The Next Shoe to Fall…Commercial Mortgage Loan

I must have heard this statement about 100 times in the last 6 months….BUT THE PEOPLE SPINNING THAT ARE MISSING THE BOAT! The shoe has already fallen….commercial mortgage loan today are being underwritten almost at their historical average-a 10 CAP Rate. You may find some local banks underwriting to an 8.5 CAP but most everyone is getting close to a 10 CAP. A 10 CAP is the historical norm for commercial pricing…Colorado small business loans are being underwritten to this norm by many national lenders at this point-meaning, the drop has already been PRICED IN! For those who are asking, what is a CAP rate and what am I really talking about? Let me explain.
The main determinant of commercial value is the cash flow of the property. If you have a cash flowing property, underwriters will lien heaviest on the cash flow valuation over comparable sales, or cost. You can have two properties in the same town, exact same size, but if one is occupied 100% and is cash flowing at 2 times debt coverage and the other one is cash flowing at 1.2 times debt coverage, the 100% occupied will not only appraise for more-it will sell for more. Comparable sales are not a very good determinant unless the comp property cash flowed similarly to the subject property. So back to CAP Rate. The CAP Rate is the Net Operating Income (NOI) divided by the sales price. A property that has an NOI of $200,000 a year that is sold for $2 Million a year has a 10% CAP Rate ($200K divided by $2 Million=.10 or 10%).
Conversely, if you know the NOI of a property, you can divide it by .10 to get a feel for where a property will worst case get appraised at. The reason I close so many loans is that I crunch the numbers and won’t take deals that won’t close. Now many reps at Banks and lenders do not really get CAP Rates-they just look at DSCR, that is why you will send a loan in that you think will work and the rep likes it but when he takes it to credit committee it gets tanked. Or the appraisal comes in low and the deal dies there. Many lender reps and bank reps have no clue about this. But back to CAP Rates.
In 2007 lenders were underwriting to a 7 CAP rate and in certain markets, like CA, they were even going as low as a 5.5% CAP rate-which was crazy-a true market top. Meaning that same property we mentioned above, with cash flow of $200,000 NOI in 2007 would appraise for $2,850,000 in most areas and as high as $3.6 Million in CA. Today, just $2 Million. The market has already adjusted! The shoe has already been factored in. I still see major Commercial Real Estate chains pricing these properties at a 7 CAP on their listing flyers. Only a fool would pay that today. I just got a deal across my desk from one of the strongest investors I have ever seen, $4 Million liquid, well over $100 million in cash flowing property, this was a purchase of an investor commercial property and he was getting a 12 CAP. The property cash flowed at 2 times. It was in Ohio, and he was experienced and knows what to pay, that guy will never lose money on that property unless the government goes insolvent and the whole game gets shut down. Assuming normal markets, that is a very safe play.
Real Capital Analytics, one of the premier providers of commercial real estate data, just reported that commercial property values have RISEN over the last few months. Kind of confirms what I am saying. We may not have bottomed in commercial, but we are very near it. Probably just as close to the bottom as residential (ask yourself this, in your marketplace, is the average home priced where you could rent it out profitably while carrying a normal mortgage payment? If not, your residential market has not bottomed yet.) But what about all the commercial notes coming due? Won’t that kill the market? I don’t think so and here is why, there is a HUGE amount of activity in “note buying”. Banks have been dumping commercial paper at huge discounts and there are trillions of dollars sitting there gobbling it all up. IF the FED takes over a bank, they move all the paper in a weekend. There is no shortage of money for buying notes.
USA Today reported on 4/20 that “Nearly $14 billion were in commercial loan workout in the last six months or did a commercial mortgage refinance. Investors also have been aggressively buying commercial mortgage-backed securities (CMBS). Research firm Trepp predicts that $25 billion in CMBS will be issued in 2010.”
This further confirms what I am saying. The biggest threat to commercial is not the notes coming due, it is no more a threat at this point then the foreclosure problem in residential. A problem-yes but one that is working it’s way through because the banks are willing to modify, and the trillions are sitting there ready to buy the paper. The biggest threat is the economy because the more vacancy, the less cash flow and the worse the property will appraise. So vacancy, is really the big fear. If you think that the economy has turned, and there is a lot of evidence to support it, then now is the time to buy commercial property. Now is the time to get aggressive in commercial. I am telling you from where I sit, there is more business happening then I can write. SBA Loans, franchise loans, experienced investors, refinances, it is all happening. Commercial is not about to bottom, commercial already has bottomed and all the experienced people I talk to are slammed with deals. It is a GREAT time to be in commercial!
Brian Peart
P.S. Did you know we are averaging about one commercial closing a day? Most of it is getting closed at NORMAL COMMERCIAL RATES through banks and lenders who are still lending. Yet 80% of the loans I close got shot down somewhere else first. If you want to get your commercial deal closed, call me at 303-400-8630. There has never been a better time!
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Here’s A Little Bit About Me. 20+ years in the finance industry, I rose to the level of Assistant V.P. with Chase Manhattan. While working for Chase, I decided that I wanted to have residual income without having to quit my job. I bought my first apartment building in 1996, three days before my wedding. In 2001, I decided I would leave the corporate world and work for myself in a net branch environment. My passions are helping people get commercial mortgage loans. I also am passionate about investing, working out and being with my family and friends.

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