Sometimes the Best Time to Invest is When Blood is Running in the Streets
by George Blackburn
Commercial real estate has lost at least 40% of its value since 2006. Banks are reeling from their losses in commercial real estate loans. Of the 100 banks with the largest percentage of commercial loans in their portfolios, 42 of them have already been shut down by the FDIC. Many private investors in commercial first trust deeds made prior to 2007 have suffered painful losses. Now is not the time to be investing in commercial first trust deeds.
Or is it? Consider the following scenario: An office building legitimately appraised for $1 million in 2006. A bank made a $700,000 loan against it. In late 2007 the Great Recession started. Commercial real estate fell by 40%, dropping the value of the building to just $600,000. By early 2008, the tenant defaulted on his lease and moved out. The investor/owner tried to carry the mortgage payment on a vacant building out of his personal savings for several months, only to finally capitulate and default in late 2008. By mid-2009 the bank completed its foreclosure.
The bank finally sells the office building as an REO for $600,000 in early 2011. The buyer is an investor with a 700+ credit score. The buyer is prepared to put 40% cash down, and he is looking for a new commercial first trust deed of just $360,000. The buyer approaches his own bank, and several other banks in town, but no bank will write the loan. They are too nervous to finance commercial real estate right now because of all of the blood that is running in the streets. In addition, the property is vacant.
So the buyer goes to a hard money broker about a hard money loan of $360,000. Is this a reasonable loan? Would it be a wise first trust deed investment for some private investor?
A good argument can be made that now is a fine time to be investing in commercial first trust deeds. A loan of $360,000 is just 36% of the property’s value in 2006. The buyer is putting 40% cash down. This means he has a lot of skin the game. He is not likely to just walk away from a $240,000 down payment. The buyer has excellent credit. Most important of all, the loan is based on an actual, arm’s length purchase. We have finally found a price at which the property can clear the market; i.e., find an all-cash buyer.
It’s terrifying to make new commercial real estate loans in the midst of a bloodbath; but sometimes the best time to invest is when blood is running in the streets. At no other time in the past 12 years could a trust deed investor regularly expect to be able to make a 12% commercial real estate loan to a wealthy investor with excellent credit on a standing commercial property at such a low loan-to-replacement cost ratio. Most other times some bank would have snatched up such a deal and offered the borrower a loan at less than 8% interest.
The deal described above is just a hypothetical deal. It’s sole purpose is to stimulate your thinking and to open your mind to the idea that there may be some interesting commercial first trust deed investment opportunities out there right now.
Note: This is not an offer to sell first mortgage investments. An offer is made only through an Offering Circular. Investing in first trust deeds and first mortgages involves substantial risk. Please be sure to carefully review the Risk Factors section of the Offering Circular before investing. A substantial and prolonged decline in real estate value is possible.