Quick funny:  Tomorrow is the National Home-School Tornado Drill.  Lock your kids in the basement until you give the all clear.  You’re welcome.  Haha!

For the past two weeks, we have been discussing the fact that just about every commercial bank in the country is out of the commercial mortgage market.

The CMBS market remains broken for now too, although the Fed’s recent purchase of billions of dollars worth of commercial mortgage-backed securities has helped to prevent a complete collapse of the CMBS market.  CMBS lenders will likely survive to lend again in a year or so.

ABS lenders are also out of the market.  You will recall that ABS stands for asset-backed securities, which are smaller securitizations of an eclectic collection of debt obligations.  An ABS pool might contain subprime auto loans, scratch-and-dent residential loans that have been kicked out of some regular securitization pools, aircraft loans and leases, equipment loans and leases, credit card loans, movie residuals, and non-prime commercial loans.

As a result of recent huge declines in the value of asset-backed securities, ABS commercial real estate lenders; like Silverhill, Velocity, and Cherrywood; are now out of the market right now.

We also discussed how several hundred commercial hard money lenders nationwide are either out of the commercial loan market or have completely closed their doors.  The slaughter has been particularly bloody among those hard money shops that use a mortgage pool to fund their loans.

As soon as the coronavirus crash started, most of their private investors lined up to withdraw their money from these hard money mortgage funds.  This left these hard money shops with no new money with which to lend.  Suddenly they had zero loan fee income coming in, so they didn’t have enough money to make payroll and to keep their doors open.

Bottom line:  When a borrower goes out searching for a commercial loan today, he is going to get turned away by just about every lender.  

Isn’t this wonderful?!  As a commercial loan broker, you make your dough helping borrowers find commercial lenders.  When every bank in the country was making commercial loans, most borrowers didn’t need you.  Now they do.

Commercial real loan officers, working for banks, are telling their prospective borrowers, “I’m sorry, but our bank is not making any new commercial real estate loans right now.”  In other words, the bank is out of the market.

I can also tell you that, after having survived the S&L Crisis, the Dot-Com Meltdown, and the Great Recession, most commercial banks are going to remain out of the market for several years.  Whenever banks bolt to their hidey-holes, they come out very, very timidly.

Those of you who have read and understood my articles about how the Multiplier Effect can sometimes work in reverse should be able to understand the huge deflationary pressures building in the U.S., as well as China.  You may not want to go “all-in” on the stock market, even though Gilead Sciences announced last night that their new therapeutic drug for the coronavirus is doing very well in a large trial.  That huge deflationary tidal wave from China is still coming.  Chinese small business owners have been traumatized, and a new drug does little to immediately restore their savings accounts.

You think it’s bad now?  In 20 years, our country will be run by people home-schooled by day drinkers…

Since banks are turning down every new commercial borrower, it is therefore an incredible time to call bankers for their commercial mortgage turndowns.  The bankers will be grateful to have someone – anyone – to service their frustrated clients.

It also makes good sense to also tell these bankers that you will not be taking their good customers to some competing bank.  “All of your bank competitors are out of the market too.”  Tell them that you have some reasonably priced private money with no prepayment penalty.

Make sure you gather the contact information on every commercial real estate loan officer working for a bank that you meet.   You can trade each bank commercial loan officer for either a free commercial mortgage underwriting manual, a free loan broker fee agreement, a free commercial mortgage marketing course, or a free regional copy of The Blackburne List containing 750 commercial lenders.

These trades are made under the Honor System.  Please don’t cheat.  You can trade trade a banker for ONE of the above four goodies.  If you want all four goodies, please find me four bankers.

And this guy must work for a bank or credit union.  ABC Bank.  First National Bank.  Helloooo?  Banks have huge metal vaults with tens of thousands of dollars in cash on hand, right?  Mortgage companies are NOT banks.  You are not a commercial loan officer working for a bank.  You can’t fill in your own name.  Nice try.  Sorry.

When this is over, what meeting do I attend first… Weight Watchers or AA?

Have you ever coveted my famous, nine-hour course, How to Broker Commercial Loans?  I will give you this course for free if you gather up twenty commercial real estate loan officers working for banks for me.

But where do you go to find these bankers to call?  Simple go to Google Maps and type in your office address.  In the Nearby field, type in “Banks”.  Voila!

