Now Is the Time to Make a Move on SBA’s 504 Program

October 1st, 2011

Now Is the Time to Make a Move on SBA’s 504 Program

As published in the Scotsman Guide by Barbara Morrison in October 2011.

With continued discussion about the slow recovery and the ongoing debate on the deficit, it’s not surprising that uncertainty about the future lingers in small-business owners’ minds. Business owners who weathered the downturn, however, see today’s bargain real estate values and historically low interest rates as a buying opportunity. The availability of attractive, affordable financing from the U.S. Small Business Administration (SBA) is another factor that has contributed to interest in buying property.

Commercial mortgage brokers who know about the recent changes to the SBA 504 program can take advantage of increased interest in purchases and secure funding for their small-business-owner clients. In addition, a new refinancing provision can help clients with loans coming due.

An affordable solution

For small-business owners, conserving cash is paramount in an era of economic uncertainty. The SBA 504 program provides as much as 90 percent financing for the purchase and renovation of commercial property. As such, small-business owners looking to purchase property can conserve cash with the program. Given the traditional 25 percent cash injection required by conventional bank loans, a SBA 504 loan may be a good solution for business owners to transition from renting to owning.

In addition to low downpayments, the SBA 504 loan program also provides below-market, fixed-rate financing. Business owners benefit from a 20-year loan with no balloon payments and a fixed, below-market interest rate for the entire loan term.

Loans are structured in two parts: a first mortgage from a conventional lender and a second mortgage from a certified development company (CDC). The usual split is 50 percent from the lender, 40 percent from the CDC/SBA and 10 percent from the borrower. Because their participation is less than under conventional terms, the 504 loan structure often is attractive to banks and enables them to make loans on projects that they otherwise might not have funded.

Bigger loans, bigger businesses

The Small Business Jobs Act of 2010 expands the definition of a small business. As a result, SBA programs can now provide larger loans for businesses that historically were ruled too big to qualify.

The new maximum SBA 504 loan limits have increased significantly. Projects of more than $20 million have been financed recently. There is no cap on the amount of the first mortgage loan provided by the conventional lender. The SBA second-mortgage loan cap has increased from $2 million to $5 million and as much as $5.5 million for manufacturing and green-energy projects. With an increase on the first mortgage to 60 percent to 65 percent loan to value (LTV), a business owner can buy a property of $15 million to $20 million with just 10 percent down.

In addition, businesses that previously were ruled too big are now eligible for SBA 504 financing. With no cap on revenue, small is defined as a business with a net worth of as much as $15 million and a two-year average net income after federal income tax of $5 million.

Debt refinancing

Many business owners who purchased property at the height of the market face the daunting task of refinancing a property that has decreased in value. With the value of their real estate worth less than the loan coming due, a conventional refinance may not be an option because many small-business owners cannot put up the cash necessary to make up the shortfall. The new 504 refinancing provision is changing that, however.

For example, let’s look at a property purchased five years ago for $5 million and financed with a five-year conventional loan of $3.75 million (a 75 percent LTV). At the time of purchase, there was no reason to believe that refinancing when the loan came due would be a problem. Given today’s decline in real estate values, however, it may be impossible for the owner to refinance with conventional financing.

Assuming the property’s value has declined 15 percent to $4.25 million, the maximum amount of a new loan — if the bank is willing to refinance — would be about $3,187,500, or 75 percent of the current value. This leaves a shortfall of more than $500,000, which many small-business owners would have difficulty producing.

With a 90 percent LTV option under the SBA’s 504 refinance program, the owner could refinance the entire outstanding loan amount. Because a 504 loan is structured in two parts, the SBA 504 refinance structure might look like this:

Balance of existing debt $3,750,000
Current appraised value $4,250,000
90% of appraised value $3,825,000

Source of funds:
Bank loan $2,125,000 (50%)
SBA 504 loan $1,625,000 (38%)
Borrower equity $500,000 (12%)

Total $4,250,000

The refinance program has additional benefits, as well. Appraisals are no longer required at application. A property-value estimate will be enough for the loan submission to the SBA, with an independent appraisal needed before closing. In addition, multiple loans may be refinanced; qualified debt may consist of a combination of loans that each meet the program requirements.

The new 504 refinancing option is a limited-time opportunity, however. Funding for this new program is limited and will expire in September 2012. Brokers should alert their clients so they can take advantage of this chance to restructure their existing commercial real estate debt.

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With low interest rates and low purchase prices in many markets, now may be the time for many small-business owners to switch from renting to owning their own commercial space. Brokers can help clients secure financing for this move with the SBA 504 loan and can help existing property owners refinance their current holdings.

Barbara Morrison, TMC

Barbara Morrison is chief executive officer and founder of certified development company TMC. In the past 29 years, TMC has provided about $6 billion in financing for more than 3,700 businesses throughout California and Nevada. TMC has been ranked in the top five certified development companies nationwide for more than a decade and is the No. 1 Small Business Administration 504 lender in Northern California and Las Vegas. Reach her at (415) 989-8855 or barbara@tmcd.com.

For more information and to read the article, please visit: The Scotsman Guide article or the TMC website.