Fannie Mae is now offering a new commercial loan modification program aimed exclusively at commercial real estate owners who are unable to make their monthly mortgage payments. The new program called the Payment Reduction Plan (PRP) comes as welcome relief to many apartment building, office building and shopping center owners who have seen drastic decreases in vacancies over the past twelve months. These vacancies have seriously impeded commercial property owners’ ability to pay their mortgages. PRP allows commercial owners to negotiate with their loan servicer for up to a 30% reduction on their commercial mortgage payments.

Breaking Down Fannie Mae’s Payment Reduction Plan (PRP)

According to the Fannie Mae website the “The PRP provides a borrower with temporary payment relief while the servicer and borrower work together to find the appropriate permanent foreclosure prevention solution. PRP offers an additional foreclosure prevention solution for borrowers who are ineligible for the Home Affordable Modification Program (HAMP).”

Under the PRP monthly commercial loan payments can be reduced up to 30% off of the total principal and interest only. The program is strictly for non owner occupied and investment properties.

The Fannie Mae website explains that “during the maximum six month period of forbearance, the servicer should work with the borrower to identify the feasibility of, and implement, a more permanent foreclosure prevention alternative. The servicer should evaluate and identify a permanent solution during the first three months of the forbearance period and should implement the alternative by the end of the sixth month.”

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This Article is Copyright © 2004-2009 BiggerPockets, Inc. All Rights Reserved.

Commercial Loan Modification Program From Fannie Mae

The IRS has issued a new rule IRS Revenue Procedure 2009-45 IRS Revenue Procedure 2009-45 that eases the restrictions on modifications of commercial mortgages that have been packaged into commercial mortgage backed securities.

This action allows borrowers to open discussions with the loan servicer prior to any default in an attempt to work out the loan. Prior to this new rule only a very small number or loans in a servicing pool could be modified and they must already have been in arrears.

What is the Commercial Loan Modification Process?

Do you or someone you know own an apartment building that is under performing? Are you behind on your commercial loan payments? Is the bank threatening a commercial loan foreclosure?

When you hire a commercial loan modification professional, it is important to know what to expect. The first step is to go through a consultation and analysis. The commercial loan workout professional will look over your loan papers. They assess your business’ financial situation, and they will explain what they can do for you. In order to get a commercial loan modification, you must qualify with the lender for the new loan agreement. Your commercial loan workout professional will pre-qualify you based on the information you provide them.

Once your commercial loan modification professional pre-qualifies you for the commercial loan modification, they will go to the bank or commercial lender to make sure you are officially qualified. Simply put, they will make sure the lender is willing to discuss options pertaining to your current commercial loan agreement. After you are qualified the negotiations begin.

During the negotiation process, your commercial loan modification professional will represent you and work to get you the best possible commercial loan workout. The commercial loan modification professional may be able to negotiate a better interest rate, an extension on the life of your loan, or possibly lowering the principal amount still owed on the commercial loan. Finally, the negotiations will result in the final modification or restructuring of the loan. A new loan agreement will be written up, and you will sign it agreeing to the new loan. Once the papers are signed and processed the new terms of the loan go into affect.

This Article is Copyright © 2004-2009 BiggerPockets, Inc. All Rights Reserved.

IRS Eases Restrictions on Commercial Loan Modifications

In what is an interesting phenomenon, apartment vacancies have hit their highest point since 1986 in cities across the country. 

According to Reis Inc., a New York real-estate research firm that tracks vacancies and rents in the top 79 U.S. markets, the vacancy rate reached 7.8% this summer, which is normally a strong period for rentals. And, the rate is expected to rise even higher in the fall and winter, when rental demand is weaker, pushing vacancies to the highest levels since Reis started keeping records in 1980. 

So, what is causing the increase in vacancies?

One word: unemployment, which is close to 10%–a 26 year high. It seems that the high jobless rate is leading would-be renters to double-up or move in with family or friends. This has really put the squeeze on landlords because unemployment has been higher among workers under 35 years old, who are more likely to rent. As a result, rents across the country have fallen by 2.7%. 

