SBA 504 Loan: Buy Commercial Real Estate With SBA/CDC Loans

The SBA 504 loan program combines two loans (one from a lender, one from a CDC) that can be used to buy owner-occupied commercial real estate, and other fixed assets like equipment. The lender portion covers up to 50% of the loan, the CDC portion covers 40%, and the borrower is responsible for the remaining 10+%.

If you’re in the market for commercial real estate, and will occupy at least 51% of the space, you may be a good candidate for an SBA loan. Businesses that have been operating for 2+ years and who have a credit score above 680 (check here for free) may qualify for an SBA 7a loan with Northeast Bank. Northeast Bank offers rates as low as 5.5% and loans from $500K – $5MM. Fill out a short online form to see if you pre-qualify.

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Loan Options for Commercial Real Estate: SBA 504 vs SBA 7a vs Traditional Loan

What SBA 504 Loans Can be Used For

Under the SBA rules, CDC / SBA 504 Loans can be used for these specific purposes:

• Buying land (and existing buildings on the land)
• Paying for property improvements (like adding parking lots, connecting utilities, and even landscaping)
• Renovating an existing property (inside the building)
• Building a new facility (or improving a facility)
• Buying other fixed assets (such as long-term equipment and machinery)
• Refinancing debt (Made permanent on June 24th, 2016, the SBA 504 refinance loan applies to debt that was primarily incurred (85%+) to acquire a fixed asset eligible under SBA 504 loan rules. The existing debt must be 2+ years old and in good standing).

An SBA 504 loan combines two different loans that are closed at the same time, one from a lender and one from a CDC (community development company). These loans can be used to purchase commercial real estate, but that’s not the only use of an SBA 504 loan.

According to Andrea Roebker, Regional Communications Director for the SBA, “A 504 loan is designed to assist with fixed assets, including the purchase or construction/renovation of real estate, as well as the purchase of long-term machinery and equipment.”

When looking for funds for one of the purposes listed above, we recommend working with Liberty SBF to get an SBA 504 loan. If you have a credit score above 680 (check here for free), you’ve been in business 3+ years, are profitable, and need more than $1MM, speak with Liberty SBF today to see how much you qualify for.

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An SBA 504 loan is not for everyone. These loans can’t be used for:

• Working capital
• Materials, supplies, or inventory
• Advertising or marketing
• Normal operational expenses
• Speculative real estate investments
• Rental properties

If you need an SBA loan for any of the purposes prohibited under SBA 504 loan rules, read our article on SBA 7(a) working capital loans. An SBA 7(a) loan is very flexible in its uses and can be taken in conjunction with an SBA 504 loan. SmartBiz has the fastest funding times that we have seen for SBA 7(a) loan under $350k. Plus, they can prequalify you in minutes.

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Top 4 Benefits Of An SBA 504 Loan

SBA 504 lending is on the rise. The SBA has guaranteed over 25% more dollars for 504 loans in 2017 compared to what they gave out in 2015. Their growing popularity among borrowers is due to the great advantages a 504 loan can give to borrowers. The four primary benefits to getting an SBA 504 loan are:

1. Low Interest Rates

Interest rates for the CDC portion of the loan are limited by the SBA and currently range between 3% – 4%. That rate is fixed and will not increase for the life of the loan.

The bank’s loan doesn’t have these limitations. The rates typically fall between 5% – 7% and can be either fixed or variable, and you can read our article to find out what the SBA loan rates are right now.

2. Low Down Payment

While most traditional commercial loans require a 20%-40% down payment, an SBA 504 loan only requires a 10% down payment. If your business is a startup or the property you want to buy is a single use building, you will need a 15% down payment. If both apply, you’ll need a 20% down payment.

3. Long Repayment Terms

While most traditional commercial mortgages are 5-10 year loans, the CDC portion of an SBA 504 loan has a 10 year term for equipment and a 20 year term for real estate. The bank portion of the loan typically has a 7 year term for equipment and 10 year term for real estate.

4. No Additional Collateral

Generally, the real estate or other fixed assets being financed by the 504 loan are sufficient collateral, and no additional collateral will be required.

