Based on your rent obligation and business needs, it may be more advantageous to buy your property, especially as interest rates are still very attractive. But when deciding to purchase or renovate an existing commercial property or construct a new building, business owners have several options as it relates to financing.
“While most banks offer conventional financing, the U.S. Small Business Administration (SBA) provides an excellent opportunity for owner-occupied commercial real estate (CRE) financing,” says Romona Davis, vice president and business development officer at Byline Bank, formerly Ridgestone Bank.
Smart Business spoke with Davis about how business owners can utilize the SBA’s loan guarantees to purchase real estate.
What are the biggest advantages of financing with an SBA loan?
The down payment and term length can be a strategic financing option for those who desire to put down less money and have a low monthly payment. With SBA loans, business owners can better manage cash flow, minimize the equity injection and avoid refinancing. A conventional loan often matures before it’s paid off. So, they have to reapply for financing and pay for a new appraisal, possibly new environmental reports and updated title work.
What does the SBA mean by owner-occupied?
The SBA is interested in guaranteeing loans for small business owners who will operate within the property. The SBA defines owner-occupied as 51 percent occupancy of square footage by the operating company for existing structures, or 60 percent of occupancy for new construction.
What is important to know about financing owner-occupied CRE through the SBA?
The SBA provides two financing options, 7a and 504. While the SBA 504 program targets fixed assets, the SBA 7a program can be used for both owner-occupied CRE and other needs, i.e., business acquisition transaction that includes the operation, commercial property and working capital. The advantages of SBA financing include:
- Down payment/equity injection: The borrower can inject a minimum of 10 percent equity toward the purchase or total project cost.
- Term: The SBA program allows the borrower to finance owner-occupied CRE up to a term of 25 years.
- Multi-purpose: Owner-occupied CRE can be combined with renovations, working capital, equipment purchases, etc.
- No balloon payment: The term and amortization will match. Conventional loans often offer a five- or 10-year term with a 20-year amortization, so the loan could mature, leaving a sizeable payoff balance that possibly requires refinancing.
- Loan to value: The SBA can allow up to a 90 percent loan to value.
- Prepayment penalty: The SBA has a three-year prepayment penalty for 7a loans or a 10-year declining prepayment penalty for 504 loans.
- Interest rates: Rates can be variable or fixed.
- Loan size: The maximum loan is $5 million.
What do banks look for when approving owner-occupied CRE?
Banks want companies to demonstrate an ability to repay the loan while covering their existing debt, either historically or with projections. Banks also want borrowers to have sufficient equity to inject toward the CRE purchase, no major concerns on an environmental report and creditworthy personal guarantors. They expect the operating company to meet the SBA occupancy requirement and the appraisal to support the purchase price.
Are companies allowed to form a separate real estate holding company?
The SBA does allow business owners to form an eligible passive company to house the real estate asset. The operating company must demonstrate an ability to service the proposed debt and is required to serve as co-borrower or provide a corporate guarantee.
Who is eligible for SBA assistance?
Businesses must operate for profit; be small, as defined by SBA; be engaged in or propose to do business in the U.S. or its possessions; have reasonable invested equity; be able to demonstrate a need for the loan proceeds; use the funds for a sound business purpose; and not be delinquent on any existing debt to the U.S. government.
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