SBA 504 Underwriting 101 - Collateral
Collateral is an asset used to provide security for a loan. Collateral in commercial real estate transactions usually consists of the commercial real estate being purchased, constructed, or renovated. The collateral asset can be seized and sold by a lender to help repay a loan in the event of default by a borrower which is why lenders use these assets as security.
The value of this collateral is important in determining how much you can borrow. This is usually determined by using the lower of cost or appraised value (loan-to-value [LTV] is a percentage calculated by taking the loan amount and dividing by the purchase price or appraised value, whichever is lower). Many lenders will require a minimum of 25% of the purchase price to be paid by the borrower. However, some lenders will loan up to 80% of the purchase price based upon credit worthiness and analysis of the property.
Another way that MCC sets itself apart from the rest is that we use total project cost to determine our loan amounts. This means that MCC takes the purchase/construction price, any improvements or renovations and your soft and closing costs, adds them all together and lends 90% of that amount (this is called "loan-to-cost" or LTC). This allows our borrowers to keep as much of their hard-earned capital as possible and utilize it where they see fit.
NOTE: Every lender has their own appraisal requirements. Before engaging an appraiser, you should always check with your intended lender to ensure that its appraisal requirements are being met. MCC in most cases will handle this piece of the due-diligence process for you, as we must send an engagement letter to an appraiser for your project.
As collateral, commercial real estate is generally classified as one of two categories:
Multi-purpose: Property that can be used by a wide variety of businesses without having to make substantial changes (office buildings, warehouses, etc.).
Special-purpose: Property that can only be used by only a few businesses without substantial and costly changes being made (gas stations, car washes, restaurants, hotels, etc.).
Special-purpose properties present more of a risk to lenders than multi-purpose properties, which is why many of them will require more of a capital injection (larger down payment) for a special-use building. MCC will only require an additional 5% capital injection in these instances. Some other considerations of your property that may affect value and use as collateral are: age; appearance; local market; location; and accessibility.