We asked the Head of SBA Lending at TD Bank, Tom Pretty, his thoughts on the benefits of getting a 504 loan. He says:

“504 loans have many advantages including: fewer fees than other SBA products; 20-year fixed pricing on the CDC portion of the deal, which is also a below-market rate. They allow for much larger loans than the 7(a) product, as there is no official borrowing cap (TD Bank, for instance, has done some 504 loans of $20 million or more); and 504 loans have no additional collateral requirement.”

SBA 504 Loan Qualifications

In many ways, qualifying for an SBA 504 loan is similar to qualifying for a traditional commercial mortgage. Some of the basic qualifications include:

• Credit Score – Need to have a good credit score (680 or better – check yours for free)
• Limited Outstanding Debt – Can’t have a lot of other outstanding debt. Your Debt Service Coverage Ratio can be calculated by dividing your annual net income by your annual loan and interest payments. Ideally, it should be no lower than 1.25.
• Down Payment – Need to be able to satisfy the down payment requirement
• Proof of Payment Ability – Be able to show that you can reasonably afford the monthly loan payment
• Clean Financial History – There should be no recent bankruptcies, foreclosures, or tax liens

Additionally, there are a few requirements unique to the 504 loan program:

• Net Worth Less Than $15 million – Your business must have a tangible net worth less than $15 million and an average net income less than $5 million after taxes for the last two years.
• 51%+ Owner Occupied – Existing buildings must be at least 51 % owner occupied. The same is true if a loan on an existing property is to be refinanced. For new construction, the building must be at least 60% owner occupied upon occupancy but gradually increasing to 80% owner-occupied by year ten.
• 10+ Year Equipment Life – Any equipment purchased with the funds must have at least a 10 year economic life (which rules out things like computers, software, etc.).
• Use of Funds Must Create Jobs or Enhance SBA Goals – You must show how the loan will help create new jobs or enhance public policy goals. For example, you can make existing facilities more energy efficient or increase your production of renewable energy.

Buying an apartment building would not be suitable for an SBA 504 loan, because of the owner-occupied requirement. You can rent out part of the building, but must be using the majority of it for your business. If you’re using the loan to construct a building, it must be at least 60 percent owner occupied at the date of occupancy and increase over the next ten years to being 80% owner occupied. This means new construction funded by a SBA 504 loan will have a maximum of 20% of permanent leasing space.

The purpose of the SBA 504 loan program is to encourage job creation and economic development. As part of the loan process, you will need to explain how your use of the loan proceeds will create or retain jobs that would otherwise be lost, or how you’ll support public policy goals. Currently, the rule is that one job must be created or retained for every $65,000 of funding. This increases to one job per $100,000 borrowed for small manufacturers.

In lieu of meeting job creation goals, you can also qualify for an SBA 504 loan by enhancing other public policy goals, such as energy conservation and supporting minority business development. The SBA’s website provides a more detailed breakdown of the different public policy goals that your project can meet.

SBA 504 loans are suitable for projects large and small. However, most banks prefer to provide SBA 504 loans for projects over $500K. This is primarily because the amount of effort required to close a 504 loan is significant and lenders are hesitant to pursue projects unless their payout is big enough. Considering the fact that they can only finance up to 50% of the project, anything under $500K begins to mean a lot of work for a very small payout.

SBA 504 Maximum Loan Amount

Current SBA rules set the maximum amount you can borrow with an SBA 504 loan is about $14 million (however, due to restrictions on use of proceeds and qualifying projects, the amount your project qualifies might be lower). In 2017, the SBA has given out 55% of all 504 loans to projects totaling between $350K – $2 million.

SBA 504 Loan Rates and Fees

You can expect to pay low interest rates and minimum fees with an SBA 504 loan. You can expect to be charged both servicing and guarantee fees that vary by borrower. The total interest rates and fees typically ranges from 3% – 6% annually, which is low even compared to other SBA or conventional bank loans.