The second and third quarters typically are the strongest periods for landlords because they are popular times for people to move. But this year, according to Victor Calanog, director of research for Reis, “vacancies just continued rising.” The third quarter saw vacancies increase in 42 markets, improve in 26 markets and remain unchanged in 11 markets. Omaha, Neb., saw the largest rise in vacancies, with the rate rising 1.1 percentage points to 7.4%. Other significant increases were seen in Memphis, Tennessee; Indianapolis, Indiana; Raleigh, North Carolina; and Tacoma, Washington. 

The falling rental market is happening while the housing market is finally showing some signs of steadying. The federal tax credit for first-time buyers and investor demand has helped to improve sales of low- and mid-priced homes this summer. However, some forecasters are warning that demand could fall when the tax credit expires and supply could increase as a result of more foreclosures hitting the market. 

And, though a housing upturn could turn the highest quality renters into buyers, the move-out rate isn’t expected to exceed the levels caused by the housing boom in the early 2000s. As a result of the mortgage crisis, credit standards have become much more stringent, which will probably keep more renters where they are. 

But, the housing bust has also caused a glut of new apartment inventory in some of the most overbuilt housing markets, as developers have been forced to convert scores of unsold condominium developments into rentals. As a result, Reis predicts that the vacancy rate will peak at well above 8% by mid-2010.

This Article is Copyright © 2004-2009 BiggerPockets, Inc. All Rights Reserved.

Apartment Vacancy Rate Hits Its Highest Point In Nearly 25 Years

I was surprised by some of the comments regarding Dr. Doom AKA Nouriel Roubini and his predictions that we are not yet out of the economic woods, and we are most likely going to experience continued turmoil in our economy in general and real estate specifically.

To the point – it seems that everyone is now paying attention to the coming challenges with the commercial mortgage market.  And who can blame anyone for thinking that the commercial market is on the edge, and will likely go right over the side in the coming 2 – 3 years.

Using Old Valuations Can Lead to Disaster!

Making this situation worse is the fact that most lenders are valuing the underlying properties collateralizing their mortgages at their original values (just like what is happening with residential properties), further forestalling the pending crisis in bank defaults.  If banks revalued their portfolios to the real (current) values of their underlying collateral… it is possible the entire system would collapse. I found an interesting dialogon public radio amongst various experts regarding the pending (actually it has already started) commercial collapse that demonstrates that some people may have their head in the sand. 

In my last article I cautioned investors who were not currently in the commercial investing side of things to tread lightly… and I will repeat it again…  The commercial world has a very different set of rules than the single family world.  It is an oversimplification to state that “commercial” investing is not a big deal… you just add more zeros… because each one of those added zeros represents significant increases in risk.

And to drive the point home… we expect that the experts, those running in the commercial world, to be very bright with a keen sense for managing and mitigating risk… yet if this were totally true, why did these geniuses buy, and overpay, at the very top of the market and not see this train wreck coming?  And these are the EXPERTS!

So, bottom line… the experts are hoping someone less bright then they are will come along and bail them out.  Don’t be that less BRIGHT person!

This Article is Copyright © 2004-2009 BiggerPockets, Inc. All Rights Reserved.

Deja-Vu… All Over Again! This time in the Commercial Real Estate Market

Commercial real estate owners who are considering hiring an attorney to handle their commercial loan modification should investigate the background and experience of the person they hiring so that they know in advance what to expect.

In my experience as a commercial loan modification specialist I have found that many attorneys who advertise themselves as commercial loan modification attorneys actually have very little experience performing successful loan workouts. Unfortunately, as many people know, there is an over supply of attorneys in the United States. This forces many lawyers to follow the latest and hottest trends in order to get new business and survive. You may see the same people who used to do accident and injury work now advertising their services as loss mitigation specialists because it has become such a needed service. For this reason the commercial real estate owner should definitely do their homework and research the actual experience of the person they are hiring.

