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Catch More Business With SBA 504 Loans (Scotsman Guide)

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Scotsman Guide
March 2013

Catch More Business With SBA 504 Loans
Working with small businesses can mean big returns if you reel in the right players

When the financial crisis hit, small businesses were among the first to feel the liquidity crunch.  Many businesses turned to financing facilities provided by various government-loan programs, like the U.S. Small Business Administration (SBA) 504 program.  With historically low, long-term interest rates, restricted conventional lending markets and hundreds of millions of untapped government funds allocated for the SBA 504 program, now is the time to get a larger catch of the financing opportunities created by the SBA 504 loan program.

Commercial mortgage brokers who understand the requirements and potential uses of these products can position themselves to net big business with small-business loans.

This past year marked a record year for the SBA 504 loan program.  The SBA approved 9,741 SBA 504 loans supporting $15.09 billion in small-business commercial real estate projects – roughly half of all SBA loans made in fiscal-year 2012.  A temporary loan-refinance provision that allowed small businesses to refinance existing debts added to the demand.  Created under the Small Business jobs Act of 2010, the program only got off the ground in 2011 and expired this past September.  This loan-refinance program comprised 26 percent of the 504 program loans made in fiscal-year ’12 and 34 percent of the dollar volume.

Despite the expiration of the temporary loan-refinance provision, the SBA 504 program still retains tremendous potential for lenders and small businesses – and the commercial mortgage brokers who liaise between the two.  The first step to capitalize on these opportunities is to have a solid foundation and understanding of the basics of working with SBA 504 loans.  Brokers also must realize that these loans can benefit all parties involved, but only with the right team in place.  Here are the top points that brokers should keep in mind when working with SBA 504 loans.

The SBA 504 program

SBA 504 loans provide small businesses with long-term, fixed-rate financing to expand or buy their own facility.  With an SBA 504 loan, a small-business owner can expect:
–          90 percent financing
–          25-year loan amortizations
–          Fixed-rate interest rates, which are currently between 4 percent and 5 percent
–          No balloon payments

The SBA provides these loans by partnering with community-based nonprofit lenders, called certified development companies (CDCs), which are regulated by the SBA.  Nationwide, there are more than 260 of these CDCs working with the SBA and other participating lenders to provide financing to small businesses to help them purchase their own commercial real estate.

In a typical SBA 504 loan, the SBA covers 40 percent of the total project costs, a participating lender supports as much as 50 percent of the total project costs, and the borrower contributes 10 percent of the project costs.  The project assets that are financed by the loan generally serve as collateral.  Personal guaranties from owners with a stake of 20 percent or more in the company also are required.

Commercial mortgage brokers should keep in mind that since the loan-refinance provision expired this past September, SBA 504 funds no longer can be used for working capital or inventory, consolidating or repaying debt, or refinancing (except for projects with an expansion component).

Financing purposes

Commercial mortgage brokers also should be fully aware of the various purposes that can be financed by SBA 504 loans.  These include:
–          The purchase of existing buildings
–          The purchase of land and land improvements, including grading, street improvements, utilities, parking lots and landscaping
–          The construction of new facilities or modernizing, renovating or converting existing facilities
–          The purchase of long-term machinery
–          The refinancing of debt in connection with an expansion of the business through new or renovated facilities or equipment

Eligibility requirements
Commercial mortgage brokers who are familiar with the eligibility requirements for the SBA 504 loan program are equipped to direct their clients to take advantage of this program and ensure a smooth lending process.  To qualify, the business and the deal must meet several conditions:

–          Net worth and for-profit requirements:  All businesses using the SBA 504 loan must be for-profit and maintain a tangible net worth of no more than $15 million, and an average net income of $5 million or less in the preceding two years.  SBA 504 loans are not for businesses engaged in nonprofit, passive or speculative activities.
–          Project size limitations:  Although there is no maximum project size, the maximum SBA portion is capped at $5 million.
–          Job creation or retention:  The business must create or retain one job for every $65,000 guaranteed.  For small manufacturers, that ratio is one job for every $100,000 in SBA-guaranteed funds.

