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I just ran into this website with it’s “Pay or Go” calculator. http://payorgo.com/

You plug in your numbers on what you owe and what you pay and it will tell you whether you should keep Paying or Go … walk away and trigger your “Strategic Default”

Is this the 2009 property specific version of “ambulance chasing”? I am certain this law firm could help you if you decide to “go” rather than keep paying. And this all begs the question is walking on your mortgage now socially acceptable. You be the judge and as one reader emailed me … “whether it is socially acceptable or not, the question of whether it is ethical remains.”

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Today Bloomberg announced that Morgan Stanley is doing just that for the second time in 2009. And the Wall Street Journal has had a series of articles on single family home owners and the epidemic of strategic defaults in home loans

More on Morgan Stanley …

Back in the boom days Morgan Stanley made a series of purchases of commercial property from folks like Sam Zell that turned heads because everyone in the industry knew they had over paid. Now the stuff is hitting the fan and Morgan Stanley is simply handing the properties back to the bank and walking away – even though the loans are still current!

• Last month they agreed to surrender 17 million square feet of office buildings to Barclays Capital after acquiring them for $6.5 billion in 2007 from Crescent Real Estate Equities.
• Now they are announcing plans to relinquish five San Francisco office buildings to its lender two years after purchasing them from Blackstone Group LP near the top of the market.

From Bloomberg:  “San Francisco prime office rents fell 37 percent in the third quarter from a year earlier, the biggest decline since 2001, as companies cut jobs, Colliers International said. The vacancy rate rose to 14 percent, the highest since 2005. Almost 1.4 million square feet of space was returned to the market in the first nine months of the year. ”

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• In 2006 Fannie Mae originated  just 34% of apartment loans
• In 2008 that share rose to 84% !! – my oh my
• Current delinquencies are at only 1.6% on the $4.5B of apartment loans that mature in 2010 – good
• Fannie and Freddie only back $300B in apartment loans … as opposed to the $5 Trillion in SFR loans they hold – good
• $180B of Fannie’s apartment loans were originated at the top of the market in 2007 – not so good

So riddle me this …

with Fannie and Freddie as basically the only functioning multifamily lenders in the nation … how will the government continue to support them in 2010? At least we can play the political card of supporting “affordable housing”. I would expect that Apartments would garner the same level of support the SFR markets have received to this point.

And I wonder … won-won-won-won- wonder when the banks and other traditional apartment lending sources will jump back into the pool … if ever?

Here’s the full article (note: you have to be a WSJ subscriber to see the whole thing)

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• Lenders not wanting to write down the value of their portfolios to acknowledge the drop in value … especially if the property is worth less than the loan … Ouch!
• And no lenders willing to loan new money on purchases of distressed assets

AND we have been under the assumption that once lenders are willing to accept the losses and new money becomes available to purchase distressed properties … this whole mess would thaw. Then we could snap up performing assets at once-in-a-lifetime prices.

BUT WAIT … the FDIC may have just thrown the whole system back into the deep freeze. Globe Street’s Tony LoPinto reported yesterday that the FDIC has made some rule changes deep underground in their infrastructure that could significantly delay the thaw in this frozen market of distressed commercial real estate. Here is a quote:

“The FDIC has just issued guidelines allowing banks to keep loans on their books as “performing” even if the value of the underlying properties has fallen below the loan amount. The guidance, issued by the FDIC, Office of the Comptroller of the Currency, and the Federal Reserve will allow examiners and financial institutions to work with commercial property owners who are “experiencing diminished operating cash flows, depreciated collateral values, or prolonged delays in selling or commercial properties”.

With the banks’ restructuring loans, the transactional grease from properties being dumped on the market at fire sale prices isn’t going to happen, leaving the distressed funds and brokers to find something else to do–at least for the time being. “

Here is the full article

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This is an all-or-none sale of the loans behind over 100 Commercial Development Projects including a number of failed Condo Projects in states like CA, NV and FL. The FDIC is not allowing the developers to buy back their own loans … the only way to buy is to take the whole portfolio and the big sharks are lining up to make their bids. It is a sweetheart deal as well since the FDIC will hold a 60% stake after the sale AND provide financing.

