Purchasing an office building and other commercial real estate

Advisor Loans assist advisors with SBA lending for commercial real estate. Commercial property (such as office buildings) can be financed with both the SBA 7(a) and 504 programs. However, SBA lending for commercial real estate is mostly restricted to scenarios where the owner occupies at least 51% of the project space (up to 49% can be sub-leased to a longterm tenant in most cases). Each program has its pros and cons related to term, down payment, rate and pre-payment penalties.  

Both the SBA 7(a) and 504 loan programs can be utilized 

This chart shows the key differences between SBA programs. However, similar to M&A lending, each SBA lender varies in the programs they offer and will have their own and different policies and procedures for commercial real estate lending. For example, the minimum loan amount the SBA will allow for in the 504 program is $125,000. But, an advisor may have a difficult time finding an SBA lender that will be interested in a 504 loan under $1 million.   

Utilizing the SBA 7(a) Program option

While the 504 program was specifically created for the purpose of commercial real estate, there are scenarios where an advisor will prefer the 7(a) program. These are the key factors where an advisor would consider the 7(a) program over the 504 program: 

When real estate is combined with an acquisition 

The 7(a) program allows for acquisition and working capital loans to be combined with the commercial property. The big advantage here is that the term of the entire loan (including the acquisition portion) can extend beyond the normal 10 year term. 

If the real estate is at least 50% of the loan amount then the loan term can go out to 25 years. If the real estate portion is less than 50% the entire loan can extend out from 10 to 17 years. While there are no pre-payment penalties for standard ten year term 7(a) loans, when terms extend to 15 years or more, there is a 5/3/1 prepayment penalty (5% year 1, 3% year 2, 1% year 3). 

Prefer no down payment and speed over savings in interest rate

For the advisors who have a business value high enough to allow for 100% financing for SBA 7(a) loans, the 7(a) program can be used to purchase real estate with 100% bank financing. 

If there is available and sufficient equity in personal real estate then the bank will place a junior lien on that property if the advisor doesn’t put a 15% down payment. A LTV of 85% is required to not pledge any other existing real estate (other than the new real estate being purchased with the loan) as collateral.

SBA 7(a) loans with real estate are processed with the SBA lender just like other 7(a) loans. However, for 504 loans, a CDC (Community Development Company) and the SBA get involved which can create significant delays and additional headaches in the process compared to a 7(a) loan.

Utilizing the SBA 504 Program option

The 504 (REAL) Program is SBA’s economic development financing tool designed to provide co-lender financing for the acquisition of owner-occupied commercial real estate. The co-lenders would be a SBA lender and a CDC (Certified Development Company). A CDC is a community-based company approved and certified by the SBA to promote economic growth within it’s local area.

The 504 loan program is delivered via a tri-party agreement. A lender provides loan approval for permanent financing on a first lien position at 50% of total project costs. The SBA via a CDC provides permanent financing for up  to 40% in a second lien position. The borrower commits a minimum of 10% equity contribution. 

With both a lender and a CDC taking part in the 504 loan, there are ultimately two loans, one with the lender and one with the CDC. The 40% CDC portion will have a lower fixed rate with 20-25 year terms. The 50% portion from the lender will typically be a higher rate, could be either a variable or fixed rate, and the terms maybe shorter or with a balloon payment (after 10 years for example).

The interest rate on the 40% CDC portion of the 504 loan is always fixed for the life of the loan. The rate is locked in once the loan is funded. The 25 year rate has ranged recently from 2.75% in May to 2.58% in October 2020.  

The interest rate on the 50% SBA lender portion may be fixed or variable, years of term maybe shorter like a 10 year balloon, and rates vary as well and could be as high as 5.75%

To best compare 504 rates to other options look at the blended rate. For example, if the CDC rate is 2.58% for 40% and the lender rate is 5,75% for 50% then the blended rate will be 4.34%.

SBA 504 uses and restrictions

The 504 loan can be utilized for:

• Acquire land.

• Improve a site.

• Purchase one or more existing buildings.

• Convert, expand or renovate one or more existing buildings.

• Construct real estate.

• Refinance non-government guaranteed commercial mortgage debt and other eligible business expenses.

The 504 loan use restrictions:

• A purpose that does not benefit the small business.

• Investments in real or personal property acquired and held primarily for sale, lease, or investment.

• General refinancing. However, funds can be used to term-out debt obtained in anticipation of the 504 project which would have been eligible for 504 financing otherwise.

• Payments or distributions to Associates of the applicant business.