As the owner of a small manufacturing business, you may have thought that owning your own building was beyond your financial means. Thankfully, there is a way to make that goal a reality: by obtaining a 504 loan from the Small Business Administration (SBA). The SBA 504 loan program makes property ownership feasible for business owners by offering financing with little money down and highly advantageous terms. In addition, the property purchased with a 504 loan may help manufacturers reduce their overhead and manufacturing costs while enjoying tax benefits.
Purchasing Helps Make Overhead Costs More Manageable
While a manufacturer has a vast array of financial issues to contend with, in accounting practice, the costs can be divided into three parts:
- Direct material
- Direct labor
- Manufacturing overhead
“Overhead” includes a lot of things. One of the most sizeable expenses on this overhead list will be rental payments. Rental payments are a recurring expense, which may increase regularly and possibly unpredictably. Unlike rent payments, mortgage payments on a fixed-rate loan will remain constant. They are also often comparable in cost.
With an SBA 504 loan, you can make this move from renting to owning with only 10% down, while a conventional lender and the SBA/your Certified Development Company (CDC) finance 90% of the loan. This comparatively small down payment leaves more capital free to use for other overhead costs, facility improvements, and other business needs.
Purchasing Can Allow You More Freedom to Choose Locations
Many leases include a clause giving the tenant the right of first refusal if the premises are sold. This is often the impetus for a business owner to buy property. For many business owners, this is a sound decision. But there are many variables involved in choosing a facility’s location, and convenience shouldn’t be your only factor.
The location of your facility has an impact on each of the three primary cost components. Let’s look at those other points now:
- Direct material – The location of your facility will affect logistics. The raw material for your operations has to be sourced and delivered to your facility. A relatively short move could create significant savings if it positions you more favorably in relation to transportation lines and hubs. The location of your facility could even determine the local markets you receive your raw materials from.
- Direct labor – Labor costs are highly dependent on location. Not only do wage rates differ by locale, but the size and quality of the labor pool do as well.
- Manufacturing overhead – As stated above, one of the greatest expenses when calculating overhead costs is rent. Owning your building will knock that off the list and replace it with a steadier and ultimately cheaper option: mortgage payments. The cost of purchasing and updating equipment also factors into the overhead, and could be alleviated by a 504 loan, which covers fixed assets including machinery and equipment.
Additionally, there are other considerations when deciding on your facility’s location. Would it be more profitable for you to be located closer to your sales market? Is there a traffic jam outside your doors every evening that keeps you from making or receiving deliveries? Do you have conflicts with your neighbors over noise because you are too close together?
Your facilities need to be a good match for your specific manufacturing process. Considering the cost and inconvenience of moving, you want to find the right place the first time you do it. One way to guarantee this is to build it yourself. You can also use a 504 loan to finance the purchase of land and all the costs of constructing your plant to your specifications from the ground up.
Purchasing Means You Get to Enjoy Tax Benefits
Location options and better overhead costs aren’t the only benefits that come from owning your building. Taxes also have a significant effect on your bottom line. If you decide to become a property owner, talk to your accountant about doing so as a separate legal entity from the business that will occupy the property. Even though you, as the business owner, will continue to pay rent, you can deduct those payments from your taxes.
Meanwhile, as a building owner and a legal entity, you will be able to take advantage of depreciation and amortization in the taxes you pay, as well as deduct the interest on your mortgage. It will also make it easier for you to keep the equity in the building if you decide to close or sell the business.
Choosing Your Financing for a Smart Purchase
If you decide to buy a manufacturing facility, key factors to consider when selecting your financing include:
- Size of the down payment. These can be as high as 40% with some conventional loan options.
- The presence of a final balloon payment. Balloon payments are not uncommon when borrowing from a conventional lender.
- Fixed or variable interest rates. These rates are often negotiable with your lender.
- Collateral. Will you have to compromise your personal assets to get a loan for your business?
To make sure that you have the best possible options for your unique business, the SBA 504 loan is designed to encourage growth and expansion of small businesses. It has a three-part structure:
- The first part is a loan from a conventional lender for 50% of the total amount. You and that lender determine the amount and conditions of that loan, which becomes your first mortgage.
- Facilitated by your Certified Development Company (CDC), the SBA makes a separate loan of 40% of the total, up to $5.5 million for manufacturing projects, at a fixed, below-market rate. This becomes your second mortgage.
- You, the borrower, contribute a 10% down payment.