Last week I blogged on the problems associated with LIBOR.  It is abundantly clear that something needs to be done to replace the LIBOR index as a measure of market interest rates.

I pointed out that $350 trillion in financial instruments worldwide are currently tied to LIBOR.  Regardless of which index the authorities end up using to replace LIBOR, the switchover is going to be tricky.  I can see in my mind’s eye some greedy attorney affixing a bib and rubbing his hands together in glee.  Yum.

The index that will be replacing LIBOR, at least here in the U.S., is the secured overnight financing rate (SOFR).  The secured overnight financing rate is a benchmark interest rate for dollar-denominated derivatives and loans.  The Federal Reserve Bank of New York began publishing the secured overnight financing rate (SOFR) in April 2018 as part of an effort to replace LIBOR.

The daily secured overnight financing rate (SOFR) is based on actual transactions in the Treasury repurchase market, where investors offer banks overnight loans backed by their bond assets.

Photo by Andrea Piacquadio from Pexels

Benchmark rates, such as the secured overnight financing rate (SOFR), are essential in the trading of derivatives—particularly interest-rate swaps, which corporations and other parties use to manage interest-rate risk and to speculate on changes in borrowing costs.

Interest-rate swaps are agreements in which the parties exchange fixed-rate interest payments for floating-rate interest payments. In a “vanilla” swap, one party agrees to pay a fixed interest rate, and, in exchange, the receiving party agrees to pay a floating interest rate based on the secured overnight financing rate (SOFR)—the rate may be higher or lower than SOFR, based on the party’s credit rating and interest-rate conditions.

In my earlier blog article, I pointed out that LIBOR had become the rate at which banks do not lend to each other because most banks are up to their gills in liquidity.  LIBOR had become nothing more than a guesstimate.  SOFR is therefore preferable to LIBOR since it is based on data from observable transactions.

Unlike LIBOR, there’s extensive trading in the Treasury repo market—roughly 1,500 times that of interbank loans as of 2018—theoretically making it a more accurate indicator of borrowing costs.

Interest rate swaps on more than $80 trillion in notional debt switched to the SOFR in October 2020.  This transition is expected to increase long-term liquidity, but it also may result in substantial short-term trading volatility in derivatives.

While SOFR is becoming the benchmark rate for dollar-denominated derivatives and loans, other countries have sought their own alternative rates, such as SONIA and EONIA.

Time will tell whether SOFR is a suitable replacement for LIBOR.  The difference between the two indices was that LIBOR was based on unsecured loans between banks, whereas SOFR was the rate that banks would loan to each other, but only if such loans were backed by rock-solid collateral.

What is going to happen if a Chinese destroyer trades missiles with an American destroyer?  Talk about “living in a powder keg and giving off sparks.”  Such an event could easily trigger World War III.

Suddenly the investment world goes into a risk-off mode.  Corporate bonds and stocks would likely plummet, while Treasuries and gold would likely soar.  Because SOFR is based on well-secured, inter-bank loans, SOFR might not increase that much.

At the same time, the demand for non-US-government debt will almost certainly plummet.  Yields on investment grade bonds could soar to over 20% in a matter of 48 hours.

What damage will be done to the U.S. financial system because SOFR materially understates real interest rates in the system?  Remember, over $80 trillion in financial instruments are already tied to SOFR.  I dunno; but it can’t be good.

My own company, Blackburne & Sons, will always be in the market – even during war time – to make commercial real estate loans.

That being said, the Company is moving more into the syndication business.  We are putting together syndicates to buy income-producing properties for all cash.  In other words, there will be zero debt.  That is where everyone should be if war does break out – trophy properties that are owned free and clear.

By George Blackburne

I have used six days because that is all that it took for the Israeli’s to smash the Egyptians, the Jordanians, and the Syrians during the Six Day War in 1967.

After the shocking surprise attack on Pearl Harbor on December 7th, 1941, the Japanese mopped up most of the American Far East Fleet and most of the British Far East Fleet near the Philippines, Wake Island, Indonesia, and Malaysia in less than three weeks.

Folks, modern wars can start and end pretty quickly, especially when one side – China  in this case – has superior weapons.  The United States is far behind the Chinese in hypersonic missiles.  Hypersonic missiles, as of now, are unstoppable.

Hypersonic missiles don’t really even need a warhead.  They travel so fast that their kinetic energy alone destroys any target.  They are so accurate that they can even strike their targets within a matter of meters.  God please protect our brave sailors.

The Chinese will strike first and without warning, probably taking out at least two of our aircraft carriers in the first salvo.  Air-launched hypersonic missiles will almost completely destroy our air bases on Guam.

While we will probably get a few planes and missiles off the ground, when our planes return from pounding Chinese missile sites, they will have no place to land.  The pilots can bail out, but our jets, each costing many tens of millions of dollars, will have to drop out of the sky.  A single F-35A costs $75 million.

We’re done.  It’s over.  Yes, our subs will get some licks in, but when a missile is conventionally-tipped, there is only so much damage that any missile can do, no matter how accurate it is.  China will pay an expensive price, but the Taiwanese War will be the end of America as the dominant world power.

Will China then leap-frog islands to bring their missiles within range of California and the rest of the country?  They pretty much have to rain missiles down on us until America has been bombed back to the Stone Age; otherwise we will eventually recover and strike back.

Fortunately, we have plenty of time – perhaps as much as two years.  What?  Just two years?   Yikes.  War is coming, folks.  I doubt there is a force on Earth that could stop it.  It’s like dropping a two-ton safe from 10,000 feet in the air.  Nothing is going to stop that safe from hitting the ground.

I have nothing against Joe Biden, but is he the Winston Churchill of our era or the Neville Chamberlain – that British Prime Minister who foolishly cozied up to Hitler before World War II?

So – BAM – much of the U.S. fleet in the South China Sea is suddenly and utterly destroyed.  The humiliation is total.

The U.S. now has to replace its fleet, at a cost of $30 trillion, build a dozen underground missile plants, build hundreds of thousands of complex missiles, and then protect its West Coast population from decimation.

From where is this money going to come?  Obviously we will have to sell $50 to $75 trillion in bonds; and now the world no longer wants them.  They don’t even want the U.S. dollar.

America used to be – because it was protected by vast oceans, because of its stable government, and because of vast military – the safest place on Earth to invest.  No more.  Now it will be the target of 1.2 billion angry Chinese.  They used have a population of 1.4 billion; but the U.S. military was not totally ineffectual.

My silly little blog articles are getting passed around (the world?).  I have been exchanging emails with a new buddy in Hong Kong, who is deeply patriotic towards his country.  “George,” he wrote to me recently, “you could kill one billion of us, and we would still outnumber the United States.”

So now we have 1.2 billion pissed-off Chinamen (probably a politically-incorrect term,  sorry) coming for us, and the U.S. has to totally rebuild its Navy and Air Force.  From where is all of this money going to come?  The U.S. government will have to print it.

Gold on Day 1:  $1,900 per ounce
Gold on Day 7:  $50,000 per ounce

Think this is crazy?  Here is a five-year chart of Bitcoin:

Bitcoin is $18,555 today; but I think I would rather own physical gold coins when the war actually breaks out.

What can you do?  If you live in California, get the flip out.  A house in the Boonies, where you can use Zoom, might work very well.  Have you been following the prices of homes in the mountains of Montana and Utah?  Through the roof.

I was proud as heck of my son, George IV, when he bought a used SUV this week with a trailer hook.  He may need that trailer hook to pull a light trailer, loaded with gas and emergency food supplies, to Indiana.

What can the U.S. do?  If I was Joe Biden, I would:

1. 1. Sacrifice Taiwan.  With our current technology, we can’t hold it, so there is no point in losing our fleet.
   2. Pull our fleet back to the East Coast.  Let’s not give the Chinese any chance to take out our carriers and our expensive aircraft on board.
   3. Let’s hurry up with the development of unmanned aerial refueling drones.  Our biggest problem right now is that Chinese missiles can outreach us.
   4. We need to grasp the concept of missile warfare and avoid investing more into antiquated aircraft carriers.  “Generals always fight the last war.”  Aircraft carriers are sitting ducks.  It’s no longer a question of whether Chinese carrier-killer missiles can hit our carriers.  It’s become a question of which window on our aircraft carriers will their missiles use.
   5. Instead, we need to covert at least forty old container ships to missiles ships.  Iran – of all countries – just created its first missile ship from a container ship this very week. The Iranians have obviously been studying many of the same military journals as I have.  Converted container ships cost 1/50th of the cost an aircraft carrier.  They are cheap.
   6. Underground-underground-undergound.  Our sharpest missile and computer engineers need to move to where they can be underground in less than two minutes.  Utah?
   7. Folks, I wonder whether we are just rearranging deck chairs on the Titanic.  China is already graduating five times more engineers and computer geeks than the U.S.
   8. Assuming we still have an outside chance, why are we making student loans to graduate more psychology students?   WTFudge?  Want a student loan?  Study missile technology!  STEM subjects only.
   9. Folks, I am an avid student of history.  I greatly worry that this war may already be over.  I find myself hugging and kissing my kids at every chance I get.  I am genuinely scared.

