Archive for category Commercial Lending
I don’t have a crystal ball but I follow the fundamentals and the market is screaming to get out of your adjustable mortgage if you have one as soon as possible. Here is why.
The federal funds rate is the interest rate at which banks lend their excess reserves to other banks which don’t meet the minimum reserve requirement established by the Fed. Currently the banks park their excess reserves with the Fed for which they are paid 25 basis points. Even though it’s known that the Fed controls this rate (by selling and buying securities to banks via the Open Market Operations) today we’re living in a climate of banks controlling such rate. Their excess reserves which exceed $1.6 Trillion create a liquidity trap that keeps rates below what the market would otherwise dictate. Take a look at the St. Louis Fed chart and ask yourself how much higher can these excess reserves go.
From 2009 until now the banks’ excess reserves grew exponentially. Such event occurred because the banks were selling securities (in many cases the toxic assets of the foreclosed real estate they held) to the Fed in exchange for dollars. In addition, they get paid a .25% to keep their reserves at the Fed. This is the reason for which you see on this chart why their excess reserves spiked in a little more than two years.
For the federal funds rate to go up one of at least two events must happen. The Fed sells securities back to banks thus reducing the banks’ excess reserves and contracting the money supply. This scenario is not much likely to happen because Mr. Bernanke is a deflationist and he fears deflation. Politically speaking he couldn’t do that even if he wanted to. Why? Because money deflation leads to Wall Street deflation and the artificially inflated stock market bubble would burst. Such event cannot happen especially during an election year.
The next and a more plausible event to occur would be when banks will start lending again. Banks are in the business of lending money therefore the question is how long will it be until banks start lending again? Obviously it can’t go on indefinitely.
Of course, other events could happen which could trigger the rise in the rate. The collapse of the dollar, China decoupling its economy from ours, the dollar’s status of the world reserve currency replaced with another stronger currency, or a devastating inflation.
Without confusing the matter too much, when the federal funds rate is low generally your adjustable mortgage will be low. When that goes up you can most certainly expect your ARM to go up, as well. And it really doesn’t matter much to which index your mortgage is tide to.
I’ve been told over and over by hesitant property owners that if the rates go up they’ll sell the property. If they can’t sell they will refinance. Here is the problem. For the past four years the real estate activity was sustained by sales of – what many would call – below market value properties. Of course, that’s debatable because the real value is based on what the market dictates (based on supply and demand) and not on what the current owner thinks his property value is nor on what the outstanding balance on the underlying mortgage is.
For he who believes he can sell his property when rates go up I wonder what makes him think that in a higher rate environment his property would sell for the price he’d want to sell it for? If his property doesn’t sell today when rates are low why would it sell later when rates go up?
The second option is to refinance when rates go up. If you study the chart above you’ll notice that during the late 1970′s the rate went up abruptly. It wasn’t a slow and gradual increase, it was fast and furious. That increase was the result of the Fed’s contraction of money supply.
When today’s refinance loans take a minimum of two to three months, if not longer, it’ll take even longer time to close on a loan when rates start spiking. Why? Because everyone else who’s in that position will be standing in line to refinance (before the rate goes higher). Not to forget that tomorrow’s fixed rates will be way higher than today’s. And folks, you must understand that the rates cannot go any lower. The chart above says it all. The federal funds rate is close to zero now.
Getting a low fixed rate for as long of a term as possible is the solution to a not so distant problem. It applies not only to those who have ARMs but also to those who have loans due to mature in the next few years. If your loan has a prepayment penalty it should not deter you from being proactive. The cost of waiting could be steep. In the long run saving today by avoiding the penalty may end up costing way more in form of a high interest rate on your mortgage.
If your life revolves around real estate you’re probably wondering when will the real estate market bounce back. And even if you’re not directly involved in real estate you’re most likely wondering when will you be able to sell your property for a price above your loan balance.
