Are you a candidate for an SBA 504 loan?
- The owner of a profitable gas station is buying his building.
- A hair-salon owner wants to purchase a small building but can only put 10 percent down.
- A small manufacturing firm is acquiring a large facility to handle its anticipated growth in the next 15 years. Initially, it will rent out 40 percent of the building and occupy the rest.
- A real estate investor is obtaining financing to buy an office building.
- The owner of a popular restaurant has made a bid on a 25,000-square-foot building. He plans to occupy 5,000 square feet and lease out the rest.
- A nonprofit organization seeks to purchase a warehouse from which to distribute food to the needy.
You should consider the SBA 504 program any time you want to get financing for an owner-occupied property. Be sure to ask the following questions when considering such funding:
- Is this loan for a building that will be at least 51-percent occupied by the owner; or is it for the construction of a building that will be at least 60-percent owner-occupied? To qualify, the answer must be “yes.”
- Does the buyer have the cash to cover the down payment?
- Can the business meet the minimum required 1.25 to 1 debt-service-coverage ratio? Cash-flow projections can be used to meet this requirement.
- Are any of the business’s associates incarcerated, on probation or on parole, or have they ever been indicted for a felony? A “yes” answer here may disqualify the borrower.
- Is the organization an ineligible business type? Ineligible business types include: nonprofit institutions; real estate developers and other speculative businesses; and businesses or organizations principally engaged in teaching, instructing, counseling or indoctrinating religion or religious beliefs.
- A low down payment: The typical 10-percent down payment frees money for the borrowers’ working capital.
- Great rates and terms: The SBA’s second-trust deed on 40 percent of the project cost comes with a 20-year term and attractive fixed rates. The terms of the bank’s first-trust deed can vary, but are always for at least 20 years. In many cases, loan payments are less than what the business was previously paying in rent.
- Funding for hard-to-finance properties: Owner-occupied buildings, single-use or special-purpose facilities such as restaurants, gas stations and carwashes are all great candidates for SBA 504 financing.
- Eligible “project costs”: Loan proceeds are not limited to the purchase or construction of a building for the business’s operations; they can also be used for tenant property improvements. This inclusion of tenant improvements frees up even more working capital for the business.
- Ongoing tax benefits: The property-owner is generally eligible for a tax write-off for building depreciation and interest expense.
- Assumable loans: The SBA portion of these loans is generally assumable (subject to borrower eligibility). This can be a huge benefit down the road and can be a selling point as well.
Let’s consider Brett, the owner of a successful local tire store. Brett has a five-year lease on his building. Although his monthly lease payments are $8,000, they are scheduled to increase $500 per month each year. Brett, therefore, decides to buy the building for $1.4 million using SBA 504 financing. He makes a $140,000 down payment and gets 20-year, fixed-rate financing on the balance at 6.5 percent. His monthly loan payments now total $9,394 ($5,219 for his bank-financed $700,000 loan and $4,175 for his SBA $560,000 loan). Over the 20-year life of the loans, Brett will make a total of $2,254,560 in payments. If he had continued to lease, his monthly payments for 20 years (assuming rent increases of $500 per month per year) would have totaled $3,060,000. Brett’s net total savings of $805,440 works out to $3,356 per month throughout the life of the loan; in just three-and-a-half years, his net savings will be equal to the amount he spent on the down payment. In addition, Brett will reap the benefits of equity appreciation on the property and a possible tax write-off of the depreciation and interest expense. Plus, he will own the property free and clear in 20 years. Quite a winning deal.
SBA 504 financing is not a perfect solution. Some of its downsides include:
- Prepayment penalties: The SBA portion of the financing includes prepayment penalties for the loan’s first 10 years. The bank loan may have prepayment penalties as well.
- Difficult paperwork: The documentation for SBA 504 loans is specific and detailed but can be managed if you are prepared.
- Long timelines: The SBA portion of the financing can take more than 75 days from submission of paperwork to financing. This is in addition to the nearly 30 days it takes to complete the paperwork.