What You Should Expect from a Commercial Loan Modification Attorney:

1. A Money Back Guarantee: Is your attorney willing to give a complete refund if he or she is unable to successfully modify your commercial mortgage?  Very few commercial loan workout companies are offering a money back guarantee but it is will worth the research to find a company or attorney that is willing to offer a written money back guarantee if they are unable to modify your loan.
2. A Written Plan or Proposal:  Make sure that your commercial loan workout attorney gives you a very detailed written proposal of all of the services that he or she is going to perform on your behalf.  Commercial loan modification can be a complicated process that requires many hours of work and research.
3. Satisfied Clients. Ask your commercial loan modification attorney if they can give you the contact information for any clients that they have successfully helped to modify their commercial loans.  They may not be able to give you any references because of their privacy policy or because of attorney client privilege but it can’t hurt to ask.  An attorney who successfully modified the commercial loans of many clients surely must have one or two who would agree to attest to the experience and results that had with the attorney who helped them.
4. Who Does the Work? Find out if your commercial loan modification attorney will be doing the negotiating and processing him or her self.  Many attorneys are too busy to actually perform the important work themselves and they may be outsourcing your commercial loan modification to a third party.  You may be able to save money and time by cutting out the middleman and going directly to the company that performs the negotiation and works with the bank.

This Article is Copyright © 2004-2009 BiggerPockets, Inc. All Rights Reserved.

Attorneys for Commercial Loan Modification. What You Need to Know.

Pricing land for development can be a daunting task for the untrained investor.  As a niche subset of both residential and commercial real estate, using comparables for land can be as dangerous to a developer as it is mysterious, sometimes causing the failure of what was certain to be a fantastic development.

However, for the savvy investor, there is one universally accepted land valuation method used by development professionals, corporations, and appraisers alike; the Land Residual Method.  By using this method you will be able to determine the current and future value of any piece of land, whether its use be residential or commercial.  You will also be able to price land, such that any development you propose will have built in profit. With some practice, you will be able to employ the land residual method in just a few moments, summing up the value of almost any property just on sight.

The land residual method has a fancy sounding name, but to use it all you need is an understanding of some simple math.  The land residual method is a calculation that takes the highest and best use of a particular piece of property and subtracts out the total cost of development to arrive at the residual value: the land value.  Once you have the numbers it’s that easy.  ”How do you get the numbers?”  You ask.  It takes some research, but even a novice investor can figure it out relatively quickly.

For the sake of this article I’ll be speaking to residential single family development or single family lot land.  Rest assured, commercial development uses the same principles, though the calculations are a little more in depth.

Use and Utility

You’ve heard the term “Location, Location, Location” thrown around in many real estate circles.  It is never more true than when developing land.  While I don’t recommend using any type of comparables for valuing land, it’s generally accepted that land near the ocean, or any other high priced corridor, has a higher intrinsic value that land based further away from a hub or commercial center.  It boils down to use and utility.  For instance, a 100 unit office building in downtown Seattle will probably be worth more than the same building in rural Arkansas.  Generally speaking, the land those properties sit on will be valued accordingly.  It’s one thing to accept that, but another to understand why.

Property value is determined by its highest and best use.  A piece of property that can be developed into a regional shopping mall will be more valuable than a property that can only be developed into a single family home.  This is because the end use of the former has a much higher finished value than the latter.  The value of the materials are more and the expected income from renting or owning the first is significantly more valuable than the second.  It all comes down to profit and a return on investment.  Generally speaking there is more profit to be made in larger commercial buildings than a single family home.  However, the commercial property takes significantly more risk and money to develop.  Hence, the larger land value.

The first part of the land residual method is to estimate the final or future value of the proposed property.  This can be done by several approaches.  In the case of a single family home development it can be quickly estimated by using recent sales comps from a local real estate broker or agent.  Make sure you’re dealing with true comps; similar in style, size, amenities, and age.  You shouldn’t be using a 10 year old sale as a comp for an about to be built home.