WHY IS THIS SALE IMPORTANT ?

There has been so little deal flow in Commercial Property this year that valuations are very hard to come buy …  we are in uncharted territory with no Comps to give us a ballpark for valuation. This sale will set a benchmark the whole Commercial Property Industry will watch closely. Here’s what the pundits are expecting.

30 cents on the dollar for non-performing loans and 80 cents on the dollar for loans where payments are current. AND the winning bidder is widely expected to sell the delinquent loans back to the borrower for a handsome profit (in the neighborhood of 80 cents/$1)

DEJA VU

Remember the Resolution Trust Corporation? Back in the 80’s savings-and-loan collapse the RTC did 70 deals just like this. Seems like another great time to make a killing buying massive amounts of inventory at HUGE discounts with government backing and waiting for the economic rebound that is sure to follow.

I will be watching the news on this sale and we will all see what “comparable sale” values come out after the dust has settled.

When you purchase a commercial property and leave the Closing Table, you will take with you several different piles of cash you don’t see in a Residential Real Estate Purchase.

They come in the form of

• - Tenant Security Deposits
• - Pro-rations
• - Credits

And in a larger property, these can easily total hundreds of thousands of dollars.

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WARNING:

We know of other commercial property Educators who advise you take this money at the close and use it to purchase additional property. They crow about “Cash Back at the Close” as a major reason to move up to commercial property.

We strongly disagree – and absolutely discourage you from taking cash out of ANY commercial property at the Close!

That is because all of this Money has a dedicated purpose.

If you use this money for anything other than its intended purpose in this property – you are literally Stealing it from the property and your Investors. Taking this money can and will sabotage the success of your investment.

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Always use this cash wisely and Only for its intended purposes.  

 Tenant Security Deposits -

Are to be returned to the Tenants when they move out. Set up an interest bearing account for them and transfer the appropriate amount of money directly from the closing table. This cash is spoken for.

Pro-rations and Credits -

Are money already set aside for operational expenses and need to be kept off to the side until these expenses are actually due.

EXAMPLE #1:

If you buy the property on July 1st you will receive a credit from the Seller for 1/2 the year’s property Taxes. This money is dedicated to paying the taxes when they are due – and if you spend it instead – or use it for ANY other purpose, you have just stolen from the property.

EXAMPLE #2:

If you buy the property in the middle of the month and the Seller has already collected the rent you will get a prorated share of the rent collected. In this case, 1/2 of it. This money has been generated this month to pay next month’s bills, leave it set aside in your operational account for use when the bills come due.

If you siphon off any of these funds for yourself or other investments, you are setting yourself up to run short of operational cash very quickly.

When this occurs your only recourse will be to ask your investors for more money, this is called a Capital Call. AND there is nothing worse for your reputation as a Project Sponsor than a quick Capital Call.

We recommend you open three bank accounts when you take over ownership

1) Operations Account – For the monthly in and out of income and expenses

2) Security Deposit Account – Best if it is interest bearing. Transfer all Security Deposits directly into this account.

3) Reserves Account – Always keep your reserve account topped up (we recommend at least one month of operating expenses). This is your rainy day fund and can be an interest bearing account as well.

We recommend you raise enough money from investors to fill the Reserve Account at the Close of your Purchase. This way you will not need to make a Capital Call if the furnace goes out in the first 6 months of your ownership.

With these accounts set up, simply transfer all Closing Table funds into the appropriate account.

AND whatever you do, don’t steal from your own property!

In today’s market, every financing option needs to be in play. The Owner Carry is one option you must learn to use when it is available. And sometimes you have to be creative to “Git Er Done”.

In this post, let’s look at ways you can get what amounts to an Owner Carry … even if the Lender won’t allow a traditionally structured Owner Carry.

With a 100% Carry you are golden …

When your Seller is giving you a 100% Owner Carry – meaning you give them a down payment and they carry all of the remaining debt – you don’t need a Lender. You are free to negotiate whatever terms you need to get ‘er done.

And if you are getting both an Owner Carry and a Conventional Mortgage, things can get sticky on occasion.

