A $60,000 second position note on a warehouse that returned nothing

This is a total loss worth studying in plain terms, because the offer shape shows up constantly. What it is. A group syndicates a $480,000 second position loan against a 44,000 sf older warehouse in a southern market. Second position means another lender sits ahead, here a bank with about $1.9M outstanding, and in a default that bank gets paid in full before the second position sees a dollar. An individual piece is $60,000. The stated rate is 11 percent, paid monthly, 24 month term, and the borrower is a small operator who wants the money to re-tenant the building after his single tenant left. Seven monthly payments arrive. Then they stop. The borrower has not re-leased the space, and the reason turns out to be simple. The building is 22 foot clear commodity space in a submarket where three new buildings with much higher ceilings delivered while he was trying to lease. He cannot get near the rent he underwrote. The bank starts foreclosure. The group can pay off the bank's $1.9M to protect its position, which a group that size obviously cannot do, or it can bid at the sale. The sale price comes in under the bank's balance. Second position gets wiped out. $60,000 gone, against roughly $5,500 of interest received. Here is the error, at the step where it happens. The investor evaluates the loan and never evaluates the building. Rate, term, loan to value, and the borrower's experience summary all get read. Nobody asks a single question about whether that specific box can be leased, at what rent, or how long it will take. The whole loan depends on a leasing event and it gets treated as a fixed income product. The correction. Before putting money behind a loan on a vacant commercial building, get someone who leases in that submarket to say what the space rents for and how long it sits, and require the payoff to work even if leasing takes twice that long. Second position on vacant collateral is worth avoiding entirely, because the position gives you no ability to act when things go wrong.

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gregpowell66 AC4BPRO 19

Sorry about the $60,000. The diagnosis is worth pushing back on a little though, because the market is not really the problem here, the structure is. Run the stack. $1.9M first plus $480,000 second is $2.38M against a 44,000 sf older box. That's $54 a foot of debt on vacant commodity space. Even in a good market, a vacant building with no income doesn't support $54 a foot of debt, because the value of a vacant building is what the next buyer will pay to take on the leasing risk, and that number is a lot lower than what a leased comp trades for. The new 32 foot clear deliveries made it worse, they didn't cause it. The second thing missing is an interest reserve. On a vacant building the borrower has no income, so every payment comes out of pocket or out of the loan proceeds. Seven payments and then silence is exactly what running out of reserve looks like. If the offering documents didn't show a funded reserve covering the full term plus a cushion, the loan was always going to depend on fast leasing, and that question is worth asking in one sentence. A similar setup shows up often on the construction side: an investor considers lending behind a bank on a small industrial shell, and the question that catches it every time is what happens if the building isn't leased at completion. When nobody involved has thought about that, the silence is the answer. Declining to fund in that situation usually comes down to one sharp question asked at the right moment. The part of the write-up worth keeping is the last line. Position matters most exactly when it's most needed.

gregpowell66 AC4BPRO 19

A $60,000 second position note on a warehouse that returned nothing

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