Since we can’t eat out, now’s the perfect time to eat better, get fit, and stay healthy.  Hellooo?  We’re quarantined!  Who are we trying to impress?  We have snacks, and we have sweatpants.  I say we use them!  🙂

Commercial Mortgage Rates Today:

Here are today’s commercial mortgage interest rates for 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

This is going to surprise you, but commercial banks, credit unions, and federal savings banks (the old S&L’s with a Federal charter) all quote pretty much the exact same interest rates and terms on commercial real estate loans.

This is true for huge commercial banks in Los Angeles and for little credit unions in Maine.  No matter where the property is located, as a commercial loan broker, you will always know what to quote.

To be clear, we are talking about commercial real estate loans on standard commercial rental properties, like office buildings, shopping centers, retail buildings, and industrial buildings.

The rates and terms will be a little more scattered for multifamily properties.  Some banks, especially savings banks, love-love-love apartment buildings.  They will quote delicious interest rates and terms.

Smaller commercial banks are less enamored with apartment buildings because their owners seldom keep huge deposits in their company checking accounts.  If they have cash, they immediately go out and buy another building.  In contrast, widget manufacturers might keep large balances in their bank for the the new bank to win.  Banks, especially smaller ones, are all about deposit relationships.

Before we get into the interest rates being quoted by banks on commercial loans today, let’s first talk about terms:

Amortization:

Most banks will quote a 25-year amortization.  A twenty-year amortization is to commercial loans what a 30-year amortization is to home loans.  It’s the norm.

If the property is older than, say, than 35-years, the bank might insist on just a 20-year amortization because the property is getting pretty long in the tooth.  The building is not going to last forever.  The bank needs to eventually get their principal back before the termites stop holding hands.

Term:

Most commercial banks today will give you a ten-year term on your commercial loan.

Fixed on Adjustable:

The typical bank commercial loan is fixed for the first five years.  There is one rate readjustment at the beginning of year six, and then the rate is fixed for the remaining five years.

When the rate readjusts, what is adjustment tied to?  In other words, what is the index and what is the margin?

This is going to surprise you, but most banks don’t say!  What????  The promissory note will simply say, “The rate will readjust to whatever the bank is quoting at the time for similar commercial loans.”

What if the bank tries to raise the interest rate to 20%?  This could actually happen, if the dollar were to suddenly collapse.

In such a case, the bank would give you a window in order to pay off their loan, without penalty, with a new loan from a cheaper lender.  A window is a period when there is no prepayment penalty.  Most commercial real estate loans from banks give the borrowers a 90-day window after a rate readjustment.

Prepayment Penalty:

Banks differ on prepayment penalties.  The penalty could vary from 1% to 2% during the entire 5-year term, to a declining prepayment penalty of 3% in year one, 2% in year two, 1% in year three, and perhaps 1% in years four and five.

So what do you quote on a $300,000 permanent loan on a little retail building in Bum Flowers, Alabama?  I want you to quote 3%-2%-1% and none thereafter.  No bank is going to refuse to make a good commercial loan if it can get a declining prepayment penalty of 3%-2%-1%.

Will a bank ever make a commercial real estate loan with absolutely no prepayment penalty?  The deal would have to be very, very good to get them to waive it completely.

Interest Rate:

Banks all quote pretty much the exact same interest rate – between 2.75% to 3.5% over five-year Treasuries, depending on the quality of deal (more on this below).

Five-year Treasuries as of January 22, 2021 were 0.44%.  Therefore the bank is going to quote you between 3.19% to 3.94% today.

You can always find the latest commercial real estate interest rates and Index values by going to our wonderful Resource Center.  Be sure to bookmark this wonderful reference source.

Quality of the Deal:

Here are the factors that affects bank interest rates on commercial loans –

1. 1. How much cash does the borrower keep in the bank?  The more liquid your borrower, the lower his interest rate.
   2. How old is the property?  The younger the building, the lower the rate.
   3. How gorgeous is the building?  The prettier the building, the lower your rate.
   4. How desirable is the location?  If your building is located on the bets street in town, you may get the bank’s very lowest commercial loan interest rate.
   5. Assuming you are at a bank of suitable size, the larger the loan, the lower the rate.  Big banks make big commercial loans.  Small banks make small commercial loans.  Match the size of your bank to the size of your deal.
   6. How close is the building to the bank?  The further your building is from the bank, the higher the interest rate you will probably get.

Moral of the Story:

Always apply to a local bank.

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

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