SBA 504 Loans: Affordable Commercial Real-Estate Loans

SBA 504 Loans: Affordable Commercial Real-Estate Loans

When people think of SBA loans, they think of the SBA 7(a) loan program, but they might not be aware that there’s actually more than one type of SBA-backed loan program. If your business is interested in buying real-estate or major equipment, then you’ll definitely want to familiarize yourself with the very affordable SBA 504 loan.

Since the majority of SBA 504 loans these days are used for real-estate, that’s what we’ll be focusing on. The real-estate purchased must be 51% owner-occupied. Also note that certain business types (speculative businesses, lending businesses, religious or nonprofit organizations) are ineligible for this loan (see complete list).

The 504 loan program is a cheap loan. The interest rates are really low and below market rates for small businesses. They can be fixed or variable, and get pegged an increment above market rates for U.S. Treasury issues. For example, as of May 2014, the rate was just over 5% for a 20-year fixed rate loan.

Furthermore, the terms are good, with 10-20 year loans. The loan (90% of the appraised value) gets covered by two parties. A local non-profit CDC (Certified Development Company) will provide 40% of the loan which is backed by the SBA, and a bank will cover the remaining 50%.

For the bank portion, the bank gets first lien on the collateral. That means that in the event of a default, the bank has the first right to the collateral. So in case of default, the bank would still break even on the loan as long as the property value doesn’t decrease by more than 50%. Since it’s a low-risk, banks really like doing these types of loans.

Another big benefit of the 504 loan program is the low downpayment required. In most cases, it’s just 10% of the appraisal value. If you’re a startup business or a specialty business (like a gas station or some medical clinics), the downpayment will go up 5% for each — so if you’re both, you’d be looking at a 20% downpayment.

While it’s not advertised, the SBA 504 loan was designed in part to help small business owners prepare and save for retirement. For example, on the SBA’s web site they have a story of a family of farmers in Washington state who used a 504 loan to help secure their retirement.

If you’re interested, check with your business’s bank to find out if they offer the SBA 504 loan. If not, check with other local banks. Since it’s a low-risk product for banks, it’s a good bet that you’ll find a bank nearby that can work with you on this product. Do note that, for banks, it’s an involved and even more bureaucratic process than standard bank loans. They require a lot of paperwork and administration, so banks usually have specialized staff to work with SBA loans. If you come up empty, you can try to find a CDC branch nearby and they can help you find a bank.

To be eligible, you have to meet the following requirements:

  • Purchase must be 51% owner-occupied and used as collateral
  • Loans from $300K up to $5M for CDC portion (40%)
  • For-profit organization
  • Net income below $5M and net worth not more than $15M (prove by providing 3 years of tax returns and 2 years of operating history)
  • Business must be profitable and have enough operating cash flow to cover monthly payments
  • Have good character and management experience

Things to be aware of

Certain activities cannot be financed with SBA 504 loans, such as: working capital and inventory; consolidating, repaying, or refinancing existing loans; or speculation or investment in rental real estate.

Also, be aware that a personal guarantee is required, but in most cases the collateral should cover you. Unlike traditional bank loans, you aren’t required to pledge your personal assets (like your home). Also note that there’s a 10 year prepayment penalty, which declines each year. And as with any personal real estate purchase, it’s also going to depend on your financial situation and local market conditions.

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