SBA 504 program can help business owner maximize leverage

Q. I am an owner of a small manufacturing business, currently renting a building and want to acquire a new building. Is the SBA 504 program a good financing match for me?

A. In general, the U.S. Small Business Administration 504 loan program is a financing alternative for owner-occupied real estate where the owner occupies greater than 51 percent of the property and wants to maximize leverage. Up to 90 percent leverage is available, allowing the borrower to limit his/her equity to only 10 percent.

The loan program is a cooperative venture between two lenders — typically a bank or credit company for the senior loan, comprising 50 percent of the financing, and a certified development company (CDC) for the subordinate loan comprising 40 percent of the financing. The bank or credit company loan is secured by a first mortgage and the CDC loan is secured by a second mortgage.

The interest rate for the SBA loan is determined by the purchasers of SBA-guaranteed loans at an auction, which is usually very competitive to bank rates. The interest rate will be fixed for the 20-year coterminous loan term and amortization period. Fees for the SBA loan are approximately 2.75 percent of the SBA loan amount and can usually be financed into the SBA loan.

Terms for the bank loan are negotiated separately with the bank or credit company lender and will usually reflect the credit of the guarantor and the risk associated with the business expansion into a new building. The rates and terms can vary substantially for the senior loan, depending upon the lender.

Obtaining an SBA 504 loan requires compliance with loan program conditions, eligibility requirements and qualifying standards, some of which are listed below:

• Fund appropriation and loan amounts (currently $1.5 million to $4 million), which are established by Congress

• Loan is designated for acquisition/renovation or new construction of a building where owner occupies at least 51 percent

• Maximum loan to value or cost is limited to 90 percent and loan term and amortization is limited to 20 years

• Available to new and existing businesses, but loan to value may decrease to 80 percent for a new business venture or business owner

• The business must qualify with a net worth of less than $7 million and net income after income taxes of less than $2.5 million

• Companies must demonstrate job growth and meet retention/growth for jobs at a ratio of one job for each $50,000-$100,000 of loan amount, depending on the type of business

• Repayment must be demonstrated from business revenues with a debt service coverage requirement of usually 1.25 times, but projections are readily accepted

• Assuming a business expansion qualifies for the SBA 504 program, the senior portion of the financing is usually aggressively sought after by banks because of the low loan to value/cost at 50 percent and the fact that the loans qualify for the Community Reinvestment Act. Banks are constantly under pressure as required by the Community Reinvestment Act to reinvest a portion of their deposits into local community projects and SBA 504 program involvement is also attractive for that purpose.

Determining whether the SBA 504 program is well suited to your business should be a decision predicated upon your available capital and the best use of that capital, compared with the additional costs, aggravation and time attributed to financing through the program.

If a business owner does not have the capital to meet a more traditional financing requirement of 25 percent of cost, then the program is a great opportunity to expand the business that otherwise might not exist. If a business owner has the capital required for traditional financing, then a determination of whether the capital is better invested in the business operations or in the real estate for the expansion must be determined.

In weighing the alternatives, the additional fees and costs of securing two loans, additional processing time with two lenders, and rigid SBA paperwork must be evaluated. When investing in real estate, even with your own business as a tenant, maximum leverage is very appealing and the additional time, fees and costs are usually worth it to reap the benefits of the SBA 504 program.

David B. Eaton, president of Eaton Partners, Manchester, manages the firm’s Commercial Mortgage Group. Questions can be submitted to him at

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