Why Lease When You Can Own?

SBA 504s Loan Provide Low-Cost Entry into Commercial Real Estate Ownership

What is an SBA 504 loan?

An SBA “504” loan is a form of partnership between a Small Business Owner, the U.S. Small Business Administration, and  a “third-party” lender like ReProp Financial or a bank.  Its purpose is to assist Small Business Owners by providing up to 90% financing on commercial real estate that is fully or partially occupied by the Small Business Owner.

The financing is structured with two separate loans secured by the commercial real estate:

  • One loan is made by the third-party lender, and is in 1st lien position.  This loan is at 50% of the property value or purchase price.  The interest rate is determined by the lender.  ReProp is offering rates that range between 7.00% and 9.50% depending on the property type and the Borrower’s credit. 
  • A second loan is made by the SBA, and is in 2nd position.  This loan is between 25% and 40% of the property value or purchase price.  Some fees and costs can be financed with this loan, which is the “504” portion.  The interest rate is fixed for the term of the loan, and is generally lower than commercial rates.  As of December 2011, the rate was 4.94%.
  • The remainder of the cost of the real estate is paid by the Small Business Owner.
  • The combined loan fee for both loans is generally around 2.5%.

How can you tell what the payment will be so you can make some comparisons?

First, you’ll need to determine how much of a down payment you’ll need.  That depends on two things:  if you have a start-up business and whether the building is considered “special purpose.”  A special purpose building is one that can’t easily be used by another business – if it is specially configured or designed.  Examples would include gas stations, certain processing plants, and theatres.

  • If the building is a “special purpose building” and you have a start-up business:  20%
  • If the building is a “special purpose building” and you have an  existing business: 15%
  • If the building is not “special purpose:”  10%

Next, you’ll need to determine what your overall payment will look like.  Call Susan at 707.444.7703 extension 703 for a personal calculation of your payment.  The typical amortization is over 20 years, but it is also possible to structure an interest-only payment period.  We’ll need the estimated property price, and the amount of your down payment to calculate combined monthly payments.

Because property values are at all-time lows, and interest rates are also quite low, it is likely that you can end up with a payment that is close to the lease payment you’re making right now for your commercial building.   If the combined payments compare favorably, an SBA 504 loan might be a great fit for you.

How do you know that you qualify?  Here’s a checklist that will give you a good idea:

You will occupy at least 51% of the building you are going to buy.

You have good credit – this means no recent bankruptcy, no defaulted federal loans (including student loans), and no repossessions.  The SBA will review any explanations of poor credit, and will approve a loan if there are good reasons for the poor credit, especially if good credit has since been reestablished.

Your financial records show that you have the ability to make the proposed loan payments.

You have the required down payment– from 10% to 20% depending on the property type.

Your business is eligible for an SBA loan.  A list of businesses that the SBA has determined to be ineligible is attached.

What else should I be considering?

Finding a building.  If you don’t already have a real estate agent, we can help refer you to one in your area.  An agent can help ensure that you’re taking all aspects of the building into account – including location, zoning, structural issues, and getting the best price.

Prepayment periods.  The SBA’s prepayment period expires after 10 years, meaning you can pay the loan off after 10 years with no penalty.   ReProp Financial will structure its prepayment period to meet your business needs – if you believe you’ll be in a position to refinance ReProp’s loan with a conventional bank, we’ll make sure our prepayment period allows you to do so.

Time.  It will generally take about 45 to 60 days to obtain a SBA loan.  The process will go more smoothly if you have good records, and work with your lender to provide all the necessary information up front.

Ownership costs.  There are costs associated with owing commercial real estate that you should take into account, including property taxes, insurance, and any assessment fees that may apply.  You may also have other costs, including moving costs, and set-up costs for new utilities or services.

Existing Contracts.  If you are already in a long-term lease or rental contract you may face penalties if you decide to break the lease.  You should check with competent legal counsel before making the decision to do so.


What Should You Do Next?

Contact Susan Diehl McCarthy at 707.444.7703 to confirm your business eligibility, and go through the process in more detail.  We make the application process as smooth as possible, and will keep in touch with you every step of the way.

 Business Types Ineligible for SBA Financing:

  • Real estate investment firms, where real estate is held for investment – rented or leased to another).
  • Businesses involved in speculative activities, where profits come from fluctuations in price rather than the normal course of business (like commodities futures).
  • Rare coin and stamp dealers.
  • Lenders – banks, finance companies, factors, leasing companies, insurance companies (not agents).
  • Pyramid sales plans.
  • Illegal activities, such as selling drug paraphernalia.
  • Gambling activities, including casinos and racetracks.  However, an eligible business can operate within those arenas, so long as no more than 1/3 of their gross annual income comes from the sale of lottery tickets.
  • Charitable, religious, or other nonprofit, government-owned organizations, consumer and marketing cooperatives, churches, and organizations promoting religious objectives.
  • Businesses where any principal is currently incarcerated, on parole, on probation, or defendant in a criminal proceeding.  Loans MAY be made when the principal was previously incarcerated, on parole, on probation, or defendant in a criminal proceeding – applications are reviewed on a case-by-case basis.

Businesses that MAY beIneligible for SBA Financing:

  • Franchises where the franchiser retains such power to control operations that the franchisee’s right to profit from efforts commensurate with ownership are limited.
  • Recreational facilities and clubs which are not open to the general public, or in membership-only situations, where membership is not selectively denied to any particular group.
  • Farms and agricultural b
    usinesses ARE eligible, but should first explore Farm Service Agency financing.
  • Fishing vessels ARE eligible, but owners seeking to financing construction or reconditioning of vessels with cargo capacity of 5 tons or more must first request financing from the National Marine Fisheries Service.
  • Convalescent and nursing homes are eligible if they are licensed by a government agency and provide more than room and board.
  • Legal aliens are eligible but the type of resident status must be assessed in determining risk related to continuity of the business.
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