By George Blackburne

I am looking for an expert witness in a commercial real estate lending case.  You will be paid an expert witness fee for your time, and qualifying as an expert looks great on your resume or your website.  Here are the details.

Lesson From Business School:

Have you ever wondered why Elon Musk is so hell-bent on building new battery giga- factories all over the world so quickly?

The reason why is because that manufacturers have learned that the more experience they garner in building widgets, the lower their cost of building each widget.

As they build widget after widget, they learn a little trick here and a shortcut there.  Pretty soon these little tricks and shortcuts add up to some real cost savings.  This leads us to The 10% Rule.

The 10% Rule:

Every time a manufacturer doubles the number of widgets that he has ever constructed, his cost to manufacture each widget falls by 10%.  In some cases, his cost per widget falls by 15%.

It is important to appreciate the word, “ever.”  If Elon Musk had manufactured one-hundred thousand electric auto batteries in the entire life of Tesla, at a cost of $1,000 per battery pack, by the time Tesla had manufactured TWO-hundred thousand batteries, the company could reasonably expect to be able to manufacture each battery pack for just $900 each.

The Japanese taught us this lesson.  In the late 1980’s, the Japanese were eating our lunch in manufacturing.  Their cars were cheaper, and their quality was outstanding.  Japanese chip makers were rising to rival Intel, Advanced Micro Devices, and Texas Instruments.

Their bread-and-butter D-Ram computer chips were as good as ours, and they were selling them at less than their cost.  “Dumping!” cried Texas Instruments, in a complaint and lawsuit before the Federal Trade Commission.  “They are bidding against us on big computer chip orders, and they are quoting prices that are lower than their cost.  They are dumping D-Ram chips at less than their cost, just to steal market share!”

Oops.  By the time the case reached trial, however, the Japanese were able to prove that they had actually made a handsome profit on that big order.  Even though their cost per chip was $100 at the time they bid on that big order, and they bid $99 per chip on that big order, the order was so large that by the time they delivered the chips, their cost had fallen to just $90 per chip.

They Japanese literally “schooled” us, and that is why this manufacturing lesson is now taught in most U.S. business schools.

So whenever Tony Stark… oops, I mean Elon Musk… opens another huge battery giga-factory somewhere in the world, just nod your head and say, “You go, Elon!  Pull even further ahead in lowering your costs.”Did you know that Elon Musk actually did a cameo in one of the Ironman movies?   Haha!  Anyone else out there think that Gwyneth Paltrow, playing Pepper Potts, looked absolutely outstanding in that white outfit?

By George Blackburne

The opposing side is claiming that obtaining an MAI appraisal is not enough when making a commercial real estate loan.  They are claiming that every commercial lender should obtain two additional broker’s professional opinions, in addition to the expensive MAI appraisal.

If you currently work as a commercial real estate loan officer or as a senior commercial real estate lending executive for either (1) a commercial bank; (2) a credit union; (3) a nonprime ABS/Wall Street lender, such as Silverhill, Cherrywood, Velocity, etc.; or (4) a hard money commercial lending shop, you might be a good candidate to testify in this case as an expert.

Sorry, guys, but the testimony of a typical commercial loan broker might not help, unless have been an unusually successful commercial loan broker for more than twenty years.

The good news is that you will almost certainly not have to travel anywhere.  In this time of COVID, the entire case will probably be held using Zoom, so we are just talking about three or four hours of depositions and testimony before a computer screen.

Obviously you will receive an expert witness fee for your time, and having testified as an expert witness looks great on a resume and your website.

Will you serve a good cause?  If so, would you kindly write to me at the email address below, telling me of your current employment, your commercial real estate lending experience, and to what you might testify on the subject of the standard of care for commercial real estate lenders in connection with MAI appraisals.

I receive on average 1,350 emails per day, so it is critical that your Subject line please read exactly as follows, “Expert Witness.”

Thank you.

George Blackburne III, Esq.
george@blackburne.com

By George Blackburne

CLO stands for collateralized loan obligations, which are bonds backed by a collection of loans.  You can tell from the title of this article that some of these CLO’s are in trouble; but it is important to note that the troubled CLO’s are NOT the ones backed by bridge loans on commercial real estate.  The troubled CLO’s are the ones backed by junk bonds.  More on this later.

I was writing a training article this week about trust deed investing.  I pointed out to our prospective trust deed investors that real estate values tend to crash about once every ten to twelve years.  The lesson for the day was that trust deed investors should be very aware of where they are in the real estate cycle.

Trust deed investors can be very aggressive right after a financial crisis, after real estate values have already plunged by 45% and finally found a bottom.  Examples of financial crises include the S&L Crisis, the Dot-Com Meltdown, and the Great Recession.

But when it has been ten to twelve years since the last financial crisis, the wise trust deed investor should dial back his aggressiveness on his loan-to-value ratios.  He should be content with lower yields in order to compete for safer deals.

Curious, I started doing the math.  Let’ see, the Great Recession was in 2008.  Today is 2020.  Twenty-twenty minus 2008 works out to … holy crap… twelve years!

Then I read yesterday the most important article about the economy that I’ve read in five years.  It was an article in the Atlantic Magazine entitled, Will the Banks Collapse?  I strongly urge you to read the full article.

The gist of the article is this:  America’s largest banks are in serious danger.  They have a poop-ton of money invested in CLO’s – even more than they had invested in subprime mortgages in 2007.  These investments could easily evaporate, and the losses would wipe out 50% to 80% of their capital – the dough they’ve retained to act as a protective buffer against loan losses and which protects depositors.

Think back to Lehman Brothers.  The crash in subprime mortgages wiped out their capital.  Poof.  Bye-bye, Lehman Brothers.

What’s so wrong with CLO’s?  First of all, in order to distinguish between commercial real estate CLO’s (which are fine) and the troubled CLO’s backed by junk bonds, I am going to call the latter, junk bond CLO’s.

Normally big corporations, when they need money, can either borrow from a bank or issue bonds in the corporate bond market.  Corporate bonds with a maturity date of less than 270 days are known as commercial paper.  The commercial paper market has little appetite for bonds rated BB or lower, which we know as junk bonds.

These high-yield junk bonds are instead bought up by companies in the CLO business known as asset managers.  There asset managers bundle them into portfolios, create different tranches (slices of the portfolio which take different levels of risk), get the various tranches rated by a rating agency (Moody’s, Standard & Poor’s, etc.), and then sell off these rated bonds to institutional investors.  The high-yield bond market is also known as the leveraged loan market.

The riskiest tranches offer sky-high yields, but they will be the first to absorb any losses in the portfolio.  The lowest-yielding tranche, however, will often be rated AAA. Think about that.  You have a collection of junk bonds, issued by companies which are sometimes close to bankruptcy, and yet somehow some AAA-rated bonds magically emerge.

About now, some of you may be asking yourselves, “Hey, wait a minute.  I think I’ve heard this song before.”  Yup.  These are the same shenanigans that took place in the years leading up to the Great Recession with subprime mortgages.  As Dr. Phil might ask, “How did that work out for you?”

The author then goes on to point out that the theory behind junk bond CLO’s is that the default correlation is low.  The default correlation is a measure of the likelihood of loans defaulting at the same time.

The main reason CLOs have been so safe (in recent years) is the same reason (why) CDOs seemed safe before 2008.  Back then, the underlying loans were risky too, and everyone knew that some of them would default.  But it seemed unlikely that many of them would default at the same time.  The (subprime residential) loans were spread across the entire country and among many lenders.  Real-estate markets were thought to be local, not national, and the factors that typically lead people to default on their home loans—job loss, divorce, poor health—don’t all move in the same direction at the same time.  Then housing prices fell 30 percent across the board and defaults skyrocketed.”

Right now the U.S. economy is reeling from the coronavirus and the lockdown.  Name brand companies are filing for bankruptcy or closing stores in big bunches.  The default correlation today is far from low.  The Coronavirus Crisis has depressed the economy so badly that we are having a tidal wave of corporate defaults.  The losses in junk bond CLO’s are likely to wreck havoc, even in the the AAA tranches of large CLO’s.

During the Great Recession, Congress and the U.S. Treasury bailed out the big banks.  The author points out in his article that when the big banks report their losses in CLO’s, Congress and the American people may be far less forgiving than in 2008.  Instead of just Lehman Brothers, Congress and the Treasury may let a whole bunch of big banks fail.  The author suggests that the result may be lots of smaller banks focussed primarily on traditional business, like taking deposits locally and lending to local companies known to the bank.