First, an Owner Carry is always much more difficult to obtain when you are assuming existing financing. It just is … plain and simple. You will want to look long and hard at any assumption that requires an Owner Carry because it is definitely like swimming upstream!

Remember: Carry + Loan = Combined Ratios

Any time you are getting a new mortgage and the Lender knows you have an Owner Carry in the works they will look at two ratios:

- The “Combined Loan To Value Ratio” (CLTV)

- The “Combined Debt Coverage Ratio” (CDCR)

They add up the Total LTV and DCR for both their loan and the Owner Carry and apply their standards to the Combined Numbers.

What if the Lender says “No” to your Owner Carry Deal?

Sometimes they say “NO” because the numbers don’t work under their lending guidelines … It looks to them like you won’t be able to make the combined payments. And sometimes it is just their Standard Policy with no good reasons behind it.

When the Lender says “NO”, MAKE ABSOLUTELY CERTAIN you take a second look at the numbers and that your Proforma still says the deal works … And if it does … here are a couple ways around your Lender’s Objections.

[In each case you end up with a structure that is equivalent to an Owner Carry, but without a Lien/Note recorded against the property.]

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Disclaimer:
This is not legal advice. These are solutions that have worked for me in the past. Absolutely do not use these deal structures without consulting your Attorney and Mortgage Brokers. And don’t do them at all unless your Proforma shows the deal works including the payments to service the Owner Carry or its equivalent.
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3 Owner Carry Equivalents

1) Promissory Note:

The Seller can loan you the money personally on an unsecured Promissory Note. They hold the note and you make the payments, but nothing is recorded against the Property.

2) Security and Pledge Agreement

The Seller can hold a note secured by your new equity (your entity’s Ownership Interest), in the Property and not against the Property itself.

It works like this:

- You form an LLC to take possession of the Property.
- That LLC has an equity / ownership stake in the Property.
- The Seller holds a note secured by the Equity Position of your LLC and not directly against the Property.
- They hold the note and you make payments, but again, nothing is recorded against the Property.

If you default, they get your Equity Stake in the Property.

3) They buy Into Your Entity

The Owner Carry is treated as a purchase of an Equity/Ownership stake in your title holding LLC. Your LLC takes control of the Property at the close and the Seller is given a “Preferred Equity” position that earns a Preferred Return from you.

It works like this:

- You form an LLC to take possession of the Property.
- At the close, the Seller gets an equity position in your new LLC equal to the size of the Owner Carry.

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NOTE: Make sure the Seller’s Equity is a fixed dollar amount and does not increase in value as the property value increases.
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- The Seller is placed in a Preferred Equity position that entitles them to a Preferred Return equal to the interest payment on an equivalent Owner Carry.

- The Seller gets their interest payments along the way in the form of Preferred Return payments … and when you sell, they only get their original stake back – just as if you had paid off a note.

All of these structures have worked for me in the past when the bank said no.

JUST REMEMBER:

1) The deal has to make sense with the Owner Carry – if the Bank says “NO”, make sure you double check your figures and that your Proforma still shows a viable deal … the Lender may know something you don’t.

2) And you MUST run these structures by your legal team and Mortgage Broker before putting them into action.

Here is a tool that may help you be the “Larry the Cable Guy” in your local market and “Git a Deal Done”. You know it already…

It’s called the “Owner Carry”
The owner carry is when your Seller (the current Owner) “Carries” part of the debt you use to purchase their property. This is usually in the form of a note that sits in second position behind the Mortgage.

When you purchase a property with an Owner Carry, you basically have two loans. The first loan is from the bank or other lender and is usually the largest, the second loan you owe to the Seller.

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Power-Play:
 
If you find a Seller who owns their property free and clear, you can negotiate for a 100% owner carry. In this situation, you provide a down payment and the owner carries a single loan. You don’t even need a bank for this transaction.
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How to negotiate an Owner Carry …

When discussing an Owner Carry with the Seller it absolutely imperative you understand the benefits the Owner Carry gives THEM. You must establish the Owner Carry as a win-win proposition. You win because it lowers the amount of money you must borrow and the cash you need to put into the deal.