So, if you’re like most people and listen to the news you would have heard this. The Federal Reserve has lowered the interest rate to revive the depressed real estate sector. Low rates would get people to buy and others to refinance. Buying would lead to more housing demand thus helping builders and realtors. Refinancing would help consumers increase their net disposable income. Therefore, these folks would start spending which in turn triggers demand in other consumer areas and blah, blah, and blah.
It may not be obvious to the untrained eye that our Keynesian anti-free market government and its media disciple have it backwards. What they don’t seem to understand is that in order for people to buy houses they must be financially able. Not only that but they also must have the security that their job will be there and their employer will still need them for a while. When nine out of a hundred people (or more realistically seventeen out of a hundred) are jobless, the majority of folks don’t think about the “American Dream”. They think about how they’ll be able to keep food on the table and keep a roof, any kind of roof, above their heads.
Then we have the Joe Smiths who may want to move and buy a new home but they can’t just seem to be able to sell their current ones. Their homes are either under water or there is no demand to buy at the price they think is fair. So the Joe Smiths will have not much of a choice but to stay where they are.
Reality is that few people today have a sense of prosperity. As a landlord myself I see how my tenants are suffering through this economy. As a commercial mortgage broker I can’t help noticing the challenges some of my clients experience. Heck, my work and my investments are affected by the people I work with, my tenants and my clients. As you can see there is a Domino Effect that impacts all of us. So, what is the solution then?
Get rid of Regulations
In order for the real estate market to get better there are some underlying fundamentals that must occur. First, we must see a business friendly environment encouraged by the government. In this case the government’s job is to slash most of the burdening regulations so that entrepreneurs can put their creative minds into action and bring new enterprises to life. We definitely need the small business and the wonderful benefits of competition. This will create employment and will fill commercial real estate vacancies.
Secondly, we need lower taxes not only for businesses but for all taxpayers. The businessman must profit in order for him to stay in business. Otherwise there is no incentive for him to take such challenge and risk. As far as the individual, he knows best how to spend his money, he doesn’t need the government to do it for him. When the individual has more disposable income he can then direct the spending in the areas he finds it most beneficial.
Get rid of Moral Hazard
Then we have the all so predominant Moral Hazard. The Wikipedia defines moral hazard as “a situation where a party will have a tendency to take risks because the costs that could incur will not be felt by the party taking the risk. Moral hazard arises because an individual or institution does not take the full consequences and responsibilities of its actions, and therefore has a tendency to act less carefully than it otherwise would, leaving another party to hold some responsibility for the consequences of those actions.” What I am referring to is the corporate welfare which entails the “generosity” of the government when bailing out insolvent corporations.
This matters because when Fannie and Freddie get bailed out it doesn’t allow the market to work in its natural course of events. It matters because when the Fed buys the banks’ bad assets it takes away the banks’ incentive to efficiently discard those properties to investors for the prices established by the market. Thus we have banks sitting nonchalantly on portfolios of foreclosed and non-foreclosed (but non-performing) assets. Why such behavior? Because they already sold their bad loans for a higher (than what the market dictates) price to the Fed. They have the money in reserves so why hurry? Ask a realtor who sells foreclosures or short sales what it’s like to work with the banks and you’ll get the real picture.
That’s it, folks, this is what must happen before we dare to even think of a real estate market recovery. Without getting rid of regulations, without lowering taxes, and without eliminating the corporate/bank welfare I don’t care what the laymen journalists say or predict. It’s all wishful thinking.
A final note. Implementing one or two of those requirements would somewhat improve the real estate market but in no way will bring it to a full recovery.
Yesterday, for the second time in less than a year, I was
invited to Washington to testify in front of a Congressional
Committee that was contemplating regulatory moves to aid the
struggling economy. This time around it was the House
Subcommittee on Insurance, Housing and Community Opportunity
that asked for my views on Federal Housing Administration’s
(FHA) policy in the apartment lending market. Although this
is a fairly narrow issue, I told them the same thing I did
last year when I testified about job creation.