Now let’s add a few more incendiary goodies to our explosive mix.  We still have not seen the wave of articles in the financial press talking about declining worldwide sales of raw materials and goods to China, the world’s number two market.  China was hurt pretty badly by the Coronavirus Crisis and the resulting worldwide condemnation.  I can’t imagine too many companies moving their manufacturing plants to China now.  Then we have China’s contracting money supply, when banks continue to rake in loan payments but fail to recycle the money into new loans.  So far China has successfully covered up their declining GDP, but sooner or later investors will realize that China is reeling.

Then we have the Presidential election.  It is looking more and more likely that Donald Trump could lose.  The left controls most of the press, so Mr. Trump could make a tough but probably wise decision (like encouraging governors to re-open their states before the U.S. economy completely cratered), but the liberal press would simply characterize the act as both the act of a dictator and as a failure of leadership at the very same time.  Haha!

With the coronavirus still active, Trump can’t bypass the press by holding huge rallies, like he did in 2016.  Perhaps the final nail in Trump’s coffin was when Twitter and Facebook began censoring and censuring his posts and political ads.  When it becomes clear that Trump might lose, the markets are not going to like it.

The only good news is that the Fed is flooding the markets with trillions and trillions of dollars.  The Fed is even buying up a bunch of junk bond CLO’s.  It has often been said, “Never fight the Fed.”  But what happens after the election, when the spigot of money is tightened?

My recommendation is to watch the price of gold.  Gold goes up, not so much during periods of inflation, but rather when investors lose confidence in the ability of corporations to make the payments on their bonds.  Unlike bonds, gold cannot default.  It will never go to zero (because women look so gorgeous wearing it).  I urge you to look at gold prices as the canary in the coal mine for the coming financial crisis.

By George Blackburne

Some more green shoots are visible as the bridge lenders are starting originations also.  The warehouse lending market (big banks lending to debt funds) has started up again, with more cautious leverage.  The warehouse lenders will also monitor loan collateral more closely.

The difference between a commercial mortgage banker and a commercial mortgage banker is that commercial mortgage bankers service many of the loans that they originate, normally for life companies.

The money in commercial real estate finance (“CREF”) is in loan servicing fees.  As I often say, “It’s the loan servicing fees, silly.”   An easy way to remember this is that mortgage bankers are rich, and mortgage brokers are poor.  Want to start earning huge loan servicing fees?

So where do debt funds get their dough their large commercial bridge loans.  We are talking here about bridge loans from $5 million to $100 million.

The general rule is that the sponsors of a debt fund will put up several million dollars of their own dough.  Then they will go out to wealthy individuals that they know, using a private offering, to raise, say $200 million.  They will make, say, $160 million in bridge loans.

Then they will go to a commercial bank and pledge the first mortgages in their portfolio for a $200 million to $250 million line of credit, giving them $400 million to $450 million in lending capital.

As the debt fund makes a profit, some of the earnings are retained as equity, giving the debt fund the ability to borrow even more.

But where do the sponsors of the debt fund go to raise their original $200 million?  Who invests equity into a debt fund?  The answer is mostly wealthy investors, family offices, hedge funds, and opportunity funds.

But what is a hedge fund?  A hedge fund is a limited partnership of investors that uses high risk methods, such as investing with borrowed money, in hopes of realizing large capital gains.  Investopedia defines a hedge fund as an aggressively managed portfolio of investments that uses leveraged, long, short and derivative positions.

There are two cool things about a hedge fund.  First of all, these public offerings do NOT have to be registered with the SEC.  Registration is a phenomenally expensive process, required before a company can go public, that involves extensive audits going back several years and immense legal documents.  The process can take almost two years, and the up-front cost is well in excess of $1 million  There are also ongoing legal costs of another $1 million per year.  Yikes.

Now remember, hedge funds do NOT have to be registered.  Why?  Because every investor in a hedge fund needs to an accredited investor, i.e., have a net worth, exclusive of his personal residence, of at least $1 million.  The SEC assumes that accredited investors are either smart enough to understand the risk or can afford to pay an advisor.

The second cool thing about a hedge fund is that a hedge fund can publicly advertise for more investors.  They just need to make sure that every investor is accredited.  This freedom to advertise is a huge deal.

So what is an opportunity fund?  An opportunity fund invests in companies, sectors or investment themes depending on where the fund manager anticipates growth opportunities.  In plain English, the manager invests wherever the opportunities lie.

Important note:  Opportunity funds often buy shares of stock in companies, known as equities.  In contrast, most hedge funds invest primarily in debt instruments.

Another difference between a hedge fund and an opportunity fund is that hedge funds investments are not publicly-traded investment instruments.  Opportunity funds, in contrast, are public offerings, offered to the general investing public.  In other words, you don’t have to be accredited to invest in an opportunity fund.  Interests in opportunity funds are typically offered by insurance plans, mutual funds, and other investment firms.

Some opportunity funds focus on real estate itself, REIT’s, and real estate debt instruments, such as mortgages, debt funds, mezzanine debt, and preferred equity.

Another concept to grasp is the concept of one fund investing in another fund.  A hedge fund might invest in a debt fund.  An opportunity fund might invest in a debt fund.  Therefore most debt funds are a fund of funds.

Now where the debt fund makes its dough is that it can often borrow for as little 3.5% to 4.0% and then make loans at 6% to 9%, plus loan fees.

Clearly debt funds are leveraged, and if the bank holding its credit line gets freaked out and calls its line of credit, the debt fund could be forced into liquidation.  The recent report by George Smith Partners that the warehouse lending market is loosening up is great news for debt funds and the availability of large commercial bridge loans.Commercial Mortgage Rates Today:

Here are today’s commercial mortgage interest rates on permanent loans from banks, SBA 7a loans, CMBS permanent loans from conduits, and commercial construction loans.

Be sure to bookmark our new Commercial Loan Resource Center, where you will always find the latest interest rates on commercial loans; a portal where you can apply to 750 different commercial lenders in just four minutes; four HUGE databanks of commercial real estate lenders; a Glossary of Commercial Loan Terms, including such advanced terms as defeasance, CTL Financing, this strange new Debt Yield Ratio (which is different from the Debt Service Coverage Ratio), mezzanine loans, preferred equity, and hundreds of other advanced terms; and a wonderful Frequently Asked Questions section, which is designed to train real estate investors and professionals in the advanced subject areas of commercial real estate finance (“CREF”).

By George Blackburne

The time to buy is when there’s blood in the streets.
— Baron Rothchild, 1815, Member of the Rothchild banking family.

There is an interesting story about this quote. Baron Nathan Rothchild was one of five sons of Mayer Amschel Rothchild.  Mayer was the founder of the famous and incredibly wealthy Rothchold banking family.  They made Sam Walton’s kids (Wal-Mart) look middle class.

Each of Mayer Rothchild’s five sons headed up a huge merchant bank in a different country.  Nathan Rothchild headed up the Rothchild Bank in Britain.

One way the Rothchild’s made big money was by syndicating huge bond offerings for their respective national governments.  There have even been suggestions (probably untrue) that the Rothchild’s encouraged war between countries so that each son could earn huge bond syndication fees selling war bonds.  George IV is in California, and Tom is here with me in Indiana.  Maybe I should encourage a big snowball fight between the states, and then have The Boys sell ice makers to each side.  Haha!

Okay, so the year was 1815.  Napoleon had just escaped from the Island of Elba, and the French king kept sending army after army to snuff out Napoleon’s little rebellion.  Napoleon had started out with just 30 members of his old Imperial Guard, but as soon as any French force would march on Napoleon, the troops would let out a great cheer, turn around, and join Napoleon’s side.  “Would you fire on your Emperor?” he once asked Marshall Ney.  Finally Napoleon sent a message to the restored Bourbon king, “There is no longer any need to send more armies after me.  I have all the troops I need.”  Haha!

The restored Bourbon king fled, and for the next 100 days, Napoleon mobilized all of France.  He reassembled the Grande Armeee, an army of 100,000 men.  The British, the Prussians, the Austrians, and the Russian were totally freaked out.  They had just fought Napoleon for almost twenty years, and they had finally defeated him.  Why won’t this little sucker just die?!

The aristocracy of Europe was gathered in Belgium to party, dance, and divide up the spoils.  Beautiful women, in fancy gowns, danced with their handsome officers to a wonderful orchestra – until a messenger staggered into the ballroom.  “Napoleon has stolen a march on us.  He has defeated the British at Quatre Bras.  Our army is in full retreat.”  Women screamed.  Some passed out.  Officers scurried everywhere.  The Duke of Wellington, who had never been defeated in battle, famously commented, “I have been humbugged.”

Wellington marshaled his beaten, but unbroken, troops, and emplaced them on the reverse slope of a row of hills overlooking the little town of Waterloo.  Placed there, Napoleon could not accurately aim his famous artillery at them because his gunners couldn’t see the British troops.  They had to fire blind.  The next day, as the Prussians rushed to help Wellington, Napoleon sent infantry division after infantry division marching up those hills.  Each time, the British drove them back.

