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As published in The Registry, June 2010 issue:
Nose Above Water
SBA data show Bay Area small-business real estate borrowers are faring better than their U.S. peers.
By David Herbert
“Thousands of Bay Area small businesses that have borrowed to buy real estate for their own use though a federal program have outperformed their nationwide peers during the recession. But proposed changes to Small Business Administration rules to make the program more flexible could go a long way toward relieving the stress of falling commercial property values, experts on the program say. Those declines in some cases are harming small companies that otherwise might survive.
“Companies apply to the U.S. Small Business Administration for up to 40 percent of the total they wish to borrow through the so-called 504 Loan program. The loans must be used to purchase fixed assets, usually land, buildings and equipment. The SBA caps its commitment at $2 million in most cases. The SBA participation entices banks to extend credit, too, because they can recoup their share of the loan before the government if the business defaults.
“The proposed modifications to the program can’t come soon enough, said Barbara Morrison, president of San Francisco’s TMC Development, the largest 504 lender in Northern California. Press coverage of the foreclosure crisis has focused on residential real estate, but small businesses also are grappling with declining commercial property values, Morrison said.
“Despite the numbers, which indicate distress among Bay Area small companies is considerably less than in the nation at large, stress among her borrowers is greater than at any time since she went into the business in 1981.
“In the past, we never had more than a handful of problem loans. Before they have always been able to sell the property and move to smaller, leased space,” she said. “After labor, occupancy is generally a business’ second biggest cost, and if you can’t reduce your occupancy costs, it can sink you,” she said. She can help borrowers modify the SBA portion of their loans, but not the bank piece.
“Nationally, the default rate on 504 loans (the SBA calls it the “purchase rate” because they are buying the bad loans) has increased substantially since 2007. Default rates have gone from 6.69 percent on loans issued from 2001 through 2004 to nearly 17 percent on loans issued from 2005 through 2008, the most recent period available, according to the SBA.
“Most borrowers who are going to default do so in the first two to four years. That means the 6.69 percent default rate probably won’t continue to rise much but the 17 percent rate likely will.
“The SBA issued more than 21,000 504 loans in the four years from 2001 through 2004; it issued about 31,000 such loans in the four years from 2005 through 2008.
“At the same time, the default rate on loans issued from 2001 through 2004 in San Jose is 7.7 percent. “On loans issued from 2005 through 2008, the default rate is 9 percent. In San Francisco, default rates are running at less than 5 percent on 504 loans issued in the later period, up from less than 4 percent from 2001 through 2004.
“The proposed amendments would increase the limit on the SBA loan participation to $5 million and allow small businesses to re-finance existing conventional debt using the SBA program. “When a business loses its home, generally that means everyone who works for that business is out of a job, and the ripple effects on the economy are significant,” Morrison said.
“Morrison’s company has originated and continues to service 1,600 outstanding 504 loans in California and Nevada with an aggregate value of more than $1 billion. One of its recent transactions with the Bank of America involved the purchase of a $10.5 million San Leandro building by a company that installs modular office furniture. The borrower got $4 million from the SBA 504 program because it could show its energy consumption would fall by at least 10 percent in the new property. The same SBA increase is available when there is a renewable energy source such as solar equipment added to the project financing.
“It is harder to use SBA loans to gauge market health on the Peninsula and in the East Bay. The SBA issues relatively few 504 loans in smaller cities, and the sample size is too small to draw many conclusions about the health of local markets. The SBA backed 11 loans in Vallejo from 2001 to 2004, with not a single default. The agency issued 10 loans from 2005 to 2008, again with a zero percent default rate.
“Yet few would argue that those rates reflect a strong real estate market or economy in Vallejo, where the city is struggling through bankruptcy, and housing prices have tumbled from a $436,000 median on Feb. 1, 2007 to $164,000 on Jan. 1, 2010, according to Zillow. In fact, you could argue that the small and decreasing number of loans in some cities reflects a poor economy. Redwood City businesses scored 29 loans from 2001 to 2004, but just 17 from 2005 to 2008, for instance.
“Despite the high concentration of technology companies in the Bay Area, they are not the typical 504 borrower. Instead, the borrowers tend to be contractors, medical and dental service providers, retailers, hotels and restaurants.
“Even if the SBA allows entrepreneurs to refinance their underwater mortgages through the 504 program, it will not be a panacea. Ed Radzikowski has run a machine shop out of a 1,800-square-foot garage in his San Jose backyard for more than 20 years. He took out a second mortgage to buy new equipment in 2000, but the latest recession has slowed business to a crawl.
“He is now two years behind on his $810-a-month mortgage payment, and he needs to drum up $28,000 or Bank of America will foreclose on his home and business. “To me, it seems like we’ve been in a recession since 2001,” Radzikowski said. “I don’t care what the economists say.”
“Ken Mannina, a senior vice president at Bridge Bank in San Jose who focuses on SBA lending, is not surprised that Bay Area delinquency rates on 504 loans are better than the nation at large. Still, he says better is a relative term. “I’ve seen what’s happening in other markets, and it’s so much worse elsewhere,” he said.
“The higher SBA loan limits and the new refinancing capability would go some way toward filling the gap that has been left by conventional lenders’ pullback from the market, he said. If the changes are made, he said, “I think the demand is there, and the loan volumes will materialize.” ”
For more information on this article, please visit The Registry web-site.
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