Remember, however, there are actually two loans made as part of an SBA 504 loan that you must pay interest on. The first is a loan from a traditional lender, like a bank. The rates, terms, and fees for that portion of the deal (up to 50%) have very few restrictions. As such, they can vary widely from borrower to borrower. That said, with a little negotiation most people find the commercial real estate loan rates and terms for this portion of the deal to still be very favorable compared to other financing options.

The second part of the loan is issued by the CDC. The rates, terms, and fees for this portion of a 504 loan are heavily regulated. The CDC loan is a 10 or 20-year, fully amortizing, fixed-rate loan. It works the same way as a traditional mortgage loan. The borrower pays equal monthly payments for the life of the loan, at which point the loan is completely paid off.

CDC Portion of the SBA 504 Loan

Now let’s take a look at how the CDC portion of the loan works, and what the typical rates and fees are. The table below shows these costs only for the CDC portion of the SBA 504 loan you’re getting.

Rates & Fees for the CDC Portion of the SBA 504 Loan

CDC Portion of the SBA 504 Loan: Monthly Servicing Fees

Here’s a breakdown of what each of the monthly service fees entail:

SBA Guarantee Fee

This is an ongoing SBA Monthly Guarantee fee presently equal to 914/1000s of one percent per annum (.914 of 1.0%) of the principal balance of the Note, calculated at five year intervals, beginning with the first payment. The Central Servicing Agent (Wells Fargo) receives 3/64th of this fee, and must remit the remainder to the SBA.

Servicing Agent Fee

The Central Servicing Agent (presently Wells Fargo) fee of one-tenth of one percent per year (1/10 of 1.0%) is added to the outstanding balance of the Note. It is calculated at five year intervals, beginning with the first payment.The administrative fee goes to Central Servicing Agent (Wells Fargo) for processing and recording loan payments. At 0.1% of the loan value, it’s not a significant portion of the cost.The SBA fee compensates the SBA for the risk of the loan defaulting.

CDC Fee

There is a CDC Servicing Fee of five-eighths of one percent (.625 of 1.0%). The CDC MUST retain at least .500 of this fee as required by SBA regulations and policies. In addition, from this servicing fee CDCs must pay 1/8 of one percent (.125%) to SBA each month. Per SBA regulations, the minimum CDC servicing fee can be 0.625% per year, and a maximum of 2% per year. For rural areas, the maximum is 1.5% per year.

The CDC fee goes toward supporting the operation of the CDC, with the minimum and maximum fee set by the SBA. However, the individual CDC has discretion to set the fee within these limits.

CDC Portion of the SBA 504 Loan: One-Time Fees

When the loan is initially made, there are some initial “one-time” fees associated with obtaining an SBA 504 loan. These are one-time only expenses that are financed along with the debenture (meaning they can be wrapped into the loan and amortized over the life of the loan). These costs typically amount to 2.5-3.0% of the loan’s value.

Common one-time costs include:

• Processing Fee
• Legal Fee
• Funding Fee
• Debenture Underwriting Fee
• Guarantee Fee (currently waived)

CDC Portion of the SBA 504 Loan: Prepayment Penalty

Prepayment penalties are common in the world of commercial real estate loans but might surprise businesses shopping for an SBA 504 loan. Luckily, the prepayment penalty for an SBA 504 loan is easy to calculate and also relatively small.

The prepayment penalty is assessed on the CDC portion of the SBA 504 loan if the loan is prepaid during the first half of the loan’s term to maturity. The prepayment penalty is calculated on a sliding, decreasing scale.The penalty is figured on the debenture interest rate (at the time the loan was issued), not the effective interest rate of the loan.

For a loan with a 20-year maturity, the penalty applies to the first 10 years of the loan and decreases by 10% each year. For a loan with a 10-year maturity, the penalty applies to the first 5 years of the loan and decreases by 20% each year.

Example: Assume when a 20-year loan was issued, the effective interest rate for the month of August 2016 is 4.960% and the debenture interest rate is 2.880%. The prepayment penalty declines by 10% of the debenture rate each year; in other words, it drops by a factor of .288% each year.