I really admire Wellington because, even though he was personally a cold fish, he took wonderful care of this troops.  He had them lay down to present the smallest possible target to Napoleon’s endless artillery cannonade.  The French cavalry tried charging the British infantry, but the incredibly brave Redcoats quickly formed into squares and presented the French cavalry with a bristling wall of bayonets.  Horses will not commit suicide by hurling themselves onto bayonet points, so six different cavalry attacks came to naught.

But each time the Redcoats formed square, they became a perfect target for Napoleon’s artillery.  Thousands of brave British boys were blown to pieces, and as the Redcoats formed square each time, the squares became smaller and smaller.  Finally, the British were ready to be broken.

Vive L’Empereur,” shouted Napoleon’s never-beaten Imperial Guard, as they marched up that apparently deserted hillside.  When they were almost to the very top, with victory just steps away, Wellington shouted, “Stand up!”  The exhausted and decimated British survivors rose up like ghosts out of the mist and formed their famous “thin red line.”

Napoleon’s columns were twelve men across and hundreds deep.  The dense formation was designed to punch through any enemy line, but only a few Frenchmen could fire their weapons from this formation.  Wellington’s thin red line had only two men to a file, and every man could fire.  They wrapped themselves around the head of the French column and fired volley after volley into it.  The fresh French troops were stopped cold.  “Fix bayonets!” shouted the few surviving British officers, who had bravely stood in place as their troops had lain down.  “Charge!”

The Imperial Guard broke and ran.  After the battle, Wellington made his laconic but famous comment, “It was a close-run thing.”  Four days later, Napoleon surrendered for good.

Nathan Rothchild had been hard at work as well.  His pre-assigned agent jumped onto a fast mail packet the instant the Battle of Waterloo was over, so Nathan had a jump-start on the markets.  At the time, Consols – the British equivalent of Treasury bonds – were struggling because of the British loss at the Battle of Quatre Bras the day before.  Who wants to own the debt of a country that is about to be overrun by Frenchmen?

Taking advantage of his prior knowledge, Rothchoild started to sell Consols short in huge quantities.  “Oh, my God. Rothchild knows.  Rothchild knows (that we lost at Waterloo).  Sell my consols at any price!” shouted hundreds of traders. …  A terrible run on Consols began.

Until Rothchild suddenly changed position and bought up enormous quantities of Consols for pennies on the dollar.

I am not telling you guys to run out and buy stocks because there is blood in the streets.  In three weeks, I predict that the new, hot story in the final press might very well be about how orders from China, the world’s second largest market, are down by 60%.  This may initiate the second down leg in the stock market, which I fear will bring us about 20% lower than our recent lows.

No, I wrote this article for for my private investors, urging them to snap up our hard money first trust deeds.

“Right now just about every bank in the country – almost all 4,000 of them – is out of the commercial mortgage market.  While commercial loan demand has plummeted, we are seeing some very, very attractive deals.”

“Folks, you have to be smart.  Until this crisis, 4,000 commercial banks and another 5,000 credit unions were competing against us in the small balance commercial loan market.  Poof!  They were suddenly and completely gone.  For the next few months, we have the market largely to ourselves.”

Commercial Mortgage Rates Today:

Here are today’s commercial mortgage interest rates on permanent loans from banks, SBA 7a loans, CMBS permanent loans from conduits, and commercial construction loans.

Be sure to bookmark our new Commercial Loan Resource Center, where you will always find the latest interest rates on commercial loans; a portal where you can apply to 750 different commercial lenders in just four minutes; four HUGE databanks of commercial real estate lenders; a Glossary of Commercial Loan Terms, including such advanced terms as defeasance, CTL Financing, this strange new Debt Yield Ratio (which is different from the Debt Service Coverage Ratio), mezzanine loans, preferred equity, and hundreds of other advanced terms; and a wonderful Frequently Asked Questions section, which is designed to train real estate investors and professionals in the advanced subject areas of commercial real estate finance (“CREF”).

Beer Drinking With George Tonight

Tonight (May 4th) at 5:00 p.m. Eastern Time, I am going to hold a Zoom BS session to just chat, share, and gossip about the amazing happenings in commercial real estate finance.

There is no cost to attend, but I would really like it if each of you would hold up a beer, a wine, or a mixed drink to show you truly grasp the spirit of the occasion.  This chat is supposed to be, first of all, fun; but I suspect we will all learn some interesting things as well.

There is no fixed agenda.  This is not a training class.  I’ll make a few observations about how to survive and prosper in a weird market like this, but after that, the floor is open to anyone to chat about anything related to commercial real estate finance.

To get into the meeting, please write to me, George Blackburne III (the old man), at george@blackburne.com for your Zoom instructions.

I literally get 1,350 emails every single day, seven days per week, so it is please VERY important that your subject line read, “Beer Drinking With George.”

We have 31 people signed up for tonight, and I am going to cut it off at 35.  If you don’t get an invitation, I’m sorry, but you missed the cutoff.  You’ll just have to get drunk on your own.  Darn!

I am using the free version of Zoom, so they will cut me off after only 40 minutes.  I urge those of you who have signed up not to be late.  It would be great if some of you could please bring either some hot commercial lenders to recommend or some related observations to share.  Thanks!

By George Blackburne

Wrap your head around the concept that every business owner in the entire country needs cash right now.  His bank is definitely not going to loan it to him.  Banks today are terrified.  Here is exactly how to find some small commercial real estate loans during this Coronavirus Crisis.

I want to emphasis the word, “small” commercial loans.  Small commercial loans close.  Commercial loans larger than $1.5 million have a closing rate that is 1/20th of smaller deals.  One-twentieth (1/20th)!  You are foolish to work on commercial loans larger than $1.5 million right now, when every large commercial lender in the country is hunkered down in his bunker.

Go to Google Maps and type in the address of your office.  You will notice on the map a number of businesses plotted close to your office.  Ignore the big businesses, like the huge car dealerships and the huge national banks, like Chase.

Then call them up and ask to speak with the owner.  At first the receptionist might try to protect him from you, thinking that you are a salesman.  Explain to her that your company loans money to businesses, and right now her boss’ business almost certainly needs money.  You might also mention that you are located right around the corner from her boss’ business.

Perhaps the first time you will be sent to voicemail, but that’s okay.  Make your pitch and leave your phone and email address.  You might call the receptionist back and explain that you left your name and number on his voicemail; but if she will please give you her boss’ name and email address, you can send him more information about a coronavirus business support loan.

I just invented that term tonight.  Sounds pretty good, huh?  A coronavirus business support loan.  If the receptionist fights you, you might politely remind her that her job might depend of her boss getting some business support cash right now.

Instead, focus on the small restaurants, the mobile home parks, the auto repair shops, the hairdressers, the RV parks, and the little retail shops.

Now the first time you reach out to the boss of the auto repair shop, he might not respond.  Keep leaving messages.  Make a call list, and try to call thirty small, nearby businesses every day.  Explain that your mortgage company is located right just down the street, but that you are working from home right now due to the crisis.

Send the business owner a new email every four days, personally addressed and referencing his particular business.  “Hey, Steve, this is Don from Jackson Mortgage, right around the block from you.  I drive by your auto repair shop there on Madison Avenue almost every day.  You must need cash right now, and I may be able to help.”

As the days go by, slide left and right on Google Maps to find even more businesses to solicit.  It is important that your potential customers – and their receptionists – understand that you are located very close to them.  You are not some call center located in the Philippines.

When you get a deal, please do NOT call or email me.  I’m retired.  Phew!  Stressful times.  Haha!  Instead, please call Alicia Gandy, our largest commercial loan originator, at 916-338-3232 x 310.  We call Alicia our Loan Goddess.  Yes, she’s that good.  You can also call my wonderful, first-born son, George Blackburne IV, at 916-338-3232 x 314.

Remember, because you know Blackburne & Sons, you know one of the only conventional commercial lenders in the entire country still making commercial real estate loans.  We just closed a $1.65 million commercial loan on a hotel in the heartland on Friday.

Final lesson:  Alicia Gandy – we call her our Loan Goddess – will be absolutely killing it over the next two years.  Her fastest and best service will go to those commercial loan brokers who brought her deals when the market was saturated with competing hard money mortgage funds.  These loyal commercial loan brokers have a relationship with her.

Those competing hard money mortgage funds are all gone now – along with the dinosaurs and the dodo birds.  Going forward, you also need to develop a relationship with Alicia and George IV, so they will be especially loyal to you when the proverbial stuff hits the fan.

Remember, Blackburne & Sons put together a fresh syndicate* of wealthy private mortgage investors on every deal.  There are always savvy investors willing to invest when blood is running in the streets.  It’s just a matter of price (interest rate).  Therefore, we were able to stay in the market every single day of the S&L Crisis, the Dot-Com Meltdown, and the Great Recession.

We are a small family company, and only a handful of brokers know us.  That’s huge for you!  So get out there and feast.  Every business owner in America needs money right now.

