free Commercial    Training Courses

 

Mr. Myagi

 

Input Your Commercial Referral Here

 

Six months later, a clever mortgage broker (named Sammy) took his former buyers to a subprime mortgage company and got them a new mortgage at 7.5%, making himself a cool $2,000 loan fee.

Indira Investor was horrified, but there was nothing she could do.  She had paid a $5,000 premium and only recouped an extra $1,500 in interest during the six months that she owned the note.  Arghhh!

 

Banks and Credit Unions:  Get 200 Free SBA Loan Leads

 

Batman-sign

 

Apply For Preferred Equity or  a Commercial Scond Mortgage

 

Franchise financing

 

Where did Indira Investor make her mistake?  She should not have paid a premium if the loan lacked a prepayment penalty!

Note:  One of the largest loans that C-Loans.com closed over the past two years was a USDA Business & Industries loan, kinda like an SBA loan but for lowly-populated areas.  The government recognized that it needed to bring jobs to the Boonies.

 

Apply To 93 Different USDA Lenders Six At a Time Until One Says Yes

 

Avocado-2

 

But the single most important reason of all to use C-Loans.com is when you are looking for an SBA lender.  Remember, a SBA lender must put at risk a ton of their own capital, even though most of the loan is guaranteed.  Different banks on different SBA loan requests see the risk differently.  Forty banks can turn down a particular SBA loan request - only to have the 41st bank approve the loan!  Got an SBA loan request?  Think of C-Loans.com first.

 

Apply to 218 Different SBA Lenders  Using the Same Four-Minute Application

 

Blackburne & Sons will buy your discounted notes!

 

Apply For a Commercial Loan to Blackburne & Sons

 

Subscribe to the Commercial  Loans Blog  Today!

 

 

Topics: discounted notes

Commercial Loans and Underwriting Discounted Notes

Posted by George Blackburne on Mon, Mar 10, 2014

Discounted NotesMy commercial loan, hard money lending company, Blackburne & Sons, competed this week to buy a discounted first mortgage note on an apartment building.  Do you know how to underwrite a discounted note when its a commercial loan?  You will after this blog article.

When underwriting a discounted commercial loan, perhaps the most important issue is the interest rate on the note being sold.  Private mortgage investors, when deciding whether or not to invest in a commercial real estate loan outside of California (yield requirements are 2% to 3% lower in California), usually insist on a yield of between 12%* and 14%*.

 

Free List of 3,159 Commercial Lenders  Sort By Your Own Criteria

 

*  Gross yield before loan servicing fee.  I've been in the hard money mortgage business for 33 years now.  Show me a hard money lender that doesn't charge a loan servicing fee of at least 1% to 2%, and I'll show you a hard money lender that will not survive the next recession.  I've been preaching this to my fellow owners of hard money shops for years.  During the Great Recession, at least 60% (85%?) of all hard money commercial loan companies failed.  The handful that didn't fail only survived because they went back to their investors and raised their loan servicing fees to at least 2% per year.

Therefore, when underwriting a discounted commercial loan, you must first discount the loan back to present value at a yield that is appealing to a private mortgage investor.  In other words, what is the proper price to pay for this commercial loan for an investor wishing to yield 13%?

When discounting a commercial loan back to present value, much depends on the remaining term of the commercial loan.  For example, let's look at an 8% first mortgage commercial loan secured by an office building.  If there are just two more years remaining on the note, the discount might not have to be too large.

We said that the investor wishing to buy this commercial first mortgage note wants to earn, say, 13%.  Thirteen percent minus 8% equals 5% per year.  Five percent per year times the 2 years remaining on term of this commercial loan gives us a rough discount of only around 10 points.  I'll teach you a more precise way of calculating this discount in a moment.  Right now I want you to focus on the concept that the longer the remaining loan term, usually the larger the discount.

But what if this same 8% commercial loan had 10 more years to run?  Just doing some rough calculations, the discount would have to make up for a shortfall in the interest rate of 5% per year.  A 5% per year interest rate shortfall times 10 years is a whopping 50 (FIFTY) point discount!  Ouch!  A far better option in the above case would be to hypothecate the note - in other words, borrow against it - rather than selling it at a discount.

