Business, Financing.
The final word on 504 commercial loans - discover the" forgotten" sba program worthy of another look. Rather than waste anymore ink, let' s get right to issue at hand. . .
Much has been written on these pages in the past two years about a little understood and even less used commercial real estate loan program called the 50As our lending firm was the first and is still the only nationwide commercial lender to exclusively focus on only this loan product, I' d like to succinctly put to rest some of the more common misconceptions about this terrific loan product. - who uses it? It is not an investment real estate loan product per se. The 504 loan is for commercial property owner - users. Borrowers of 504 loans must occupy at least a simple majority( or no less than 51% ) of the commercial property within the next year in order to qualify. In other words, a 504 loan doesn' t have to be just one small business owner purchasing his commercial property.
Two operating companies can come together to form an Eligible Passive Concern( EPC) (otherwise known as a Real Estate Holding Company, typically as an LLC or LP) , however, to take title to the commercial property. - it could be a physician and an accountant each utilizing 3, 000 square feet in a 10, 000 square feet office building( at 6, 000 total square feet in their llc, they would occupy 60% and be eligible) for example. S. citizens or resident legal aliens( those considered to be Legal Permanent Residents) to qualify. Additionally, at least 51% of the total ownership of the Operating company( ies) and EPC must be comprised of U. There are no revenue restrictions or ceilings for 504 loans, but there are three financial eligibility standards unique to them: operating company( ies' ) tangible business net worth cannot exceed$ 7 million. And the guarantors/ principals' personal, non - retirement, unencumbered liquid assets cannot exceed the proposed project size.
Operating company( ies' ) net income cannot average more than$ 5 million during the previous two calendar years. - these three criteria usually do not disqualify the typical, privately - held small to mid - sized business owner. Last fiscal year( October 1, 2004 to September 30, 2005) , nearly 8, 000 business owners used 504 loans for over$ 11 billion in total project costs representing a recent five - year growth rate in the program of 22% year - over - year. Only the absolute largest ones get tripped - up on these. Why Use It? Hard construction/ renovation costs.
These loans are structured with a conventional mortgage( or first trust - deed) for 50 percent of the total project costs( inclusive of: land and existing building. - furniture, fixtures and equipment[ ff& e] ; soft costs. The remaining 10 percent is the borrowers' equity and is usually a third to half as much as traditional lenders require. And closing costs) combined with a government - guaranteed bond for 40 percent. This lower equity requirement lowers the risk for small business owners as opposed to lowering a lender' s risk profile with more capital injected into the project like with ordinary commercial lending. Unlike most commercial bank deals, these loans are meant to finance total project costs as opposed to a percentage of the appraised value or purchase price, whichever is less.
It also allows the small business owner to better utilize their hard - earned capital, while still getting all of the wealth - creating benefits commercial property ownership provides. - the first mortgage( or trust - deed) is typically a fully amortizing, 25 - year term at market rates, while the second mortgage( or trust - deed) is a 20 - year term, but with the interest rate fixed for the entire time at below - market rates. The second mortgage( trust - deed) on 504 loans is guaranteed by the U. Small Business Administration( SBA) and is, contrary to popular belief about SBA loan programs, the cheapest money available for typical small business owners. Not only do these loans provide better cash flow for borrowers( by borrowing at better rates and terms) , but they also provide the highest cash - on - cash return available in the commercial - mortgage industry which is a financial metric used by most successful real estate investors. For most of the past two years, the SBA bond rate hovered near six percent fixed for 20 years, which is an incredible deal for any small to mid - sized business owner and very tough to beat. Furthermore, these loans are assumable should borrowers decide to sell their property in the future, but a better strategy for most small business owners would be to sell their operating company while keeping their EPC and cashing rent checks long into their retirement.
