For business owners who are purchasing, constructing, or refinancing their owner-occupied business real estate, SBA financing provides lower down payment requirements, longer repayment terms, and easier qualifying criteria than conventional bank loans. Not all commercial real estate, however, is eligible for SBA financing.
Since the SBA loan programs are actually business loans, rather than real estate loans, only owner-occupied small business real estate is eligible for SBA financing. What kinds of real estate are, therefore, ineligible for SBA financing? Basically, ineligible real estate is property that is not used and owner-occupied by a small business. This would include undeveloped raw land and investor property held for rental income such as apartments, multi-tenant office buildings, mobile home parks, single tenant buildings, and multi-tenant retail strip centers.
The good news is that a small business is eligible to purchase or construct a new building with SBA financing, even though they have some rental income from tenants in the property. The SBA rule that dictates eligibility requires the small business purchaser of an existing property to immediately occupy at least 51% of the square footage under roof. For new construction, the small business must immediately occupy at least 60% of the square footage under roof.
Following are some examples of real estate which is eligible for SBA financing:
- Office/warehouse property
- Manufacturing facility
- Child daycare facility
- Medical, dental, chiropractic or veterinary clinic
- Restaurant or catering facility
- RV park or campground
- Assisted living facility
- Drycleaner or Laundromat
- Self storage facility
- Attorney, CPA, insurance agency or other professional office building
- Gas station, convenience store or carwash
- Auto repair facility
- Wholesale or manufacturer’s rep business
- Oilfield or other service business
- Antiques mall
- Auto, motorcycle, boat or equipment dealer
- Retail store
- Bottling plant
- Machine shop
The above list is not a complete listing of all SBA-eligible business properties; however, it displays a good sampling of the possibilities.
When should a small business owner consider SBA financing for their real estate instead of conventional bank financing? Because many businesses have a track record and good relationship with a conventional bank lender, SBA financing may not be appropriate for them. The business owner who will benefit from SBA financing may have lost his long term banking relationship. When shopping for a new lender, he may find bank financing requiring a large down payment such as 30%, or the bank may require excess collateral for the loan, or they offer only short term financing instead of a 25 year loan offered through the SBA program. Because most SBA loans have a variable rate of interest tied to changes in the Wall Street Journal Prime Rate, some borrowers will fear the interest rate risk. What they do not contemplate is that the conventional bank loan is typically a short term loan for three years or five years, and they will once again have interest rate risk at that time.
Also, with a short term bank loan, there is renewal risk. I cannot tell you how many times I have heard from business owners who just assumed their bank would renew their loan at maturity. That is not always so! If the business is experiencing any declining trends in revenue at the time for renewal, they might be denied for credit risk. If the bank changed ownership or management, they might be denied for new policy reasons. If the bank was taken over by the FDIC, there may no longer be a bank to discuss renewal terms. The typical SBA real estate borrower is one who justifies the interest rate risk with other advantages in the loan structure. These include factoring in changes in the interest rate to feel confident the payments are manageable even with interest rate increases.
The business owner may also be comforted by knowing the SBA government backed loan got them into property ownership with much less down payment which preserves cash for the business. Additional comfort comes from knowing the loan will stay in place for 25 years if needed. Finally, an SBA loan allows them to enjoy ownership while establishing a payment track record on the SBA loan. This could help them qualify for more attractive refinancing terms after two or three years. The SBA 7(a) loan has prepayment penalties only for the first three years. The business owner can still pay ahead on the loan principal up to 25% of the loan balance in each of the first three years while prepayment penalties exist, without incurring the penalty.
Another advantage on an SBA real estate loan includes being able to finance loan closing costs and other business needs such as financing for working capital, new business equipment, and debt consolidation. Once again, since this is a business loan, rather than a pure real estate loan, the use of loan proceeds can be flexible. In summary, any business owner needing to borrow up to $5 million for small business real estate should investigate all options including SBA financing. With SBA financing, we have happy borrowers who found a way to own their real estate and control their destiny when other financing options did not work for them.