Hard money mortgage funds rely on fresh deposits to make new loans.  When the financial markets are in turmoil, not only do new deposits dry up, but existing investors line up to withdraw.

Remember, every business owner in America needs money right now.

Are any of you guys savvy stock pickers?  If so, you might want to consider shorting those companies which provide services to the construction industry.  For example, those companies that manufacture, deliver, and/or set up huge construction cranes are likely to face some tough years ahead.

Why?  There may be very little new commercial construction – apartments, office buildings, shopping centers, residential subdivisions – over the next three years.

The reason why is because the banks have stopped making new commercial construction loans.  Banks are terrified right now, and the first thing that banks do when they get scared is to stop all commercial real estate lending.

This lending freeze is especially true of commercial construction loans.  I have lived through three commercial real estate crashes in my forty years in commercial real estate finance (“CREF”) – the S&L Crisis, the Dot-Com Meltdown, and the Great Recession.  Each time commercial real estate declined by almost exactly 45%.  Remember that number – 45%.  Commercial real estate may decline by 45% again as a result of this Coronavirus Crisis.*

It’s almost like a game of musical chairs.  Whichever banks are caught with construction loans outstanding are the ones that take the largest losses during the commercial real estate crashes that seem to happen about once every twelve years.

It is important to grasp the concept that local commercial banks make 95% of all commercial construction loans.  Construction loans are are funded gradually, as the work progresses.  If you just gave a developer $5 million to build an apartment building, he’s likely to skip the country, along with Lola La Boom-Boom, to some sunny beach to South America.

Because Lola looks awfully good in a string bikini, we simply cannot trust Don Developer with all of the money at once.  Instead, the proceeds of the construction loan are paid directly to Don’s subcontractors, and they are paid only after the subcontractors have correctly completed their work.  The bank has to sign off on this work too, after it has made a progress inspection.  A progress inspection is a quick inspection by a bank employee to verify that certain construction work has been properly completed.

Every ten or fifteen days the bank has to send a loan officer out to the construction site to take a look at the progress of construction.  The subcontractors will be clamoring to get paid.  Some huge New York bank, for example, couldn’t possibly fly a loan officer all the way out to Phoenix every two weeks to make these inspections.  This is why commercial construction loans are almost always made by local banks.

“But George, if the banks are too scared to make construction loans right now, why can’t some other type of enterprising commercial lender start making them?”

There are several problems with this.  First of all, banks offer construction loans at rates as low as 4.25%.  I actually had to look up the current rate on commercial construction loans for this blog article, and do you know where I went?  I actually went to our new Commercial Loan Resource Center, which always shows you the latest interest rates on commercial real estate loans.  Haha!  If you have not checked out our new Commercial Loan Resource Center, you are really missing out.  Totally free.

A competing commercial real estate lender (private money lender) might have to charge 8% to 11% for a construction loan, and that higher interest cost would cut deeply into the developer’s profit.  An extra 4% interest on a $5 million construction loan is real money.

The second problem is that construction loans have to be disbursed as the work progresses.  That means that the lender has to sit on his dough, not earning any meaningful interest, until the developer is ready to draw down on his loan.  That’s not very attractive for non-bank commercial lenders (think private money lenders).

The private money lender could fund the entire loan proceeds into a builder’s control account and demand that the developer pay interest on the entire loan amount from Day 1; but this would be horribly expensive for the developer.  A builder’s control account is an independent escrow set up to hold the proceeds of a construction loan until certain work is done.

The last problem with having a private money commercial lender make construction loans is that the lender will often be located too far away to make timely progress inspections.  Suppose the lender is based in San Diego and the project is located in Phoenix.  Progress inspections would be hard… but not impossible.

It has occurred to me that a great many developers across the country have started residential subdivisions, and they personally guaranteed their acquisition and development loans (“A&D”).  They had their normal bank all primed to make the construction loan, once the horizontal improvements were in place.

An A&D loan is a loan to a developer to buy the land, to get it properly zoned, and to complete the horizontal improvements.  It’s like a pre-construction loan.

Horizontal improvements including the clearing of the land, grading of the land, compacting the land, and installing streets, curbs, water, sewer, and power.

Now imagine you’re a very good homebuilder, a responsible guy who tries not to use excessive debt or take too many chances.  You have successfully built out and sold off five previous residential subdivisions.  You have built up a respectable $7 million net worth.  You take out a $4 million A&D loan on your next subdivision.

Suddenly the Coronavirus Crisis hits, and the $4 million balloon payment on your A&D loan, which you have personally guaranteed, is due in just three more months.  Your bank notifies you that they will not be making any construction loans for the foreseeable future.  You contact two dozen other banks, and they all say the same thing.  “Quick, Jack, what do you do?”  (Famous movie line.  Can you name it?  Hint: The bad guy lost a finger defusing a bomb.)

I think there is a real opportunity for some mortgage funds, if any of them have survived, to fund the completion of this project for the developer and to charge him an equity kicker of an absolutely insane percentage (85%?) of the profits.  What choice does the developer have?  He personally guaranteed the A&D loan!  He simply must get out from under that personal guarantee.

An equity kicker is additional interest, in addition to the nominal interest rate, that takes the form of a share of the increased value of the property or a share of the profits upon sale.  A common equity kicker might be 10% to 30%.  The nominal interest rate is the interest rate stated or “named” on the note.

Conclusion:

If your brother-in-law is a union carpenter, he would be smart to apply right now for a job delivering goods for Amazon or Wal-Mart.  His construction job is not coming back.  There will be very few commercial construction loans funded over the next three years, which translates to very few required construction jobs.

*President Trump and the Fed are determined not to let commercial real estate fall by 45% again, so they are using massive deficit spending and even more massive quantitative easing to keep the U.S. economy from deflating like a pierced balloon.  The problem is that China is not taking similar inflationary steps.  I fear a deflationary tidal wave coming from China later this year, and that wave will impair much of Trump’s and the Fed’s inflationary efforts.  I will blog on what this deflationary tidal wave might look like later in the week.

By George Blackburne

If you need a commercial real estate loan right now, there are very few remaining commercial lenders from whom to choose.

Because of the Coronavirus Crisis, almost every commercial bank in the entire country is out of the commercial mortgage market. 

Commercial banks are herd animals, and they are easily frightened.  They are all waiting for the danger to completely pass before venturing timidly back into the market.  “Oh, my Goodness, are we going to have a depression?”  (Actually, we might.)

If you are a real estate developer, and you will be trying to get a commercial construction loan later in the year, you may really be screwed.  I just can’t see the banks coming back into the commercial real estate loan market for a very long while.

Quick Training Note:

In the first paragraph, I used the term, commercial bank, rather than just bank.  This is to contrast a commercial bank from an investment bank or a merchant bank.  Investment banks (think Goldman Sachs and Morgan Stanley) sell equity investments (stocks) and help companies to go public. 

A merchant bank is a very different animal.  Merchant banks today make very high interest rate loans (mezzanine loans, preferred equity investments, and venture equity), or they make direct equity investments in start-ups and young companies.

Merchant banks are often subsidiaries of bank holding companies and life insurance company holding companies.  They are where the super-rich owners of banks and life companies speculate and gamble in high finance.  There are probably fewer than 50 bona fide merchant banks remaining in the entire country.  If you are ever at a commercial real estate finance trade show, and some guy describes himself as a merchant banker, 99% of the time he is full of poop.

The second training note is that 95% of all construction loans are made by commercial banks.  This means that very few commercial construction loans will be made over the next three years.  If your brother-in-law is a union carpenter, working in commercial construction, he may not be working for awhile.

Okay, Back to the Destruction of the Commercial Lending Market:

Last week I wrote that the asset-backed securities (“ABS”) market is drying up.  This means ABS commercial lenders, like Silver Hill, Velocity, and Cherrywood, are likely to remain out of the commercial loan market for a very long time.

CMBS bonds – investments secured by large first mortgages on shopping centers, office towers, and industrial centers – have taken a beating since the start of the Coronavirus Crisis.  I think the plunge in CMBS bond values must be more than 20%.  I can’t see bond buyers rushing back into a low-yield market, where they just lost 20% of their principal.

As a result, no new CMBS loans are being closed… at all… period.  The CMBS industry never completely recovered from the Great Recession, and this new setback may leave the industry without even the slightest wind in its sails for several more years.  

It’s really a shame.  The CMBS loans written over the past five years have truly been of superb quality.  “Hey, Federal Reserve and the Treasury Department, you can buy CMBS bonds right now, save the entire industry, and earn some really nice yields, all at no real risk to the U.S. taxpayer!”

But commercial real estate income has coodies right now.  Eeeuuu.  Don’t touch it.

The abhorrence of any type of commercial real estate income is so bad that Freddie Mac and Fannie Mae, in their SBL apartment loan programs, won’t let their underwriters use one penny of income from any commercial units.  Let me explain this more clearly.