For our example, let’s assume you’re building a 3 bedroom, 2 bath home, 1,500 sf in size, with a lot size of 1/2 acre.  Let’s also assume your comparable report shows the median home sales price in the last 6 months for this type of home to be $500,000.

Once you’ve arrived at an estimate for the final or completed value of your property you move on to figure out what it will cost to build your proposed property.

Development Costs

Development costs can vary wildly from state to state and city to city, dependent on things like the amount of work in the area and the cost to deliver materials to your site.  When estimating development costs I counsel investors to research their market by calling local developers.  Find out what they paid.  Talk to contractors and find out what the going rate for material and labor is.  Talk to local builders’ associations.  They often keep data on home building costs in the area.

There are two ways to estimate costs.  You can use a $/sf method, or actually go line item by line item.  The second method can only be done if you have a list of all the line items required to build your home.  The $/sf method is easier to obtain, but not as accurate as the line item method. Your goal is to determine the total soft and hard development costs.  Soft and hard costs break down as follows:

A hard cost is anything that contributes to the direct construction of the structure itself.  These are usually limited to the costs to go vertical. Soft costs are anything that do not fit into that category.  Some soft costs are brokers fees, financing fees, horizontal development like running of utilities, demolition of existing structures, clearing and grading of the land, curbs, roads, and driveways, among others.

If your local contractor tells you the average hard and soft cost to build your home would be $100/sf, then you know your total development cost would be $150,000 ($100/sf  X 1,500 sf  = $150,000).

Do the Math

Now it’s time to resolve your numbers.  The value of the completed home is estimated at $500,000, which is hopefully the amount it will fetch when you’re ready to sell.  Your development costs are  $150,000.  The residual land value is the difference between finished value and development costs.  In our example, the residual land value of the proposed property is $350,000 ($500,000 – $150,000 = $350,000).

What this means, is that for you to build a home that would cost $150,000 and have a value of $500,000 in the open market, you could pay up to $350,000 for that piece of land.  This is the break even point.  If you pay more for the land there is a great potential for you to lose money.  If you pay less for the land you’re potentially building in profit.  And that’s exactly how a professional developer would do it.  They don’t stop at the residual land value.  They go one step further by working in their profit.

Work in your profit

As a developer/investor you’re here to make a profit.  You want to work that into the equation before you price your land and make your offer.  Most developers of residential property like to make between 20-30%.  Anything below that will be hard to finance through a conventional lender, and would also be a risk on your part. Markets move up and down, sometimes as much as 10% in a few months.  If your profit margin was only 15% and the market drops 10% you’re left with a 5% profit.  For that kind of money you don’t need the risk of development you can just go out, buy a T-Bill, and sip iced tea on your front porch until retirement.

If you’re cost to develop was estimated at $150,000 and you’d like to make a 30% profit on costs, your profit margin would be $45,000 ($150,000 X 30% = $45,000).  This number is then subtracted from the residual land value of $350,000 for a maximum offer price of $305,000  ($350,000 – $45,000 = $305,000).  That means, to make a 30% profit on your development costs, you wouldn’t pay more than $305,000 for the land.

Well that’s fine and good, but most developers want to make profit on their entire project, not just the costs.  Thus we do this calculation one more time; this time on the land purchase portion as well.  Assuming you’d want to make 30% on the land portion to, how much would you have to back out?  You’d back out approximately $90,000 ($305,000 X 30% = $91,500).

Max Offer Price

Take your residual land value minus your profit on cost and your estimated profit on the land cost and you can determine your maximum land offer price.  For our example, the final land value and max offer price would be $215,000 ($305,000 – 90,000 = $215,000).

For the property cited in the example I would offer the seller no more than $215,000  to purchase their piece of land.  This ensures I can get the development done and make a nice profit for myself.  Just to check my numbers, I run the math one more time.