SBA 504 Loan – CDC Prepayment Penalty

Note: Although the prepayment penalty is small, don’t forget that SBA 504 loans are assumable. Don’t overlook the benefit of having a new borrower assume a 504 loan with 16 or 17 years remaining at a low fixed rate of 4.960%. The 10-year effective rate remains an even lower 4.510%. What could be more appealing to a new buyer down the road than the opportunity to assume a fixed interest rate loan in these ranges without going through the full application process?

Bank or Non-Bank Lender Portion of the SBA 504 Loan

The interest rate offered on the lender portion of an SBA 504 loan is at the discretion of the bank (or non-bank lender). Ultimately, you and your representatives must negotiate the best possible rates, fees, and terms for your deal. Beyond coming to the table as a qualified borrower, you will also benefit from having a robust business plan, complete with detailed financial projections.

SBA 504 Loan Interest Rates & Fees

In most cases, the bank/non-bank lender loan will have a 5-10 year term amortized over 20-25 years. In the case of loans with 10-year terms, the interest rates usually reset after 5 years. This means that after 5 years, your interest rate could go down, go up, or stay the same. It depends on what the market rates are at that time.

While the long amortization will keep your monthly payment lower, it will also mean you have a balloon payment due in 5 – 10 years. At that point, the remaining balance is due in full leaving you to pay the balance or, as is more often the case, refinance the loan and continue making monthly payments.

Refinancing a first mortgage when a balloon payment comes due can be problematic, in some cases. If your business (or industry) sees a downturn prior to refinancing or if your property has significantly depreciated, it maybe difficult to find a lender willing to work with you.

The bank portion of the loan may come with its own set of closing costs and third party costs such as appraisal fees, environmental fees, and architectural and legal fees. Fortunately, these too can typically be included in the financing.

Another SBA-backed option that avoids the prospect of balloon payments is a long-term SBA 7(a) loan for commercial real estate. If you’ve been in business for 2+ years, will occupy at least 51% of the building, and have a credit score above 680, you may qualify for an SBA 7a loan with Northeast Bank. Northeast Bank offers rates as low as 5.5% and loans up to $5MM. Fill out a short online form to see if you pre-qualify.

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Applying For An SBA 504 Loan

The bank portion of an SBA 504 loan can be funded by large, national banks, small community banks, credit unions, and more. Regardless of what bank you work with, you’ll need to find a CDC willing to work with you on the loan.

There are 270 CDCs nationwide. In order to find one that will work with you, we suggest using the SBA’s CDC Finder tool. To find a bank, you can try your local bank, or the CDC might recommend a number of banks that it has worked with in the past. SBA district offices also sometimes compile rankings of the top 504 lenders in the region.

We recommend working with Liberty SBF for SBA 504 loans. If you have a credit score above 680 (check here for free), you’ve been in business 3+ years, are profitable, and need more than $1MM, speak with Liberty SBF today.

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Will Your Banker Talk About SBA 504 Loans?

Bankers have complicated relationships with CDCs when it comes to SBA 504 loans. On one hand, loan officers at banks are the top source of small business referrals to CDCs. At the same time, loan officers can feel pressure not to make referrals to CDCs.

The reason banks can seem conflicted is that as the economy and real estate market continue to improve, banks have been making efforts to increase the number and size of the commercial real estate loans they issue. Loan officers have a financial incentive (bonuses) to loan as much money as possible to a borrower, providing the loan meets the bank’s underwriting standards. When loan officers partner with a CDC to provide a small business an SBA 504 loan, they limit the bank’s loan size to 50% of the project, but it might have been as much as 80% had they funded alone.

There are other reasons why many loan officers don’t promote the SBA 504 loan program. These include:

• Speed: The process moves slower when there is more than one lender involved.
• Education: Many loan officers are more familiar with the SBA’s 7(a) loan program, and don’t know enough about the SBA 504 program to recommend it.
• Compensation: Banks can see a quicker payout by selling the guaranteed portion of a 7(a) loan than collecting interest and fees on SBA 504 loan.

