SBA 504 Loan

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1 Purpose
2 Structure
3 Common Misconceptions
4 See also
5 References

[edit] Purpose

The Small Business Administration (SBA) 504 loan program was created to help small to mid-sized business owners acquire commercial property without the financial hassles. While this program is less-used and very little understood, in order to qualify, over half (51%) of the property must be occupied by the borrowers within one year of ownership. Another option is forming a holding company from two operating companies. This company can then take the title to the commercial property. To qualify for this program, U.S. citizens or permanent residents must hold a majority of the ownership of the operating companies and the holding company. The 504 Loan does not contain any restrictions or ceilings; however, there are three criteria for eligibility:

The company’s average net income cannot surpass $2.5 million.

The anticipated project size must be greater than the personal, non-retirement, unencumbered liquid assets of the guarantors/principals.

Net worth of the operating companies must be $7.5 million or less.

[edit] Structure

The format of the 504 loan employs a traditional mortgage for 50 percent of the total project costs. This includes the cost of land and existing buildings; hard construction/ renovation costs; fixtures and equipment; furniture, soft costs; and closing costs. A government-guaranteed bond is utilized for 40 percent of the loan. The borrowers’ own equity makes up the remaining 10 percent, which is 50 to 66.7 percent less equity than conventional lenders want. Since the required equity is so low, there is much less risk involved for owners of small-businesses. This program lets companies continue to use their hard-earned capital, while gaining the capital-generating benefits of owning commercial property. Project costs are financed in their entirety with the 504 loan, unlike most commercial bank loans, which only finance a percentage of the purchase price/appraised value. For the first mortgage, the term is 25 years at market rates, and it is fully amortizing. The best value that small business owners can find is the 20 year term, which is used for the 504 loans’ second mortgages. Any small to midsized business-owner would be hard-pressed to find a deal that beats this one. Borrowers can enjoy better cash flow, as well as the greatest cash-on-cash returns that exist in the commercial mortgage industry. Additionally, if borrowers decide to sell their property, these loans are assumable.

[edit] Common Misconceptions

Lots of paperwork is involved.

A few years ago, that might have been the case, but now, new information and a more developed system limit paperwork immensely. Now, with the availability of specialty lenders and a new, fast-paced SBA application procedure, the 504 loan is just as easy as any other commercial loan. Though specific, detailed documentation is required, small business owners are more than willing when the alternative, no-documentation or stated income loans, would increase their interest rate by 2-3 points.

There are added fees.

Including all closing costs, 504 loans average roughly 25-50 basis points more in total loan fees for typical transactions. However, these fees may be negotiated with a strong borrower. Also, most small business owners don’t mind the slightly higher fees, since they get longer loan terms, below-market fixed interest rates on nearly half of the deal, with the highest cash-on-cash return for their property.

These loans take up to four months to close.

Many 504 loans can be done in 60 days, which is just as fast as any other commercial loan. There are instances, however, when a 504 loan can take up to only 35 days, with most of the time spent on the appraiser. Now, the pre-approval standard for many specialized SBA lenders is becoming 24 to 48 hours, with commitments in four to five days.

Borrowers have to use their house as collateral.

This is unlikely, with the majority of 504 loans only securing the commercial property and/or the equipment that is being financed. Most lenders do not require someone’s house as collateral.

Borrowers with an imperfect history are always turned down.

The 504 loan program is able to approve those with personal bankruptcy, as long as it has happened more than 7 years ago. The SBA is also allowed to approve those with misdemeanors and felonies, though the process will take a little longer to close.