How To Purchase Commercial Real Estate-----Part 3-------Summary

Small business owners thinking about purchasing or renovating commercial real estate and/or major pieces of equipment to grow or expand their businesses should consider the U.S. Small Business Administration’s Certified Development Company/504 Loan Program. With a 504 loan, small businesses can access the same type of long-term, fixed- rate financing that large firms obtain through the bond market.

 
The 504 Program provides growing businesses with long-term, fixed-rate financing for real estate and/or equipment purchases through SBA-licensed certified development companies (CDCs). Proceeds from 504 loans must be used for purchasing fixed assets such as: land and improvements, including existing buildings, grading, street improvements, utilities, parking lots and landscaping; construction of new facilities, or modernizing, renovating or converting existing facilities; or purchasing long-term machinery and equipment with a useful life of at least 10 years.

Soft costs like architectural and legal fees, environmental studies, appraisals, and interest and fees on the construction and/or interim bank loan can also be rolled into the note. The 504 Program cannot be used for working capital or inventory, consolidating or repaying debt, or refinancing existing debt.

 
Typically, a 504 project includes a loan secured with a senior lien from a private-sector lender covering up to 50 percent of the project cost, a fixed rate loan secured with a junior lien from the CDC (backed by a 100 percent SBA-guaranteed debenture) covering up to 40 percent of the cost, and a contribution of at least 10 percent equity from the small business being helped. Because of the lower down payment required and the ability to finance the soft costs, the small business will realize upfront cash savings of approximately $100,000 on a $1 million project.

 
Maturities of 10 and 20 years are available. Interest rates on 504 loans are pegged to an increment above the current market rate for five-year and 10-year U.S. Treasury issues. The rate on the 504 loan is fixed for the life of the loan and is set when the CDC sells the bond to fund the loan. 504 bonds are amortized securities. Fees total approximately three (3) percent of the debenture and may be financed with the loan.
All SBA loan programs are reserved for small businesses. SBA defines a business as being small for a 504 loan if its net worth is under $7 million and net profits after taxes are under $2.5 million. Any type of legitimate business is eligible for 504 financing, including manufacturing, wholesale, service, professional service or retail.

SBA 504 loans are a good deal for small businesses. The usual structure for SBA’s 504 program is: 50% bank financing, 40% SBA financing at a fixed rate with the owner required to inject just 10% in most cases.Consider the following advantages of the SBA 504 program versus conventional mortgage financing:

• Low down payment. In most cases, the company is required to inject just 10 percent, which allows the business to preserve cash for working capital. Most banks will lend only 60-70 percent of the appraised value of the real estate leaving the company to sink in 30-40 percent plus the cost of renovations and soft costs. Most conventional commercial mortgages require equity positions of 30% or more.
• Fixed rate on the SBA 504 portion. Small businesses don’t have to worry about the prime lending rate going up and can calculate the exact amount of their mortgage payments for 20 years.
• Long term. 504 loans are for 10 or 20 years. Because the CDC is in second lien position, the bank or other lender doing the 50 percent first lien loan, are willing to lend at a longer term. Longer terms reduce monthly payments.
• Low interest rate. Even with all the fees and closing costs included in the rate, the 504 program offers a low rate for a subordinate mortgage loan, particularly for small business. The blended rate between the bank portion and the SBA’s 504 portion makes the project very affordable.