Many bankers and brokers don' t like to offer 504' s because they fundamentally are smaller loan amounts for the bank( typically only 50% first mortgages or trust - deeds versus the common 80% ), which means a banker has to work that much harder to bring in more assets and the smaller loan amounts also hit the typical commercial loan officer right in the pocketbook. - why you may not know much about these loans? They would rather discuss the SBA' s more notorious 7( a) loan program, which has a well - established, if not egregiously well - paying secondary market( due to Prime - based, floating rate pricing) already in place, when the issue of low down - payment commercial loans comes up. So what are Some Common Questions about These Loans? When you couple those two reasons with the fact that these 504 loans take more effort and skill only on the part of the lender, it' s no wonder this loan product has only recently started to catch fire in the marketplace. Isn' t There Tons of Paperwork Involved? With the advent of more and more specialty lenders and the recent focus on streamlining the SBA application process, 504 loans are no more involved than most ordinary commercial loans.
This was certainly the case years ago, but it is no more. - while the documentation is specific and detailed, most small business owners are ably organized and prepared when the alternative is to pay two to three points higher in interest rates with no documentation or stated income commercial loans. When all closing costs are considered, 504 loans usually average about 25 to 50 basis points more in total loan fees on an average sized transaction. Aren' t There Extra Fees Involved? With stronger borrowers( i. e. better debt service coverage ratios[ DSCR] , higher personal liquidity, and/ or better personal credit scores) , these fees can usually be negotiated lower. This is exactly the reason my business partner and I chose a 504 loan when plenty of alternatives were available to us.
Most small business owners utilizing 504 loans are willing to pay slightly higher fees, in order to, however receive longer - term, below - market fixed interest rates on nearly half of their deal, while receiving the highest cash - on - cash return from their property. - that' s right - we actually have a 504 loan and have been in the shoes of 504 loan borrowers, so i have first - hand experience of using the loan product that we offer. This is another old relic of the past regarding these SBA loans. Don' t These Loans Take 3 or 4 Months to Close? Our quickest 504 loan to date took only 35 days from the first phone call to the closing table, and the commercial appraiser ate - up most of those days while we waited. If a lender claims they need nearly four months to fund a 504 loan, then perhaps you should look elsewhere. We' ve done countless others in much less than the typical 60 day commercial real estate contract.
Twenty - four to forty - eight hour pre - approvals and four or five - day commitments are becoming the norm with most specialized SBA lenders. - plenty of 504 loans are approved with start - up borrowers and/ or borrowers that don' t have dscr' s greater than 25 times. Aren' t These Loans for Start - ups or Low DSCR Borrowers? While it is true that most 504 loans are for more credit - worthy( usually bankable) borrowers, this is not a necessary condition. Projections - based deals and franchised deals are often great candidates for 504 loans when the project involves commercial property. Frequently, 504 loan borrowers with lots of experience in a given industry, but no actual ownership experience, will have an easier time securing a 504 loan than a conventional bank loan.
There are other SBA loan programs that may be a better fit for pure start - ups, as 504 loans do not allow for the financing of working capital, but those other SBA loans can often be used in conjunction with SBA 504 loans. - only some lenders require this for 504 loans, and it is increasingly rare. Doesn' t a Borrower have to Pledge their House as Collateral? Other SBA loans, on the other hand, must be" fully collateralized" in order to maintain their government - guarantee which is where this generalization comes from. What if a Borrower has a" Checkered Past" ? Most 504 loans only secure the commercial property and/ or equipment that are financed as part of the 504 loan project.
Misdemeanors and/ or felonies are not in and of themselves, reasons to disqualify someone from getting a 504 loan. - defaulting on previous government - guaranteed financing, will preclude someone, however from securing a 504 loan or any other sba loan. There is an added process that often lengthens the time to closing, but the SBA usually approves borrowers with misdemeanors or borrowers with felonies that occurred in the distant past. Personal bankruptcies that occurred more than seven years ago usually will not prevent a 504 loan approval, assuming the present - day underwriting variables look promising, but more current bankruptcies are examined subjectively and frequently won' t be approved. If you visit a lender' s website to do some due diligence on them, make sure they at least list and/ or mention 504 loans, as a means by which you might gauge their competency with these loans. How do you determine who to Call for a 504 Loan?
Any lender can say they do 504 loans, but it is far better to work with those that can demonstrate their past experiences with the product, as well as detail their commitment to it on a go - forward basis. - it is a question of how well they can provide it. Like most things delivered better by specialists, it isn' t usually a question of if a regular lender can provide a 504 loan. Choose wisely