Government programs don’t solve problems, they just create new ones. While I
thank the Committee for inviting me, I believe the congressmen may have gotten
more than they bargained for. I can apologize for shaking up what would have
otherwise been a sleepy and forgettable proceeding, but I won’t apologize for
trying to inject respect for the Constitution and free market capitalism into a
venue that has been doing its best to destroy both.
I have edited down the more than 2 hour hearing into a package of slightly more
than 30 minutes. This includes all of my testimony and some of the more
noteworthy exchanges I had with the congressmen. The seven other people who
testified besides me all represented the many interest groups who benefit from
FHA loans. I represented only the interests of U.S. taxpayers, a group that
congressmen usually don’t hear from when considering legislation.
This video should give all Americans a better idea of how insulated Congress
is from the American taxpayers who are being asked to pay for the government’s
spending and borrowing. If you share my concerns, share this video with a friend.
Viral videos have a singular power to influence the national conversation. Let’s
get it started.
The Great Recession has brought upon us the Great Credit Contraction. That means that commercial real estate lenders have become more cautious. The high loan to values (LTV’s) have been replaced by higher investment capital from borrowers. Lower credit scores have been replaced by higher minimums. Raw land and Construction loans have vanished. Stated Income and Reduced Documentation loans have left the lending stage making room for the Fully Documented loans. Appraisals are scrutinized from top to bottom and local economic data are given its deserved emphasis.
At first one may be inclined to think of all these events as a negative element that would impact an economic recovery. But this is far away from the truth. Our current economy can be easily described as an alcoholic man. The credit that’s been pumped into our economy during past decades (dot.com, Y2K, real estate boom) has had the equivalent effect – figuratively speaking – of alcohol abuse. The nondiscriminatory credit expansion along with below market interest rates – made available by the central banks – has given wrong signals to individuals and businesses thus causing “malinvestments” and speculation. Our economy has become addicted to credit for too much consumption (and not enough production) and finally withdrawal symptoms are kicking in. There are certain unpleasant steps that are required to sober up and that is just one of the requirements necessary for an economic recovery.
For one that has been in the field of lending for a few decades he can probably attest to the fact that in reality today’s lending guidelines are not much different than what they were back during the 70′s, 80′s or even the early 90′s. They are in one word, conservative. Of course, if one compares current lending to only five years ago, the difference appears quite drastic. And drastic difference it is but not because today’s guidelines are way too rigid but because yesterday’s were way too loose.
So, where does this leave the entrepreneur or business man of today? To start with he needs to be prepared to play in the same field with the rest of the competitors. He must be well equipped to prove himself and his project worthy of new credit. This implies a well documented and up to date loan package. He must emphasize his strength and generously compensate for any minor weakness. His project must be sound and viable from an economic standpoint. His background must be rich in experience and knowledge. His financial strength must be outstanding, in other words, he must have some serious skin in the game. And finally all of the above requirements must be clearly described in the project’s summary without leaving any room for ambiguities. For more details on how to position yourself first in line for financing read Reality vs Fantasy in Commercial Financing.
The conclusion is that lenders are not willing to take high risk anymore. The current credit deflation has decreased the pool of funds available for lending thus competition for money is fierce. This does not mean there is no more money to lend, it simply means that the current available funds will be distributed to those who can prove their competence and efficiency best.
Apply for a Commercial Loan to hundreds of commercial lenders to get instant responses to your loan request. It’s free!
Maybe you’re looking to buy an investment property outside of your area. The property looks great in the pictures, the net operating income and the CAP rates are excellent, but how do you know the area in which the property is located suits your criteria? Before you spend money on an airline ticket there is something you can do, something that will only take a few minutes of your time and costs no money.
Or maybe your son or daughter is being relocated in another part of the country and he/she needs a place to call home. I know your heart will be broken but after getting used to the idea that your child is not moving away from you but is moving away to better her life there are few things you may want to help with. You want to be sure your child will be living in a safe place and below are a few tips of how to accomplish that.
Spend a few minutes checking out this free internet tool at NeighborhoodScout.com. This tool ranks neighborhoods into four shades of blue, with dark blue being the safest. You can also input the address of the property you’re looking to buy or the apartment your kid is planning to rent, and voila, you’ll get all kind of “goodies’ about the area.