SBL stands for Small Balance Loans.  Both Fannie Mae and Freddie Mac have competing apartment loan programs with terrific, low interest rates.  Their Small Balance Loan programs are for apartment loans of between $1 million and $7 million.

Many apartment buildings in big cities are built as relative high-rises, and they have retail units on the ground floor.  Perhaps one of the retail units will have a convenience store, a hairdresser, or a clothing store.

This type of building, with retail units on the bottom floor and apartments above them, is known as a mixed use building.  Mixed use does not mean a mixed combination of office and retail units, nor does it mean retail units on the street and self storage units in the back.  That is known as a mixed commercial center.

Historically, Fannie Mae and Freddie Mac will finance mixed use buildings, as long as the income from commercial units does not exceed 20% of the total scheduled income.  But no longer.

While Fannie Mae and Freddie Mac will still finance mixed use buildings, they will not use even one penny of scheduled commercial income.  The deal has to fly based solely on the income coming in from from the residential units.  In other words, they will only go around 12% loan-to-value on mixed use properties right now.  I’m kidding, of course, about the 12% LTV.  They might even go 13% LTV.  Haha!

Income from commercial real estate has coodies.  Eeeuuu!

But then the bombshell dropped this week about hard money lenders.  With the banks, the CMBS lenders, and the ABS commercial lenders out of the market, you would think that the hard money lenders would be making a killing.

A dear friend of mine, a fellow old veteran, read to a list to me this week of twenty-one of the largest commercial hard money lenders in the country that had either dropped out of the market or completely closed their doors.  The list was a veritable bloodbath.

Each of these failed commercial hard money lenders had one thing in common.  They were funds.

I have written extensively over the years that most hard money mortgage funds are almost Ponzi schemes.  In order for the sponsor of a hard money mortgage fund to survive, it needs to be constantly bringing in new deposits and making new loans.  It needs those new loan fees to make payroll and to pay for loan servicing and for the management of the inevitable foreclosed properties.

But here’s the thing.  Every twelve years or so (four times now since 1980), commercial real estate crashes by 45%.  We had the S&L Crisis, the Dot-Com Meltdown, the Great Recession, and now the Coronavirus Crisis.  Am I saying that commercial real estate will crash by 45% in this crisis?  No one knows for sure, but if history holds true to form…

So when commercial real estate crashes, the private investors in these hard money mortgage funds all line up to withdraw.   Yikes, there is no new money with which to make new loans.  Any payoff’s go to the investors lined up around the block to withdraw.  No loan fee income is flowing into the sponsor of the hard money mortgage fund.  He has no money with which to pay his loan servicing, property management, and accounting staff.  Bam!  The company goes belly-up.

So twenty-one of the largest commercial hard money mortgage funds have gone belly-up in the past three weeks.  Who does that leave to make commercial loans?

Blackburne & Sons is one of about forty surviving commercial hard money shops that syndicate every loan that they make.  We do not use a pool to fund our loans.  We send out an announcement to our wealthy private investors, and then we assemble a syndicate of these guys to fund each loan.  Every deal uses its own syndicate, and every syndicate has different members than the deal before.

I know that this sounds painfully slow, but the truth is that with email and DocuSign, it can be a very speedy process.

Summary:

Well over 98% of all commercial real estate lenders in the entire country are out of the market, and they are likely to remain out of the market for several years.

Even hard money lenders have gotten crushed.  Fortunately, about forty hard money shops that syndicate every commercial loan have survived to help out through the Coronavirus Crisis.

Heavens, the world was doing so well.  A trade deal had been reached with China.  Unemployment was at fifty year lows.  Real wages were increasing by over 3% per year.  And then, bam!  “Man plans, and God laughs.”  — old Yiddish saying

Attention Commercial Loan Brokers:

My Heavens, this is the greatest time in the history of commercial loan brokerage for you to make money.  You could make hundreds of thousands of dollars this year brokering commercial loans; so turn off Netflix and get your tail to work!

You can’t rely on referrals in this market.  Your will have to find the commercial borrowers yourself.  But here’s the thing – every business owner in the entire country needs cash right now!  It’s like shooting ducks in a barrel.

Go onto Google Maps.  Plot your home or office address.  Surrounding your office you will see scores of businesses.  Call them!!!!!  Speak to the owner.  Does he own his commercial building?  If so, you already know he needs cash.  Start gathering up his loan package and get it to a commercial hard money shop that syndicates its investors to fund deals.

Naturally, I recommend Blackburne & Sons.  Oh, my goodness, you could make soooo much money right now.  American businessmen desperately need you because you know the one place to get money.  Work!

By George Blackburne

The Coronavirus Crisis is now the fourth commercial real estate crash that I have experienced in my forty years of running our family commercial mortgage company, Blackburne & Sons.  They seem to happen about once every twelve years.  Each time commercial real estate fell by exactly 45%.

To those of you who are commercial loan brokers, you should keep working!  There is some serious money to be made during these crashes.  The old, savvy real estate investors know that the best time to invest is when blood is running in the street.

The first commercial real estate crash began in 1986, when President Reagan changed the income tax laws to eliminate the tax shelters previously provided by commercial real estate.

Prior to 1986, a surgeon earning, say, $500,000 per year could shelter, say, $150,000 of his income from taxation by buying highly-leveraged apartment buildings or commercial properties.  The depreciation from these rental properties provided a paper loss – often without too much of a negative cash flow.  These paper losses could be used to reduce the amount of the physician’s taxable income.

When rich guys could no longer use depreciation to shelter their earned income – bam – the value of commercial real estate suddenly plunged like a falling rock.  By the time the crash was over, commercial real estate values had fallen by a whopping 45%.  Please remember that number – 45%.

Savings and Loan Associations (“S&L’s) were heavily invested in first mortgages on commercial properties.  By 1992, one-third of them had failed.  The Resolution Trust Corporation (“RTC”) came in, closed up 3,234 of these S&L’s, and then sold off their foreclosed apartment buildings and office buildings at fire-sale prices.

The RTC offered these buildings at just 50% of an already-depressed fair market value, but the purchase had to be for all cash.  Since 95% of banks in the country were out of the commercial real estate loan market, hard money brokers had an absolute field day.  So did the commercial loan brokers who stayed in the market, originating commercial loans for them.  (Please read that last sentence again.)

In October of 2002, the NASDAQ crashed by 78%, when most of the big dot-com stocks melted down.  Commercial real estate crashed by 45% during the Dot-Com Meltdown.  Once again, there is that magical number:  45%.

Once again, almost all of the banks pulled out of the commercial lending market in 2002, and they stayed out for more than four years.  Banks are nothing but a bunch of frightened herd animals.  Once the bottom (nadir) of the real estate cycle had been found, banks should have been making commercial loans like crazy.

During every one of the commercial real estate crashes in my lifetime, commercial real estate fell by 45%.  After hitting a bottom about two-and-half years into each crisis, commercial real estate recovered to new highs within three years.

But I was thrilled that the banks were a bunch of scarety-cats.  Surviving hard money shops (“Aye, there’s the rub,”), like Blackburne & Sons, made a killing after the Dot-Com Meltdown.  We were the only guys at an all-girls school dance.  Our best commercial loan brokers, who brought us all of our deals, made a killing too.

During the Great Recession, commercial real estate once again fell by 45%.  There is that number, 45%, again.  Just as during the previous crises, the banks immediately dropped out of the commercial loan market, and they stayed out of the market for far too long.

Hundreds and hundreds of hard money mortgage companies also closed up shop during the Great Recession, leaving Blackburne & Sons, and just a handful of others, as the last men standing.  Once again, as the only guys at the dance, we all found lots of dance partners.  We made a ton of superb quality loans.  The commercial loan brokers who brought us these deals made a fortune.

Why did so many competing hard money shops close their doors?  Answer:  Because most of them were structured as funds.  As soon as the crises hit, all of their investors lined up to withdraw their investments.  Previously, these mortgage funds made 85% of their money by making new commercial loans and earning new loan fees.  With no new money flowing into their funds, these hard money shops had no dough with which to make new loans and to earn new loan fees with which to make make payroll.

The situation is even worse today for hard money shops.  Ninety-five percent of them are structured as mortgage funds – as opposed to just 55% of them before the Great Recession.  Your favorite hard money commercial lender?  I’d be surprised if it ever made a commercial loan again.

Do you own a hard money commercial mortgage fund.  Don’t be pissed at me for telling the truth.  You’re screwed, but you can still save your company.  Announce to your investors immediately that you are now charging 390 basis points (3.9%) for loan servicing fees and property management fees.

The single best thing you can do for your hard money investors is to stay in business –  calling for late payments, force-placing fire insurance, exercising your assignment of rents, getting receivers appointed, moving properties out of Chapter 11, hiring property security companies, cleaning up the properties, winterizing the properties, renovating the properties, renting the properties, and selling the properties.

