It can be very tricky for a commercial lender to foreclose on a blanket commercial loan. If he doesn't bid exactly the right amount at each foreclosure sale, even an over-secured commercial lender can still take a painful loss. An example will make this clearer.
Suppose a commercial lender has a $9 million blanket loan on an $11 million apartment building in Nevada and a $6 million office building in Pennsylvania. Suppose further that this lender is based in Nevada, and he is not terribly familiar with the Pennsylvania commercial real estate market.
The borrower bitterly contests and delays the Nevada foreclosure, but he offers no resistance on the Pennsylvania foreclosure. The commercial lender therefore completes his foreclosure on Pennsylvania building first. Local Pennsylvania foreclosure law states that a foreclosing commercial lender must make a reasonable foreclosure bid, absent specific contractual language to the contrary. At the foreclosure sale the commercial lender therefore bids $5 million. No one outbids him at the sale.
Important note: It is very rare, but not totally unheard of, for bidders to actively bid at commercial foreclosure sales. The reason why is because any bidder must pay all-cash, and commercial properties are usually far more expensive than homes. For example, five million dollars is a lot of cash (actually bidders use cashier's checks) to bring to a foreclosure sale.
Okay, so now the commercial lender owns the Pennsylvania office building for $5 million. This leaves just $4 million remaining on the $11 million Nevada apartment building. The commercial lender bids his $4 million at the foreclosure sale. When an $11 million apartment building goes to sale for just $4 million, this is one of those rare times when the Big Boys whip out their cashier's checks and outbid the commercial lender. Therefore the commercial lender only receives $4 million for his security interest on the nice, Nevada apartment building.
Now the trouble begins. The commercial lender discovers friable aesbestos in the Pennsylvania office building that costs $600,000 to remediate. Then the commercial lender's commercial broker drops a bomb. A local chemical company - the city's largest emplyer - is moving its nearby national headquarters to another state. Demand for office space in the area plummets, as the local economy tanks. The lender is only able to sell the office building for $3 million, and this formerly over-secured commercial lender ends up taking a whooping $2.6 million loss!
Okay, so what went wrong? The commercial lender foreclosed on the out-of-state property first, in a market that he did not know. Had he been based in Pennsylvania, he might have read about Orkin Chemical Company moving out of town. He would have known to have bid far less on the Pennsylvania office building.
The borrower also forced the commercial lender to foreclose on the Pennsylvania property first. If only the commercial lender had a choice of where he wanted to foreclose first, he could have foreclosed on the Navada property first, a real estate market that he knows. His foreclosure bid would have been far more precise.
The moral of the story is this: If a commercial lender is going to make blanket commercial loans, he needs to add a clause to his deed of trust or mortgage that allows him to foreclose on any property, in any order he wants, and to bid any amount he wants.
I want to thank my old mentor and good friend, Bill Owens of Owens Financial Group for his help with this blog article. Bill taught me the commercial mortgage business over thirty years ago. Owens Financial Group just successfully converted its private mortgage fund into a commercial mortgage REIT listed on the New York Stock Exchange. Wow!!!
Bill Owens reports that his REIT has plenty of dough with which to make new commercial mortgage bridge loans. He is looking for commercial bridge loans requests from $1 million to $10 million in the western states. You can reach Bill Owens at (925) 935 - 3840.
A long-time blog subscriber asked, "Why would the lender, who already put a $9M mortgage on the two properties, have to bid at the foreclosure sale?"
When a commercial lender forecloses, the commercial lender is required by each state's foreclosure law to bid an amount that he will accept in lieu of keeping the property. The maximum amount the commercial lender can bid at the foreclosure sale is everything that is owed to him - principal, interest, late charges, past due interest, default interest (which is just like regular interest but at a higher rate - say, 20% per annun rather than 11% per annum), trustee's fees, legal fees, and legal costs. A bid where a foreclosing commercial lender bids everything that he is owed is called a full credit bid.
Remember, its a foreclosure sale, not a foreclosure seizure. This is easy to forget because almost no one ever bids at commercial property foreclosure sales. If you are going to offer something for sale, there has to be some price that you will accept. That price is the lender's bid at the foreclosure sale.
By the way, did you know that many states will allow the agent of the foreclosing commercial lender to increase his credit bid at the foreclosure sale? For example, the commercial lender above could have started the bidding out at just $2 million. The foreclosing commercial lender will normally instruct his foreclosure agent as to a starting bid and a maximum bid. "Start the bidding at $2 million, Mr. Trustee, but if anyone is bidding against us, keep increasing your bid by an extra $10,000, up to a maximum of $5 million."