Placing a commercial loan on a very desirable commercial property is often problematic. When lots of commercial investors compete to own a well-located property (think of a well-maintained but small apartment building within walking distance of Chinatown), the prospective buyers bid up of the price. This drives down the cap rate, and the purchase money commercial loan simply does not cash flow.
For example, most small, average-quality, apartment buildings in average locations sell at cap rates of around 5.5% to 7.0%. You may recall that a cap rate is just the return on your money (think of it like an interest rate) you would earn if you bought an investment property for all cash.
But what if the small apartment building is within walking distance of Chinatown in any major U.S. city? The Chinese are admirable savers, and many Chinese immigrants do not drive. Therefore being within walking distance of Chinatown is a very desireable feature for an apartment building. Thrifty Chinese real estate investors would bid on that property like hungry sharks.
If the apartment building was generating $50,000 per year in Net Operating Income (NOI), the first buyer might offer $800,000 - which works out to a 6.25% cap rate, a fair price for an average quality apartment building in an average area. But then some other hungry investor might offer $875,000. "I'll pay $975,000!" shouts another investor. "No, I'll pay $1,250,00!" shouts another. Up and up the bidding goes, until some investor closes out the bidding at $1,428,000 - which works out to a cap rate of just 3.5%.
Then the winning investor goes to the bank and applies for a commercial loan. The loan officer at the bank, trying to underwrite the commercial loan, takes the $50,000 NOI and divides it by a 1.25% debt service coverage ratio. This produces a Net Income Available for Debt Service of just $40,000. Plugging $40,000 per year into his financial calculator, at a 5.0% interest rate and with a 25-year amortization, produces a maximum allowable commercial loan of just $564,000.
Now think about this for a moment. The purchase price is $1,428,000, and the maximum allowable new commercial loan is just $564,000. This means that the new buyer would have to put down a whopping $864,000. That works out to 60% down! This is because the property will only carry a new commercial loan of 40% LTV.
Small apartment buildings in Chinatown are not the only type of commercial property that will only carry a very small commercial loan. Here are some more commercial properties that typically sell at a very low cap rates: office condo's, industrial condo's, small commercial-investment properties that are affordable to a great many new commercial real estate investors, commercially-zoned homes on busy strips used as office buildings, small office buildings located close to a courthouse (attorneys love them), apartment buildings located near public transportation, and extremely well-located commercial properties, such as the grand buildings located near Central Park in New York City.
So how do you get a decent-sized commercial loan on such a property? One way is to get a preferred equity "loan" from Blackburne & Sons. Even though our preferred equity "loan" will not cash flow, we will happily add our preferred equity "loan" on top of a new bank commercial loan, in order to bring the capital stack up to 75% loan-to-value. This means the buyer only has to put 25% down.
Let's return to our example above. The bank will only make a new commercial loan $564,000 (40% LTV). Blackburne & Sons will place a $507,000 preferred equity "loan" behind the bank's new commercial loan, bringing the entire capital stack up to 75% loan-to-value. This means the buyer only has to put 25% down.
If you have a commercial loan request on your desk that seems to fit, you can apply for a preferred equity "loan" immediately by clicking on this link.
You may have noticed that I have always placed the word "loan" in quotation marks whenever I referred to a preferred equity "loan". That is because preferred equity is actually equity capital, rather than a loan. For a terrific whitepaper on preferred equity, written in simple layman's English, please click the gray button below.
