The economy's tepid recovery presents business owners with an intriguing opportunity: to acquire their place of business. If there's one thing more important in real estate than location, it's timing, and the timing right now may be good, says Everett Allen Greer, managing member of Greer Advisors, a real estate advisory firm. "Interest rates for commercial real estate loans are at 60-year lows," he says, adding that properties may be considerably underpriced. Moreover, he notes, owner-occupied properties may well appreciate the fastest in the near future, unlike the trophy commercial real estate that investors flocked to buy when prices fell.
These commercial real estate deals can be even more attractive when financed by U.S. Small Business Administration (SBA) 504 loans, which are designed to help small and midsize companies grow and create jobs. Because their low interest rates and down payments are low, SBA loans may make sense even for small businesses with enough cash to buy the property outright.
Keep your working capital
Using an SBA 504 loan can address growing companies' concerns about spending capital on the 20% to 25% down payment that many lenders require for conventional commercial real estate loans. "Most businesses buy a building when they are growing, which is exactly the time they need considerable working capital for expansion, equipment and operating expenses," says John De Franza, senior vice president and Credit Solutions executive at Bank of America Merrill Lynch. "And the No. 1 reason businesses fail is that they run out of working capital."
An SBA 504 loan requires only a 10% down payment from the borrower (or 15% to 20% for a special-purpose property, such as an ice-skating rink, a bowling alley or a hotel, all of which have limited resale value). Also, because the federal government funds a portion of the loan, the interest charged is typically lower than conventional rates.
How it works
Any for-profit business in operation for at least two years with up to $5 million in net annual profit after taxes (averaged over the past two years) and up to $15 million in tangible net worth can qualify for a 504 loan. Qualified companies, which by definition occupy at least 51% of the building, can apply to borrow as much as $14 million, compared with only $5 million two years ago. They can use the loan to purchase buildings, make improvements on existing business properties, acquire major equipment or — if they subsequently occupy at least 60% of the premises — build commercial space from the ground up.
A 504 loan is actually a combination of two loans. Whereas one is underwritten by a bank, the other is secured through a private, nonprofit certified development company (CDC), which works with the SBA to provide financing backed by a full federal guarantee. The bank holds the first mortgage for as much as 50% of the value of the property, the CDC holds the second mortgage for as much as 40% of the value, and the borrower contributes as little as 10% equity. The CDC/SBA portion of the financing is a 20-year fixed-rate loan, unless it's used by a company to acquire capital equipment, in which case the loan matures in 10 years. Locking in a loan for such a long period helps businesses plan for costs and pay off the debt more slowly, freeing up capital for other uses.
Bank of America's terms for the first mortgage can be customized to the borrower's needs, De Franza says. Business owners who are more comfortable knowing their company's fixed costs might want to consider a long-term fixed-rate loan. "But if business owners plan on selling the property or business in three to five years, they may want a shorter fixed- or variable-rate loan," De Franza advises.
In the event that the property changes hands before the end of the loan's term, the new owner can assume the CDC/SBA portion of the loan. "If interest rates have gone up since you bought the building, a low fixed-rate mortgage from the CDC/SBA can be a selling point," De Franza says.
SBA loan myths
Contrary to what many business owners believe, the out-of-pocket fees for a CDC/SBA loan are comparable to those associated with a conventional commercial loan. "People have the impression that a 504 loan is expensive because fees are paid to the bank and to the SBA," says Rick Benito, senior vice president, Global Commercial Banking at Bank of America Merrill Lynch. Although fees are typically higher than those for a conventional loan, financing the second mortgage's SBA 504 fees together with the loan amount reduces out-of-pocket costs. What's more, the interest on the SBA loan is typically below market rate, making the blended rate for the two mortgages very attractive.
Some business owners have shied away from 504 loans for fear of bureaucratic red tape. In fact, the average period for closing and funding a 504 loan is 60 days — the same as for a conventional commercial loan. "The CDCs deal with the government, not the borrower, so the loan process feels seamless to the business owner," De Franza says.
Buying a building is an investment in your company's future. You'll have room for potential expansion, and the property may appreciate in value. There may even be tax benefits, with possible deductions such as interest property depreciation and real estate taxes. And to add cash flow, you could rent out a portion of your space, Benito says. "With a 504 loan, you'll be able to put much more of your capital to work growing a successful business."
Ask your Financial Advisor these questions when considering whether to purchase your place of business by taking out an SBA 504 loan:
- Is my business well suited for an SBA 504 loan?
- In light of my current finances, would it be wise to make a down payment on my place of business?
- What SBA 504 loan terms would make the most sense for my business?
ARL5I734 | 02/17/2013