Below are instructions on how to properly and accurately compute the discount on a commercial loan.  Don't try to slug through them right now.  You can always come back and study this article in detail (bookmark it?) when you have a real deal to underwrite.  Instead, just skip right now to the rest of the article below the instructions.

-------------------------------------------------------------------------------

HOW TO COMPUTE A DISCOUNT ON A COMMERCIAL LOAN

How do you compute the discount on a commercial loan properly and precisely?  Take out your financial calculator.  You will notice that your financial calculator has a row of five buttons:

  1. N (Stands for Number of payments until the loan balloons.)
  2. I (Stands for Interest rate.  You may have to convert this to monthly.)
  3. PV (Stands for Present Value or the loan balance)
  4. PMT (Stands for Payment.  Usually this will be monthly)
  5. FV (Stands for Future Value or balloon payment)

As long as you know four of the five values, you can compute the fifth.  In this case, we're trying to figure out how much to pay for this commercial loan.  In other words, we are trying to figure out the PV.  As long as we know the other four values, we can compute the PV.

Therefore, in the N field, insert the number of months until the maturity date.  

In the I field, insert, not the monthly interest rate on the actual commercial loan, but rather 1/12th of the desired yield by your private investors!  In this case, you would insert 1/12th of 13%.

In the PMT field, insert the monthly payment.  On some financial calculators, you may have to change the sign of the monthly payments from positive to negative, or vice versa.  Be careful not to forget the final month's payment.  Is it included in the ballon payment?  Don't double count, but also don't forget the last monthly payment either.

In the FV field, insert the ballon payment.  On some financial calculators, you may have to change the sign from positive to negative, or vice versa.  Is the last monthly payment included in the balloon payment?  Don't forget it ... but don't double-count it either.

We are now ready to compute the size of the discount.  Ask your financial calculator to compute the PV - what you should pay for the commercial loan if you want to yield 13%.

-------------------------------------------------------------------------------

Let's suppose you are trying to buy a $100,000 commercial loan, and you compute the discount to be $17,000.  Does this mean that you should pay $83,000 for the commercial loan?  No.  You have forgotten about the loan fee being charged by your lender and your own loan brokerage fee.

Let's suppose that Blackburne & Sons is charging 4 points, and you are charging a loan brokerage fee of 2 points.  Therefore you should subtract from the purchase price of the commercial loan the combined loan fee of 6 points, or in this case, $6,000.

We're still not quite done.  There will be closing costs - attorney's fees, title insurance, and recording fees.  A good rule of thumb for these costs is 2.5 points for commercial loans with a face value of less than $500,000 and 1.5 points for commercial loans with a face value larger than $500,000.

Therefore we have a $100,000 face value commercial loan, minus a discount of $17,000 to make the yield attractive, minus $6,000 in combined loan brokerage fees, minus $2,500 in closing costs - for a net to the seller of $74,500.

Why would a seller take just $74,500 for his commercial loan?  (1) He needs money; and (2) he no longer wants to take the risk that the borrower won't pay.

We are not done yet underwriting the deal.  You need to look at the loan-to-value ratio.  The end private investor, in our example, is paying $83,000 for the commercial loan ($100,000 minus the $17,000 discount to bring the yield up to 13%).  Is this a reasonable loan-to-value ratio?  Divide $83,000 by the current value of the property to make sure that it does not exceed 70% LTV.

What is the payment history of the underlying borrower on the commercial loan?  The above discussion assumes that the underlying borrower has been paying essentially perfectly.  If not, the discount may be significantly larger.

What is the credit of the underlying borrower?  Did the original owner of the commercial loan pull a credit report on him?  Does the loan package include old tax returns, showing that the underlying borrower was making money, at least when the commercial loan was originally made?  Is the property owner-occupied?  Does the maker's (the underlying borrower's) business look like it is thriving?  Is this a rental property?  If so, does it look fully-occupied?

If the answer to all of these questions is yes, the private investor buying the commercial loan may only require an 11% yield, rather than a 13% yield.

One the other hand, if the answers are not so appealing, the discount may have to be larger.  That being said, this is a capitalistic world.  There is some discount that is large enough to make almost any first mortgage commercial loan worth buying.

Apply For a Commercial Loan to Blackburne & Sons

Topics: discounted notes