As posted in the Scotsman Guide.
The U.S. Small Business Administration (SBA) has been assisting small-business owners through its 504 loan program since 1980. Now, with the 504 program’s refinancing option made permanent, the opportunities for commercial mortgage brokers and borrowers are even greater.
Partially funded by a certified development company, or CDC, these loans have long-term, fixed interest-rate features to help property owners generate lower monthly payments. And the SBA 504 refinance program provides mortgage brokers with another path to do business with new and existing clients.
Initially introduced as a pilot program under the Small Business Jobs Act of 2010, the 504 refinancing program expired in September 2012. The SBA, small-business owners and lenders fought to bring it back, and it was permanently reinstated in May 2016.
This gave business owners an additional way to free up equity in their properties and reduce their monthly loan payments. It also allowed mortgage brokers to bring owner-occupied commercial real estate deals back into a bank’s comfort zone.
The 504 refinancing program allows small-business owners to refinance commercial real estate with a loan-to-value (LTV) ratio of up to 90 percent. In addition, the transaction can include cash out totaling up to 20 percent of the appraised value of the assets. For cash-out projects, the maximum LTV is 85 percent.
Benefits and structure
It’s clear that small-business owners can reap the rewards of the 504 refinance, but they aren’t the only party to profit. The benefits to a commercial mortgage broker include:
- Generating more business, either from new or existing clients;
- Minimizing risk to the first-mortgage lender by limiting their capital infusion to 50 percent of the loan amount;
- Generating new fee income for the first-position lender through a quality portfolio loan;
- Unlocking a client’s trapped capital and reducing their downpayment requirement to as little as 10 percent, and;
- Simplifying the loan process, both for the broker and the borrower, by partnering with a CDC.
The SBA’s regulations for the 504 refinance program allow loans to be structured like a traditional CDC/504 purchase loan, comprised of a first and second lien. A conventional lender provides up to 50 percent of the total project cost and holds the first lien position.
The SBA authorizes a CDC, which is a nonprofit organization, to provide financing for up to 40 percent of the project’s cost and to take a secondary lien position. The borrower contribution must be at least 10 percent of the project’s appraised value, a requirement most often satisfied through the borrower’s equity in the collateral. The participating bank loan and the CDC/504 loan can be in equal amounts, but the CDC’s contribution can never be greater than the bank loan.
There are essentially no restrictions on the bank’s loan in regards to structure or terms. The bank uses its own underwriting standards and sets its own terms, rates and fees. The bank loan, however, must be include at least a 10-year term for commercial real estate or seven years for an equipment loan.
Eligibility and requirements
The eligibility requirements are the same for the CDC/504 refinance as they are for the CDC/504 purchase loan. To be eligible, a business must operate for profit and occupy at least 51 percent of the building’s total square footage at the time the application is submitted to the SBA.
Eligible size standards vary widely and depend on the business in question. About 25 percent of all manufacturing businesses, for example, have up 500 employees and are eligible. Alternate standards include a $15 million cap in a borrower’s tangible net worth and after-tax net income of less than $5 million for the past two years.
In addition to these requirements, there are some specific rules within the 504 refinance program that mortgage brokers should know about. First, one or more commercial loans can be refinanced, but no existing loans through the SBA, U.S. Department of Agriculture (USDA) or other government programs are eligible.
The loans to be refinanced must be at least two years old, and the borrower must be able to prove, using financial statements, that they owned and operated the business for the entire two-year period. If ownership has changed hands within the past two years, the SBA considers the business “new” and will require a larger downpayment. The loans also must be current, meaning no payments were more than 30 days overdue during the past 12 months.
Lastly, the maximum refinance LTV is 90 percent of the pledged collateral for existing mortgages and debt. The maximum LTV drops to 85 percent of the collateral when business expenses are included. Eligible business expenses include — but are not limited to — salaries, rent, utility payments and inventory. The financing request also may include funds for eligible business expenses that were already made or are planned for the next 18 months. The amount of eligible expenses cannot exceed 20 percent of the appraised value of the collateral being pledged.
Below are two hypothetical examples for how the CDC/504 refinance program works. Keep in mind that refinancing can be helpful for business owners with existing debt on a property who are in need of funds for a major renovation or expansion. A project can include these costs, in addition to the existing debt, as long as they meet eligibility standards.
The request: A hotel owner owes $3 million on a conventional loan that he took out five years ago to finance a new acquisition, but he also needs an additional $1.2 million in cash to cover a variety of business expenses. Cash out for business expenses is eligible up to 85 percent LTV and the cash component is allowed up to 20 percent of the appraised value.
The hotel’s appraised value is $6 million. To refinance, the owner contributes $1.5 million in existing equity, or 25 percent. The bank and the CDC split the remaining 75 percent by contributing $2.25 million each. The LTV is limited to 85 percent because of the owner’s cash-out requirement. The bank could do a conventional loan at 75 percent LTV, but is more comfortable with the 37.5 percent LTV that the CDC’s involvement allows.
The request: A restaurant owner owes $1 million on the building he purchased five years ago. His restaurant is booked solid every night, so he would like to expand the seating area to accommodate the high demand. The improvements will cost $600,000 and the property’s as-completed value is estimated to be at least $1.78 million.
Under the refinance structure, the bank contributes a $1.2 million first mortgage and the CDC contributes a $400,000 second mortgage. Because the existing debt ($1 million) exceeds 50 percent of the new costs ($600,000), the overage is added to the bank loan after the 504 loan is structured. No capital injection is needed from the business owner as his contributed equity equals 10 percent.
The bank helped the borrower to not only obtain better terms on a new loan, but also to finance improvements aimed at increasing business and revenue. The bank is in a comfortable position with a 67 percent LTV and the borrower gets a below-market, 20-year fixed-rate loan from the SBA.
The CDC/504 refinance program is a fantastic opportunity for commercial mortgage brokers to expand their offerings and help out their clients in a big way. Don’t miss the chance to capitalize on what the SBA refinancing program offers.