Yeah, your private investors will be pissed at you for awhile.  Remember, however, that most of then are invested in several different hard money mortgage funds.  When their other hard money shops close up entirely, their whole attitude will change.  The portfolios of these competing mortgage funds will get devastated by vandals, breaking pipes, and even worse, by greedy attorneys and their fees.  Your investors will bless you for raising their loan servicing fees and property management fees, thereby staying in business.

Anyway, now back to the needs of our commercial loan brokers.  Blackburne & Sons doesn’t use a mortgage fund.  We syndicate every new commercial loan that we make – maybe 30 investors or so per deal.

Now the sexy thing about being a syndicator is that wealthy private investors always have dough to invest.  It’s merely a matter a price (interest rate).  Therefore Blackburne & Sons intends to stay in the market, making commercial real estate loans, every single day of the Coronavirus Crisis – just like we did during the S&L Crisis, the Dot-Com Meltdown, and the Great Recession.

If you are a commercial loan broker, your eyes should be seeing dollar signs right now.  The banks are now out-of-the-market, and so are 95% of the commercial hard money mortgage funds.  Commercial loan brokers by the tens of thousands have probably resolved to find another occupation.

Because of the Coronavirus Crisis, commercial real estate is likely to once again fall by 45%.  All of the banks will soon be out of the market.  They will no longer be competing against you.  You have broken into the clear.  The businessmen near you who own commercial real estate surely need money, and you know one of the few commercial lenders still making loans.   Go feast!

Contact every business owner you know who owns commercial real estate.  Do you need cash?  Seriously, who doesn’t need cash right now?

By George Blackburne

Conduit loans, also known as CMBS loans, enjoy a fixed rate for a whopping ten years.  Unlike a fixed-rate commercial loan from a bank, there is no rate readjustment after five years.  The rate is fixed for the entire ten years.

And with ten-year Treasuries at just 0.79%, there has never been a better time in history to get ten-year, fixed-rate conduit loan.

Conduit loans are priced at some negotiated spread over the higher of ten-year Treasuries or corresponding interest rate swaps.  Here is where you go to find ten-year Treasuries.  Here is where you go to find today’s interest rate swaps (as known as the swap rate).  Here is another site that provides interest rate swaps.

Today (3/8/20), ten-year Treasuries are at 0.79%, and ten-year interest rate swaps are at 0.81%.  Therefore we will use the higher of the two indices – interest rate swaps.

Okay, but what is the spread or margin over the index?  Conduits are pricing their office, retail, and industrial commercial permanent loans at 140 to 290 basis points over the index.

Therefore, we are talking about conduit commercial loans priced at between 2.21% to 3.71%.  Wow!  So who gets the 2.21% rate, and who has to pay 3.71%?  It depends on the loan size, the risk, the debt yield ratio and the tenancy.

The larger the deal, the smaller the spread.  The safer the deal, the lower the spread.  For example, if your property is located on Madison Avenue in New York City, you will enjoy a lower spread than a deal located on a nice retail street in Salt Lake City.  Madison Avenue is a more proven location.

There are some properties, however, that sell for such incredibly low cap rates – for example, Madison Avenue in New York City – that the debt yield can be too low.  This is a bad thing.  Sometimes the debt yield ratio on that Salt Lake City property can be more attractive to a CMBS investor.

Do not confuse the debt yield ratio with the debt service coverage ratio.  Interest rates are so low that it is easy for most commercial properties to offer a 1.25 or higher debt service coverage ratio today.  The ratio is almost irrelevant when it comes to conduit-size deals ($5MM and larger).

The quality of your tenants also determines your spread over the index.  Quality refers to strength of your tenants.  If you have a shopping center anchored by Target or Krogers, you will enjoy a tighter spread than a shopping center anchored by a mom and pop grocery story.

CMBS loans are made by commercial real estate mortgage investment conduits “REMIC’s”, known as conduits.  There are specialized commercial mortgage companies that originate large, cookie-cutter commercial permanent (long term first mortgage) loans for eventual securitization.  In layman’s terms, a conduit loan is a very plain-vanilla first mortgage on one of the four basic food groups – multifamily, office, retail, and industrial properties.

Is your deal kinky?  Does it need a long story to explain it.  If so, its probably not a conduit-quality deal.

But it is important to note that your property does NOT need to be almost brand new and very beautiful.  Life company lenders demand such properties, but most conduits would be perfectly happy to make $8 million permanent loans on forty-year-old neighborhood shopping centers or on occupied, downtown, office buildings.

Every commercial lender prefers to make loans on multifamily properties, so the spreads on multifamily deals are about 10 bps. tighter.  You will not be shocked to learn that hospitality spreads are fifty basis points higher than standard conduit deals.

What about loan-to-value ratios?  You will seldom get a conduit lender to go higher than 65% LTV on a hotel.  The loan-to-value ratios on the four basic food groups are typically between 70% to 75%.  The higher the LTV and the lower the debt yield, the higher the spread (and eventually the higher the interest rate) that the borrower will pay.

Lastly, conduit lenders do NOT lock in their rates at application.  Most of them will, however, lock in their spreads, while the conduit commercial loan is in processing.  That being said, there will be a floor of 5 bps. to 10 bps. below the interest rate quoted at application.  In other words, if interest rates go up during application, the borrower will have to pay a higher rate.  If interest rates fall, the borrower might enjoy a slightly lower rate.

Investors, I know you are all freaked out that you might die from this coronavirus (its out to kill all of us “old-gomers”); but you can apply for a conduit loan from the safely of the virus bubble in your home.  Focus.  If you can close a conduit commercial loan during this crisis, your cash flow, and that of your heirs, will be fantastic!  Git ‘er done. Ten-year Treasuries may never be lower.

By George Blackburne

George Smith Partners recently released a tombstone about a commercial loan closing that used a financial term of which I had never heard:

“George Smith Partners arranged $23,750,000 in bridge financing for the refinance of a 229-key, full-service hotel located in Downtown Minneapolis, Minnesota…  The Property, built in 1986, underwent a PIP in 2017.”

What in heavens is a PIP?

A PIP is a Property Improvement Plan required by a brand or franchise – usually a hotel franchise, like Marriott or Hilton – to maintain or improve standards.  Often the property owner needs to obtain a secondary loan or refinance the property.

A property improvement plan (PIP) is required to bring a hotel in compliance with brand standards.  According to HVS, an effective PIP should help owners gain market share, increase guest satisfaction, drive revenue performance, and enhance profitability.  Elements like lighting, faucets, and fixtures are foundational for brand standards, but now energy-efficient equipment upgrades are entering the equation.

One hotel franchisor recently said that her company is pushing hard to incorporate sustainability measures into the conversion process. There are things that the franchise is recommending in order for the franchisee to run an efficient building.

For instance, if a boiler system has a 30-year life expectancy, but it’s only 20-years-old, the franchisee might consider changing it out early because there is no down time, new systems are 30 percent more energy efficient, and there is a good ROI attached.  “We’re looking at mechanical systems, chillers, boilers, and things that are not very sexy,” she says. “It’s really important in looking at how much it’s going to cost to operate that piece of property.”

Property Improvement Plans (PIP’s) are not cheap.  PIP costs can vary greatly with different brands, hotel sizes, and property locations.  One of the most popular PIP’s, Holiday Inn’s Formula Blue, usually costs between $10,000 and $25,000 per room.  Since the average Holiday Inn Express location has around 75 rooms, that adds up to between $750,000 and $1.875 million in total costs.  Hampton Inn’s Forever Young Initiative is another popular PIP, which experts estimate will cost between $15,000 and $40,000 per room.

Yikes.  That’s real money. SBA loans are often, but not always, utilized to finance a PIP.  It is important to understand the types of improvements a prospective hotel owner can make using SBA funds.  Experienced hotel owners often focus on the following areas:

• Renovations to exterior facades – including signage, roofing, and colors
• Room and lobby updates such as lighting and fixtures
• New amenities such as indoor/outdoor pools and fitness areas
• Expand or improve parking
• Replacing mechanical items that are close to end of their useful life – such as the roof or heating system.

Instead of obtaining secondary financing, many property owners choose instead to refinance the entire property.  Because ten-year Treasuries are so low, this is the best time in history to refinance your property with a CMBS loan.

Article By George Blackburne

No sooner had I written a blog post last week about the attractiveness of CMBS loan rates right now, than I got a message for one of my subscribers informing me that conduits are no longer making hotel loans.

By the way, CMBS lenders are still making their large permanent loans on the Four Basic Food Groups – multifamily, office, retail, and industrial – at incredibly low interest rates today.

It makes sense why the conduits have stopped making hotel loans.  Hotel occupancy rates are getting slammed right now by the Coronavirus Crisis.

Conduits make large, cookie-cutter, commercial real estate loans that are quickly aggregated into large pools and securitized into commercial mortgage-backed securities (“CMBS”).

Conduits are not portfolio lenders. They can’t just say, “Well, hotels are getting clobbered right now, but the world is not going to stop needing hotels. Since all of our commercial lending competitors are out of the hotel loan market right now, our bank will sneak in there and make a bunch of juicy loans on some of the very nicest hotels in the country.”