Check the math

To check your final expected profit, simply run the numbers forward from the start.   Here’s how it would look:

$215,000 Land Purchase

+ $150,000 Development and Construction Costs

$365,000 Total Project Cost

$500,000 Projected Revenue from Sale

-  $365,000 Total Project Cost

$135,000 Profit

$135,000 profit / $365,000 total project cost = 37% total profit Margin

Keep in mind we have not accounted for taxes of any kind.  That will of course reduce your profit margin, but still, this is not bad for a development that probably took less than a year from start to finish.

For even higher returns, your land offer would be made at an even lower number than your max offer price, in case you end up negotiating the price higher with your seller.

You can see that the residual land value method of obtaining land value is an easy and efficient way to make sure you’re paying the true market value of the land, while working in profit for your potential development.

Photo Credit: pnwra

This Article is Copyright © 2004-2009 BiggerPockets, Inc. All Rights Reserved.

Developing Real Estate: How to Price Land for Profit

Income properties are, to many, the ideal investment. Not only does one receive rental income on a monthly basis, but he also gets to enjoy capital appreciation—or at the very least, a solid hedge against inflation. With favorable tax treatment throughout and available 1031 tax deferred exchanges, one would be silly to not at least consider real estate investment.

And so he does. Hypothetical investor Bob purchases his first income property: an 8-unit multi-family in sunny San Diego, California. He loves the fact that it’s in a great location, has a favorable unit mix, and there has only been one vacancy in the last two years—and that vacancy didn’t last very long. As far as Bob is concerned, he has made the perfect investment. How could he do any better?

Raise the rents!

Typically, investment properties in low-vacancy, heavily renter-occupied housing areas that incur vacancies about as often as the Chicago Cubs win World Series have one problem: their rents are too low. If the rents weren’t below market, they would incur significantly more turnover.

That’s the key word: turnover

Turnover is a good thing; vacancies, themselves, are not. What’s the difference? A vacancy occurs when a unit has been turned (i.e. “rent ready”) and it does not have a tenant, or a prospective tenant. Turnover occurs when someone moves out of a unit and another moves in.

You may be saying to yourself, “that sounds like basically the same thing. Why not keep rents low to keep the same tenants longer?”

Using Bob’s property above as an example, let’s explore why it behooves an investor to keep rents at market.

As stated earlier, Bob owns an 8-unit property that has incurred zero vacancies over the last year. The rents are below market; each unit rents for $1400 per month. Thus, the property’s Gross Operating Income (GOI) is $134,400 (=$1400 x 8 units x 12 months).

Let’s assume that the market rents are closer to $1600 per month and that Bob will incur the standard vacancy rate in the San Diego area: 4%. Apply these assumptions to Bob’s property and its GOI increases to $147,456 [($1600 x 8 units x 12 months)-4%].

That’s a difference of $13,056 (=$147,456 – $134,400) in GOI which should equate to a similar difference in net operating income, assuming expenses stay about the same.

Let’s take it even further; let’s say Bob has some trouble with vacancies during the rent increase and incurs double the normal vacancy rate: 8%. The resulting GOI of $141,312 [($1600 x 8 units x 12 months) – 8%] would still result in an increase in revenue of $6912 over Bob’s initial figures!

That’s not all!

While the immediate improvement in cash flow is nice, the real perk is the increase in property value. If you recall, a building’s value is determined by its Net Operating Income divided by its market Cap rate. Thus, if the market is trading at a 6% Cap rate, then Bob’s building’s value would have increased by $217,600 [=$13,056(difference in GOI) / 6% Cap Rate]. Using the 8% vacancy rate example, the building’s value would have increased by $115,200 [=$6912(difference in GOI) / 6%].

To conclude, Bob could continue to keep rents below market and enjoy a fully occupied building. Or, he could maintain rents at market, allowing him to enjoy more cash flow and significantly more building value with normal vacancy. Which would you choose? Happy investing!

This Article is Copyright © 2004-2009 BiggerPockets, Inc. All Rights Reserved.

If Your Building is 100% Occupied, Your Rents Are Too Low!!!