When a business wants to acquire or build owner occupied real estate and buildings, the SBA’s 504 loan program is a very good alternative to consider.
Like all SBA loan programs, the 504 program has numerous rules and restrictions, but most business real estate / building purchases will fall within the perimeters.
There are three “lending parties” involved in the 504 program. First a bank or non-bank SBA lender must originate the loan and is the primarily point of contact for the borrower. The primary lender approves a loan request first, and then takes it to a local CDC for participation of a portion of the loan. CDCs are non-profit organizations designed to help communities create jobs, provide affordable housing, and assist commercial lenders provide certain kinds of loans to small businesses. The last party in an SBA 504 loan is the SBA. Although the borrower only had to deal with the primary lender, the CDC and the SBA ideally work hand in glove with the primary lender to spread the financial risk of the transaction.
Typically, the borrower contributes 10% to the cost of the purchase (down payment), the primary lender contributes 50%, and the CDC (junior lender) contributes 40%. The SBA guarantees 100% of the loan to both of the lenders.
SBA 504 loans generally allow a business to finance real estate for a much longer period then conventional bank real estate loans. Rates are also favorable and loan to value ratios are not quite as critical as they are for traditional conventional loans.
Eligibility: To be eligible, the business must be operated for profit and fall within the size standards set by the SBA. Under the 504 Program, the business qualifies as small if it does not have a tangible net worth in excess of $7.5 million and does not have an average net income in excess of $2.5 million after taxes for the preceding two years. Loans cannot be made to businesses engaged in speculation or investment in rental real estate.
Use of Funds: Proceeds from 504 loans must be used for fixed asset projects such as: purchasing land and improvements, including existing buildings, grading, street improvements, utilities, parking lots and landscaping; construction of new facilities, or modernizing, renovating or converting existing facilities; or purchasing long-term machinery and equipment.
The 504 Program cannot be used for working capital or inventory, consolidating or repaying debt, or refinancing.
Costs and Fees: Interest rates on 504 loans are pegged to an increment above the current market rate for five-year and 10-year U.S. Treasury issues. Maturities of 10 and 20 years are available. Fees total approximately three (3) percent of the debenture and may be financed with the loan.
Size of Loan: Varies depending on type of business. In rare circumstances, the size can be as large as $4 million. In general, limits are either $1.5 million or $2 million.
Sam Thacker is a partner in Austin Texas based Business Finance Solutions.
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