Put $60,000 into a second position note on a warehouse, and nothing came back

This is the first thing I ever did with real money and it went to zero, so here it is in plain terms in case someone else is looking at the same kind of offer.

What it was. A group I'd been reading about for a few months syndicated a $480,000 second position loan against a 44,000 sf older warehouse in a southern market. Second position means there was another lender ahead of us, a bank with about $1.9M outstanding, and in a default that bank gets paid in full before we see a dollar. My piece was $60,000. The stated rate was 11 percent, paid monthly, 24 month term, and the borrower was a small operator who wanted the money to re-tenant the building after his single tenant left.

I got seven monthly payments. Then they stopped. The borrower had not re-leased the space, and the reason turned out to be simple, the building was 22 foot clear commodity space in a submarket where three new buildings with much higher ceilings had delivered while he was trying to lease. He couldn't get near the rent he had underwritten.

The bank started foreclosure. Our group could have paid off the bank's $1.9M to protect our position, which we obviously couldn't do, or bid at the sale. The sale price came in under the bank's balance. Second position got wiped out. $60,000 gone, minus the $5,500 or so of interest I'd received.

What I got wrong, at the step where it happened. I evaluated the loan and never evaluated the building. I read the rate, the term, the loan to value, and the borrower's experience summary. I did not ask a single question about whether that specific box could be leased, at what rent, or how long it would take. The whole loan depended on a leasing event and I treated it as a fixed income product.

What I'd do differently. Before putting money behind a loan on a vacant commercial building, I'd get someone who leases in that submarket to tell me what the space rents for and how long it sits, and I'd want the payoff to work even if leasing takes twice that long. And I'd stay out of second position on vacant collateral entirely, because the position gives you no ability to act when things go wrong.

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1gregpowell66AG4BPRO8

Sorry about the $60,000. I'll push back on your diagnosis a little though, because I think you're blaming the market for a structure problem.

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 him leasing fast, and you can ask that question in one sentence.

I came close to the same thing on the construction side, lending a builder friend $40,000 behind a bank on a small industrial shell. What saved me was that my lawyer asked what happens if it isn't leased at completion, and the answer was that nobody had thought about it. I didn't fund. That was luck plus one sharp question from him, not skill.

The part of your write-up I'd keep is the last line. Position matters most exactly when you most need it to.

Put $60,000 into a second position note on a warehouse, and nothing came back

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