Another excellent tool is SpotCrime.com. It describes each of the crimes committed in a neighborhood – shootings, assaults, robbery, thefts, vandalism, etc. If you invest your hard earned money in a property outside of your city you may have preferences of location based on the crime rate. If your kid has chosen an apartment because it was less expensive be sure to check the neighborhood crime before committing to a lease agreement. Sometimes a higher rent is justified considering our kids’ safety is priceless.
One of my favorite research tools is City-Data.com. Free demographics provided on this website allows me to better understand the economy and real estate values. These reports include population, income levels, demographic trends (are people moving out), and the crime rate.
Last but not least another important internet tool is available when you are ready to (instantly) place your commercial loan. This easy to use website is called C-Loans.com. C-Loans is the largest of the commercial mortgage portals, and it enjoys 750 different participating commercial lenders.
The user merely inputs his commercial real estate loan request and then chooses six of the suggested thirty commercial lenders. If none of the first six commercial lenders wants to make his commercial real estate loan, the user merely comes back and checks the next six commercial lenders. And best of all? C-Loans.com is free!
Due to my dedication to the mortgage industry for the past two decades I often get questions like “When will lending return to normal?” or “How long will it be until rates go up?” While I do not have a crystal ball I can only theorize based on my knowledge of macroeconomics and experience in the lending world. First I will address that what we had for the first part of the last decade was not a normal lending activity in the sense that “free money for all” was an extreme event. What we’re experiencing today – a credit freeze – is the other extreme. The problem is however on how the equilibrium can be re-established and when. To have a prosperous economy a nation must have a healthy – not excessive and not rigged – lending sector. But alas, our political leaders and Central Bank are still trying to figure it out.
To get you an idea of where lending may be heading I have to bring in the topic of inflation and deflation as they are very much connected. The “Inflation or Deflation?” is one of the most debated daily topics amongst economists and central bankers. Recently it’s been one of the most debated topics I’ve had with friends and colleagues that I highly respect so I decided to analyze the subject based on purely Austrian fundamental principles. Of course there are other factors that could throw off my theory and change the outcome of what I believe to be runaway price inflation. For example, we could be involved in another major war, possibly WWIII, where unemployment would decrease (based on the idea that many unemployed people would be needed to go and fight the war) and the U.S. production would increase dramatically due to the need for military devices. That would not be a natural recovery and I don’t endorse it due to tragedy and loss of lives that it involves.
So, what’s it going to be? Inflation or Deflation? To determine the potential outcome one should understand how the money supply is one of the biggest pieces of the puzzle. The monetary base represents roughly a small percentage (15% or so) of the true money supply TMS. The U.S. Central Bank directly controls only this portion of the money supply. I should emphasize the word directly because indirectly there are a lot of things that the Federal Reserve can and does control, yet that’s another topic of its own on which I won’t elaborate at this time. Many experts argue that the monetary base has remained relatively flat. But in looking at the chart below I see a steady increase from 1980 until 2008. Then in 2008 from $850B the base shot up to $2.8T (as of July 14, 2011) in response to the first few rounds of “Quantitative Easing.”
The monetary base comprises physical currency and bank reserves. When the Fed purchases securities through its open-market operations, the monetary base increases by a corresponding amount, but it is ultimately the banks and their customers who determine the amount of circulation credit built on top of the monetary base. Indeed the Fed cannot force banks to make loans to individuals and businesses but by continuing to buy securities from banks it helps them increase their reserves, and do remember that bank reserves are part of the monetary base. This monetary base increase to infinity should and will eventually react in a less than desirable form.
OK, so now we understand that Mr. Bernanke is not really “printing” all the money that many believe he does, and again he only directly affects about 15% of the total money supply but indirectly he does rely on banks to expand the remainder through the fractional reserve banking system. Mr. Bernanke feels confident that at least for a while banks will not make loans due to factors such as newly taken risk (in form of new loans at low rates) at a time when the banks are still trying to heal their balance sheets.
