Our hard money commercial mortgage company, Blackburne & Sons, has continuously been in the market to make new commercial mortgage loans for more than 25 straight years. In other words, we're always in the mood to make commercial loans. This is not just some advertising plug. I have an important point to make in just a moment, and my point will be made in red. It will surprise you.
In contrast to the "always ready" hard money brokers, a great many banks are constantly in and out of the commercial mortgage market every few years. For two years a bank might be hot-to-trot to make commercial real estate loans. Then, for the next three years, the bank might turn down all but the most perfect commercial mortgage loans (about as common as unicorns). It's fair to say that 99% of the banks in the country today are only making commercial real estate loans to unicorns asking for perfect commercial loans.
So why are hard money brokers always in the market to make commercial real estate loans? Hard money brokers are just market-makers. They just have to lower the loan-to-value ratio and raise the rate until they reach a point where some private investor will invest in the loan.
For example, let's suppose the stock market is tumbling 500 points a day. Unemployed Americans are marching in the streets, and the demonstrations are becoming more and more violent every day. Already dozens of cars have been burned, and the police have been forced to fire over the heads of the protestors in order to quell the violence and vandalism. (I actually foresee this for America within two to three years.)
Now suppose a retired real estate investor owns a very nice office building in one of the more desirable areas of town. He owns it free and clear. Suddenly the retired investor gets nervous. He wants to have more cash in hand, so he applies to a hard money broker for a quick commercial loan. At the first the broker offers his private investors a loan of 70% loan-to-value at 12%. No one invests in the mortgage loan. The investors are too frightened to invest in a first mortgage. The true unemployment rate is over 20%, and there is far too much violence in the streets.
Therefore, the broker might cut the loan to 60% loan-to-value and re-offer the loan at 14%. If there are still no takers, he might eventually cut the commercial loan all of the way down to 45% LTV and offer the loan at a whopping 18% interest. Finally, the investors will probably start buying, and the loan will finally sell out. You could say that the loan has finally cleared the market. The hard money broker finally found that combination of low loan-to-value ratio and high yield that would prove irresistable to wealthy mortgage investors.
Therefore, for most modern and desirable commercial properties, there is some combination of loan-to-value ratio and yield that will allow a hard money mortgage broker to arrange a commercial loan.
Ah, but here's the rub! Here is the whole point of this article. Sometimes, because private mortgage investors are nervous, the interest rate on a hard money commercial loan has to be so high that the borrower cannot afford the monthly payments! And everyone loses if a hard money mortgage broker is ever forced to foreclose.
This is why Blackburne & Sons has recently developed the participation mortgage. A participation mortgage has a very low interest rate - say, 7.9% in a market where most hard money investors are demanding a yield of at least 14%. The missing yield is recaptured as an income kicker and and an equity kicker. In other words, the hard money mortgage investor takes a piece of any future increases in the property's gross monthly income and in the property's fair market value. In effect, the current owner of a commercial property gives up future income and appreciation, in return for a much lower monthly payment today.