This doesn’t mean that there isn’t a need for these loans, however. Tom Pretty at TD Bank says that these loans are in demand, and the amount of loans they’re doing is growing. “504 and all SBA products including 7(a) continue to be popular and are showing growth at TD Bank. A recent TD Bank survey of small businesses showed that 21 percent have had or will have credit needs in the next 12 months, and we expect that a number of these businesses seeking credit will find that an SBA loan offers advantages as they grow.”

Who Is Getting Approved for SBA 504 Loans

The SBA has given out more 504 loans in 2017 than they have in the last four years. It’s a great time to look into getting an SBA 504 loan for your next fixed asset purchase, or commercial real estate project. Here’s a quick snapshot of who’s getting approved for SBA 504 loans:

Existing Businesses

Only 13% of all SBA 504 loans in 2017 were given to new businesses. This has been consistent for the SBA over the last 5 years, that existing businesses are approved at a much higher level, totaling between 85-89% of all 504 loans in that 5-year period.

Women Owned Businesses

Women owned businesses are getting approved for SBA 504 loans in 2017 at a higher rate than they have at any point in the last five years. Women owned businesses have received 20% of all 504 loans in 2017. But, those same businesses only received 15% of the money disbursed.

Minorities

SBA loans are a great option for minority owned businesses. They have policy goals that encourage them to lend to minorities. Even better, minority owned businesses received 23% of all SBA 504 loans in 2017, but 28% of the money lent out. According to Andrea Roebker at the SBA, “Minority business owners received a record combined $8.65 billion in 7a and 504 approved lending in FY2016.” The 2017 numbers are blowing that record out of the water already, with lending to minorities in both loan programs up a full percentage point.

Misconceptions of CDC/SBA 504 Loans

The average small business owner doesn’t think about SBA 504 loans until they’re ready to buy commercial real estate. That occurs much less often than, for example, people seeking credit cards or small business loans. Because everyone is less familiar with SBA 504 loans, there can be misconceptions that are hard to know the validity of.

To help us clear up the top three misconceptions around SBA 504 loans, we spoke with Kristin Wood, an SBA loan specialist since 1989, and the Executive Director of SPEDCO, a CDC which serves the states of Minnesota and Michigan. Here’s the top three misconceptions:

1. There is a ton of additional paperwork for 504 loans. “Simply, not true,” says Kristin Wood. With the exception of a couple of documents, the paperwork is the same for an SBA 504 loan as it is for a conventional commercial mortgage.
2. There are large prepayment penalties. “The penalty currently starts at under 3% and decreases by 10% – 20% per year,” says Kristin Wood. After 10 years there is no prepayment penalty.
3. The loans are not assumable. If one re-finances the bank loan, the CDC loan needs to paid off. “The loans are assumable,” says Kristin Wood. If a small business refinances the bank loan, the loan from the new lender will be senior to the CDCs loan, just like the original bank loan. With rates near all time lows at present, the ability to assume a fixed rate SBA loan in the range of 4.5% without going through the full application process is a huge advantage to both buyers and sellers.

Bottom Line: SBA 504 Loan

An SBA 504 loan is one of the first types of financing you should consider if you’re purchasing commercial real estate to operate your business out of, or if you’re buying long-term equipment that holds its value. The low interest rates and long repayment terms will be easier on your cash flow, and the low down payment will allow your small business to preserve more cash for working capital.

We recommend working with Liberty SBF for SBA 504 loans. If you have a credit score above 680 (check here for free), you’ve been in business 3+ years, are profitable, and need more than $1MM, speak with Liberty SBF today to see what you can qualify for.

Another option for small businesses looking for a government-backed loan is a long-term SBA 7(a) loan for commercial real estate. With a max term 5 years longer than a 504 loan, no risk of a balloon payment, and one less lender to coordinate the deal with, an SBA 7(a) can be appealing to many borrowers. If you’ve been in business for 2+ years, will occupy at least 51% of the building, and have a credit score above 680, you may qualify for an SBA 7a loan with Northeast Bank. Northeast Bank offers rates as low as 5.5% and loans up to $5MM. Fill out a short online form to see if you pre-qualify.

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