Because conduits are not portfolio lenders, they can’t hold commercial loans on their lines of credit for very long.  They need to sell them off quickly.  They can’t hold these loans for two years, say, until the hotel market recovers.

Conduit is short for commercial real estate mortgage investment conduit, a specialized type of commercial mortgage company that originates loans for the CMBS market.

The thing that is special about conduits is that they get to sell their loans to a special kind of trust, called a pass-through trust, created by Congress, which does not have to pay taxes on its income from these commercial mortgages.

This special pass-through trust assembles a whole bunch (100 to 300) of these large, cookie-cutter, commercial loans into a pool.  Then the trust sells pass-through securities, backed by the stream of payments and payoff’s coming from the first mortgages in this pool.  We call them pass-through securities because only the securities buyer (bond buyer) has to pay taxes on his interest income, not the pass-through trust.

Think of an old-fashioned C-corp.  The C-corp pays taxes on its net income, and then the stock owners pay taxes on their dividends.  C-Loans is a C-corp.  Yikes.  It’s a form on double-taxation.

Congress created authorized commercial mortgage investment pass-through trusts to avoid this double-taxation.  (They had created residential mortgage pass-through trusts a couple of decades earlier.)  This move to avoid double-taxation created the commercial Real Estate Mortgage Investment Conduit industry (“REMIC”) industry.

By the way, a portfolio lender is a lender that makes its loans using its own dough and intends to hold these loans for the entire term.  A bank is an example of a portfolio lender.  A family office is another example of a portfolio lender.

A commercial lender using a line of credit from a bank is not a portfolio lender because the bank that is providing the line of credit is probably going to reevaluate that credit facility annually.  There is no guarantee that the bank will renew it.

Therefore, a commercial lender using a line of credit will need to sell off the commercial loans in his portfolio on a regular basis.  He won’t hold them until maturity.

Lastly, I have used the term, “large commercial loan”, throughout his article.  Conduits seldom make commercial loans of less than $5 million.

Some Thoughts on the Coronavirus Crisis:

You will recall that I made you uncomfortable (and probably bored) a few months ago when I described how the virus would soon become a pandemic and that it would cause another great recession, or possibly even a full-blown depression.

I just wanted to remind you that Chinese small business owners, who employ 60% of the Chinese workforce, have been traumatized.  They are not going to want to take on additional debt.

The Chinese Communist Party can order the Chinese banks to lend, but it can’t order small business owners to borrow.  When banks can’t find willing borrowers, yet they keep raking in monthly payments, the multiplier effect kicks into reverse.  Any monthly payment that is not recycled into a new loan reduces the Chinese money supply by a factor of twenty.

In other words, if a Chinese bank takes in a $1,000 loan payment and doesn’t immediately recycle it into a new loan, a whopping $20,000 gets sucked out of the Chinese money supply.  In the parlance of economists, $20,000 is destroyed.  During the Great Recession, about $4 trillion were destroyed.

The reason why this is important is because even if a cure, or even an effective treatment, for coronavirus is discovered today, the average Chinese small businessmen has already been traumatized.  He is not going to be borrowing even more money from the bank.

China is facing a horrible deflationary vortex, where tight money leads to company failures, which leads to employee layoffs, which leaves fewer workers with money to buy products, which leads to less demand, which leads to more company failures and more layoffs.  Its an ugly feed-forward cycle, a deflationary vortex.

If President Xi died and made me Emperor, I would put a moratorium on the loan payments on all bank consumer loans and bank business loans in the country.  The Chinese Central Bank (“CCB”) can easily replace the dough lost by the country’s banks.  After all, the dough is just digits in some computer.

Now if you hear the Chinese doing such a thing, there may be hope for us all; but absent that, prepare for a deflationary tidal wave coming out of China.  Despite what you might think, we do NOT want China to fall into riots and chaos.  They make the industrial parts and the medicines that our manufacturers need.  They buy a poop-ton of our industrial and agricultural products.  We should not wish them ill.

Article By George Blackburne

When a bank makes a commercial construction loan, it is certainly not going to take all of the risk.  A bank will usually require that the developer cover at least 20% to 30% of the total project cost – land cost, hard costs, soft costs, and a contingency reserve equal to 5% of the hard and soft costs.

Usually this takes the form of the developer contributing the land free and clear of any liens, plus having paid much, if not all, of the engineering and architectural fees.

Therefore I was shocked to read a tombstone sent out by my friends at George Smith Partners, one of the oldest commercial mortgage banking companies in the country.  You will recall that a tombstone is a closing announcement designed to show the types of commercial loans that a particular lender makes.

The tombstone boasted of the closing of a $4 million non-recourse land loan in Beverly Hills, at 8% interest for one year.  This land loan was made at 90% loan-to-cost (LTC)!  Ninety percent on a land loan???  I know that Colorado oregano is now legal in California, but 90% LTC on land is an insane amount of leverage.  (In this particular case, the cost was the same as the fair market value.)

So I wrote to my buddy, Bryan Schaffer (a very good man), and asked, “Bryan, I don’t understand.  What is the exit strategy?  Any construction lender is going to expect the developer to contribute the land free and clear, and it might require even more developer’s contribution.”

Before I share with you Bryan’s answer, I need to explain that, prior to the Great Recession, banks were allowed to give developers credit for the appreciation in the value of their land.  For example, suppose a developer purchased some land for $1 million, and three years later, because he bought shrewdly, the land now appraises for $3 million.

Back then, the bank was allowed to value that land at $3 million for equity purposes.  Therefore, if the developer only owed $500,000 on this $3 million piece of land, the bank would say that the developer contributed $2.5 million in equity towards the proposed construction loan.

But then the Great Recession hit, and construction lenders took huge losses.  To curb what Federal regulators deemed as reckless commercial construction lending, banks were only allowed to value land at the developer’s actual cost – in this case, just $1 million.  This has greatly restricted commercial construction lending over the past decade.

We are now ready to reveal Bryan’s answer to the question, “A land loan of 90% loan-to-value?  What the heck have you been smoking?”  Haha!

“George, It is very hard to get the full appreciated value of the land.  On this deal, if you just did a construction loan, most lenders would only give the developer his basis (actual cost), which was $1.4 million.”

“With a $4MM land loan and an appraisal at $4.4 million, the bank will give us at least a $4 million value for land – and most likely the full $4.4 million value.  At some banks, if he deposits the $4 million (from the loan proceeds), they will loan him the entire $4 million against it at a very low rate, which he will use to pay off his land loan.  He will get the full $4 million to $4.4 million credit (for the value of the land) and will also show $4 million of liquid assets, but it will be in a restricted account.”

“So the hard money loan cost him $200K to $300K, but in exchange he does not have to bring in fresh cash of $2-3 million and likely also looks better for future loans because he has the $4 million in a restricted account.  It is a little bit of a financial game, and it is only good for someone that does not have the cash.  Hope that helps, Bryan.”

Did you get lost?  It helps to understand that banks only want to lend to developers with lots of cash on hand.  Our developer will take this $4 million in land loan proceeds and stick it into the account of the bank which will make the new construction loan.  It’s a restricted account, so the dough can only be used to construct the proposed 12-unit apartment building.

Because the land has a whopping $4 million loan against it, the bank can’t just value the land at the developer’s cost of $1.4 million.  It makes no sense, so the bank is forced to value it at least at $4 million.  And since the bank is already breaking the Fed’s rule about valuing the land at the developer’s actual cost, they will probably cave in and value the land at its $4.4 million appraised value.

So the land loan costs the developer $200,000 to $300,000 in loan fees and interest – but it reduces by $2 million to $3 million the amount of equity the developer has to contribute to the property.

As Bryan explained, its kind of a shell game (1) to make the developer look liquid and rich; and (2) to get around the Fed’s rule that bank construction lenders must value the land at the developer’s actual cost.  I suspect that there are a lot of parties winking at each other.  Haha!

By George Blackburne

I have a great training article about commercial loans for you today.  How do conduits price their commercial loans?  After all, commercial lenders cannot buy a forward commitment from Fannie Mae or Freddie Mac, like a residential mortgage banker; yet most commercial loans today are fixed rate loans.  How on earth do the commercial loan officers, working for these big-time commercial lenders, know what to quote?

Prices and interest rates across the entire world are declining.  This could be wonderful news for those of us in the commercial loan business.

Before I explain, I want to bring you up to date on a blog article that I wrote last week postulating that a world war with China and Russia may be brewing.  This was a pretty important article, and I urge you to read it first.

The ten largest economies include (1) the United States; (2) China; (3) Japan; (4) Germany; (5) United Kingdom; (6) India; (7) France; (8) Italy; (9) Brazil; and (10) Canada.  I was personally surprised to see that the economies of both Brazil and Canada made the top ten.

Most of these economies are shrinking in population, and this is extremely deflationary.