To purchase their own commercial real estate, borrowers who use SBA 504 loans often can fund projects with as little as 10 percent equity.  This creates opportunities for commercial mortgage brokers to work with clients who otherwise couldn’t afford the 20 percent to 30 percent equity-injection requirement that typically is required by conventional lenders.

Commercial mortgage brokers and lenders also can benefit from the opportunity to turn the deals made through this program into long-term client relationships.  Because the SBA 504 is designed to finance growing companies, clients likely are investing in permanent facilities and entering into the largest business-related loans of their careers.  If brokers are able to secure financing for these business owners in a smooth and efficient manner, these SBA 504 loans can be the basis of long-term, mutually beneficial relationships.

Lenders of all sizes also see additional benefits in using the SBA 504 loan program.  For example, banks that participate in SBA 504 loans are eligible for Community Reinvestment Act tax credits on certain projects.  The program also allows banks to have better control of their risk exposure and take on projects that would be otherwise overlooked.  By doing so, smaller banks can entertain larger projects, and larger banks can limit their exposure to certain industries or to a particular borrower.  Generally, lower commercial real estate loan concentrations on a bank’s balance sheet reduce regulatory concerns.

Commercial mortgage brokers should understand that lenders’ appetite for SBA 504 loans often is driven by the desire to limit the lenders’ risk – which is helped by the 504 loan structure.  In a typical 504 project, the third-party lender claims first-lien position and provides 50 percent of the total project cost, minimizing collateral risk.  Because SBA 504 loans make it possible to leverage lending capacity across a larger base of borrowers, lenders can diversify default risk and reduce loss in the event of a default.  In addition, the presence of an active secondary market for 504 first-mortgage loans further ensures banks reduced risk exposure and augments the bank’s non-interest income – all while retaining the customer’s primaring banking relationship.

One point commercial mortgage brokers should keep in mind is that loan pricing is at the lender’s discretion – which may be another reason that lenders often look at this program favorably.  The SBA 504 loan’s up-to-90-percent financing means more of the borrowers’ funds can remain on deposit, whether the business owner’s commercial banker handles the project or refers it to an SBA 504 specialist.  The bank, therefore, can earn fees and interest on the interim loan if it can, and wants to, do it.  It also can generate fee income from sale premiums and loan fees if it sells the first-mortgage loan in the secondary market.

The bank also may provide interim financing or a bridge loan for the construction phase of the project, if necessary – or it could source this out to an SBA 504 specialist lender.  When construction is complete, a CDC then provides financing with an SBA-guaranteed second mortgage that takes a second-lien position, pays off the interim loan and provides permanent financing for a 10-year term or 20-year term at a competitive, fixed interest rate – the rate currently is in the 4 percent to 5 percent range.

Although misconceptions that SBA 504 lending is lengthy and requires more work than conventional financing persist in the marketplace, the truth is that the SBA has worked to streamline and simplify the loan application, approval and closing processes.  Approvals typically are relatively fast, with no unnecessary paperwork or inconvenience for the borrower.  Keep in mind, however, that – as is the case with other commercial loans – selecting the right SBA 504 specialist and CDC can make all the difference when navigating these specialized loan products.

It’s clear that more commercial mortgage brokers, lenders and business owners are interested in familiarizing themselves with the benefits of 504 loans.  With that familiarity comes an understanding of the process and the crumbling of outdated, negative stereotypes that have surrounded SBA lending for years.  For commercial mortgage brokers who have not worked with this loan program, now is the time to get started.  After a record year in 2012 for SBA lending – and the 504 loan program in particular – expect the momentum to continue this year.


Chris Hurn is the co-founder and CEO of Mercantile Capital Corp. in Orlando, Fla., a three-time Inc. 500/5000 company, two-time U.S. Small Business Administration Champion, and a nationwide provider of small-business real estate loans and interim financing.  Additional information about SBA 504 loans and the benefits for business owners and commercial mortgage professionals is available at or in Hurn’s new book, The Entrepreneur’s Secret to Creating Wealth.  Reach him at (866) 622-4504.