It is known that these reserves are sitting quietly at the Fed generating a yield to the banks of 25 basis points (.25%). This gives me a hint that inflation could be the possible threat but not until banks start lending at their full potential. Back in March 2011 the amount of reserves posted by St. Louis Federal Reserve Bank was $1.2T. My recent search showed it spiked to $1.6T in just four months (see chart below.) But eventually the banks balance sheets will heal and they will be ready to lend again. And this is the concern for those that believe inflation would be the cause of another economic crises. In simple terms the reserves that were idle for a while would start circulating in the global economy and would lead to more money chasing the same amount of goods raising their prices and known as inflation.
So, where does that leave us? Will lending or can lending be frozen forever to avoid a potential massive inflation? For a while it may work considering the banks are still not ready due to lack of sufficient qualified borrowers. Eventually, down the road banks and borrowers will be ready but that event could trigger the massive inflation that most of us are not prepared for. To avoid it the Fed would have to use the strategy of banks reserves reversal. But it;s easier said than could be done because the Fed cannot simply take them away from the banks. From a banker’s standpoint this would be analogous to stealing. The option left would be for banks to buy back securities – that include toxic assets – and return some of these excess reserves back to the Fed while the Fed would remove them from their balance sheet. But again if banks buy back the assets they sold to the Fed – in exchange for the reserves they currently hold – their balance sheets would be no better than in 2008. This would lead to sky rocketing interest rates and a banking system failure worse than back in 2008. Either way a soft landing gets harder and harder to achieve.
Following is a brief reminder of how all of this had started during the early 2000 through the housing boom (that not coincidentally extinguished the potential harm caused by the dot.com bust.) The Fed’s expanded credit via banks – multiplied through the fractional reserve banking system – during the “roaring” 2000’s went primarily into hard assets and primarily into real estate. Through this credit expansion phenomenon the rates were kept at artificially low levels (when the money rate should have been allowed to rise in a free market scenario) and it distorted the value of assets by inflating them artificially. Then the defaults started to gain traction and what once used to be a good asset (for the bank and the borrower) it ended up being a toxic asset. Along with this the banks stopped making loans, the real estate activity suddenly dropped and the glut of foreclosed homes brought down the values of the rest of the homes.
To end with a more defined answer I will recap the options that appear to exist. One would be a moral one for the Federal Reserve and our leaders by allowing freedom of the markets to take its course. This would be expressed in form of very high interest rates, lack of lending capacity associated with a credit contraction, bankruptcy of many Wall Street institutions, and a deflationary depression that would be required for a fresh start. With this option the risk of Hyperinflation is considerably minimized. The other option, that appears more of where we’re heading is the one with government intervention in the markets. The Fed continues to expand the monetary base, keeps interest rates at the bottom, and when banks are ready to start lending at their full potential it may trigger a massive inflation or hyperinflation along with the destruction of the dollar.
Growing up in a communist regime where food and just about everything was rationed instilled in me a constant need for survival. My parents were always preoccupied with having enough food to feed the family. Whenever they had the opportunity to get anything classified as “life necessity” they would make sure they’d stock as much as they were allowed. That was of course a while back… about 30 some years ago. Being an American for more than two decades however didn’t change much in the way I think despite the abundance that our country had experienced during all this time.
I talk to people everyday and few appear to be concerned with the future. For many it’s still business as usual. Yes, food prices have gone up and so is gasoline but the concept of fiat money or a currency collapse is not really a concern.
So, let’s start with the emerging countries. Brazil, China, India, Russia are working on a plan to trade in currency other than the dollar. What that means for us here in the U.S. is that our dollar will soon not be in demand. Not long ago the Chinese government declared that it intends to strengthen the Yuan to the level of the world reserve currency. The Chinese government and people have been quite busy during the past few years buying gold. That may very well lead to a yuan currency backed by gold and gold is indeed real money. I clearly see a rising of the East and a decline of the West.