The Owner/Seller wins in three ways.

1) No Carry … No Deal …

In many cases a significant Owner Carry is the only way the deal makes sense in the current market – it may be the only way you will complete the purchase and the only way they can sell the property.
With our credit crunch in full swing, negotiating an Owner Carry may be much less difficult than getting a larger mortgage. And when you run your investor’s pro forma you may see that an Owner Carry offers the only way for you to hit your ROI numbers.

Rule of thumb is this:

- The less they owe
- And the more motivated they are to sell – for whatever reason …

The more likely you will be able to negotiate a favorable Owner Carry

2) Maintain an Income Stream …

An Owner Carry allows the seller to maintain an income stream from the property without the hassles of property management. They get Passive Income, You manage the property. For a Seller in trouble who has negative cash flow and is “feeding the beast”, selling with an Owner Carry actually reestablishes positive cash flow for them.

3) Defer Cap Gains Taxes …

An Owner Carry defers the Seller’s Capital Gains tax payments on the amount of the loan.

Summary:

An Owner Carry benefits the Seller because:

- It gets the Deal Done
- It gives them Passive Income
- It defers Cap Gains taxes

Ask for it upfront…

If you need an Owner Carry make sure you ask for it in the LOI. Follow up the letter with the call directly to the seller and tell them why you feel the Owner Carry is a win-win structure. And make sure you let the Broker know this is the only way you will purchase the property. They become an ally in convincing the Seller to accept.

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Power Tip:

If the numbers make sense, you may wish to present a Two-Part Offer:

A higher price with an Owner Carry and a lower price without one. You will basically give them full price, in exchange for favorable terms on the Owner Carry.
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Carry Back Terms:

Ask for as long a note as you can get. Typical time periods are 3, 5, 7 and 10 years. Offer a reasonable interest rate — something around 6% in today’s market. And try to make the Owner Carry co-terminous (end at the same time as) your underlying mortgage.

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Yet Another Power Tip:

If you need money for rehab, here is how you can use the Owner Carry to get that money from cash flow at the property…

When you and the seller agree that rehab is essential, you can ask the seller to defer payments on the owner carry back for a period of several months.

The terms might look like this: a five-year note for $200,000 at 6% interest with no payments for the first six months. This would give $2000 a month for a total of $6000 you can use for improvements … taken right out of the property’s cash flow.
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Those are the basics of the Owner Carry. Make sure you review and understand the concepts. The Owner Carry may be the key to your next Commercial Property purchase.

If you are lucky … you get a squeaking sound like a rusty gate. That’s if you are lucky and the market is moving at all … even if it is just that little squeaky bit.

For most of us the Commercial Lending Markets are not moving at all. Here are two examples…

1) Globe Street today ran an article stating that Commercial Property CMBS Loans will fall to ZERO in 2009. These are the loans that in the “good old days” were packaged up into securities and sold by the originators and provided the majority of larger loans prior to this credit crunch. They used to be king of the Market with $230 Billion in originations in 2007 … crashing to $30 Billion in 2008 … and now ZERO.

Even worse … $160 Billion in Commercial Loans come due this year … how in the world are they going to get funded in this lending environment.

2) Big Pharma can’t even get a break. Not many things safer than large drug companies … wouldn’t you say? And two of the biggest are merging as Pfizer is buying Wyeth for $68 Billion.

Turns out Pfizer needs a $22.5 Billion dollar loan to close the deal and here are the terms they were able to get.

• One year term
• 7-9% interest
• The lenders can walk away from their committment if Pfizer’s credit rating drops

Not exactly favorable terms for a stable company like big Pharma.

What is the lending world coming too? Fortunately or not, we live in interesting times … stay tuned.

• It will be very interesting to see what happens with the Commercial Property Loans that must be refinanced during 2009. $160 Billion is a very large number in a frozen market.
• It will also be very interesting to see what happens to the Pfizer/Wyeth loan when they need to refinance this time next year.

And here is the fun part … at this time your foecast of what is going to happen is as good as ANY so called “expert” in commercial lending because not one living soul knows what happens next.