The idea that the roles between the East and the West could reverse is not far-fetched. When the Chinese people were working numerous hours for little wages in what could be known as “slave conditions” they were indirectly providing the West – including the U.S. – with a high standard of living. They were the producers and we were the consumers. Our purchasing power was phenomenal as a result of a powerful (petro)dollar and the Chinese products that were manufactured at a very low cost. After all these years of hard work at minimal wages Chinese standard of living has already started a major improvement. I see both, literally and figuratively, gold on their horizon. A nation of producers and savers, the birth of a sound currency with a strength that comes with the world’s reserve status, these events can all be “threatening’ to the American way of life.
Then we have a government that is spending like there is no tomorrow. The Central Bank in cooperation with most of the politicians have diluted the dollar to the point of no return. Take a glass of a good old scotch and throw it in the ocean…the strength and quality of the scotch are gone. That’s exactly how our beloved dollar is dissipating in an ocean of Quantitative Easing. The dollar is during its last breath and when it dies drastic changes will occur. It’s hard for many to comprehend such an “absurd” idea of living through an economic depression, or that a loaf of bread or a gallon of gas could cost $50 or more. I don’t know of any people who think incomes will go up at the same rate as the prices of goods. That would – for sure – be a naive thought. But advancement in technology does not necessarily imply a societal or economic advancement. The pendulum is moving from our part of the world and a few smart Americans have already made the steps to preserve their hard earned assets.
So, how do you keep your dollars from being stolen through inflation? A few smart people convert their dollars to real money such as gold and silver. Ron Paul, the biggest advocate of sound money, in his book Pillars of Prosperity claims that buying precious metals is not an investment but a requirement of asset preservation. Statistics of American investments in gold show an astonishing 0.6% of all financial assets investments. This does not come as surprising to those who know that the 1980’s was the beginning of Wall Street “manufacturing” a myriad of paper assets.
I also believe in investing in tangible assets such as real estate. Of course, not every real estate deal qualifies for a good investment. First, the price must be right. During the credit boom era price was not anymore an issue. Most buyers were assured price would go up and terms were more important. Not so anymore. The lending industry has gone through a major shift in the underwriting and qualifications criteria. Today, it’s either cash or the borrower and the transaction must be very strong. Going back to pricing, I say price must be right so that it’s low enough where investors can benefit from steady and large enough monthly cash-flow (after all expenses are paid.)
The type of real estate is also key to a successful investment. There are two kinds that I find exceptional. One is the multi-family real estate, you know the apartment complexes. The CNNMoney 2011 Spring Housing Guide predicts the rents to go up much higher and in a relatively short period of time, thus they are alerting renters to lock in their leases. Demand is up, supply is down…all thanks to the banks that are unwilling to negotiate a decent loan modification and are sitting on millions of vacant foreclosed houses while keeping their prices at unrealistically high levels.
Second type is the Assisted Living Facility (ALF), again the result of high demand and short supply. The aging population is becoming less independent and more dependent on a facility that is equipped with the right staff and living conditions, and so far for many residents money has not been an issue. They are willing to pay so long as they are well taken care of. This kind of investment could be a potential cash cow when purchased in the right area, at the right price, and operated by the right team.
If leverage is needed I found that lenders are much friendlier and more willing to lend on these kind of real estate transactions. After all valuation of such kind is based on the occupancy (and these tend to have higher occupancy rates in many areas) and Net Operating Income (again these tend to have a higher NOI). One of the qualifications of a good investment is that it is an asset that satisfies one or more human needs and with these types of real estate it is obvious that it satisfies the housing need.
Lenders also know that these two particular investments if managed and operated properly they have the potential to generate substantial revenues for its owners not only during good times but also and especially during rough economic times. That’s another reason they have more money to lend on these kinds in comparison to a shopping center whose tenant retailers are suffering due to revenue drops. This is what my experience had taught me and I am eager to share with all of you.
Can we fix the economic problems that our beloved country is going through? Certainly not, as we can’t make most politicians become honest. But I believe that by taking responsibility of our own future individually there will be less people hurt and fewer negative statistics. And I am all for it!