The Small Business Association or “SBA” was incorporated by the US Government to ensure small businesses succeed and are eligible for commercial loans. While SBA loans follow a different process, they are similar to conventional commercial loans. The factors that distinguish the two loan types are government guarantees, certain terms, interest rates, and fees and closing costs.
Conventional Commercial Loans
Compared to an SBA loan, a conventional commercial loan today has less closing costs, higher rates, and lower leverage. Commercial loans require the borrower to have strong business financials and follow some very strict terms. Coupled with a higher interest rate the borrower must also pay certain closing costs, although with less lender fees than an SBA loan.
Commercial lenders don’t always allow for fees and closing costs to be financed in the loan.
• Loans fees, if financed includes points fee, application fee and credit report fees
• Prepaid interest, if financed
• Inspection fees, approximately $0.10 per sq. foot
• Appraisal, usually $3,000- $5,000 depending on the appraiser
• Environmental report
⁃ Environmental screen costs $500 – $1,500
⁃ Phase I Report costs $2,500-$3,000 ( required for most industrial property)
⁃ Phase II Report costs $4,000+
• Title Insurance, half paid by buyer, half by the seller
• Recording fees
• Documentary Stamps on the Notes
• Property taxes, shared with the seller
Typical closing costs for a buyer on the purchase of a commercial property using conventional financing are in the range of 2.5-3% of the purchase price.
SBA loans are an amazing prospect to reignite small businesses. The SBA has two main loan programs for commercial real estate, the SBA 7(a) and SBA 504. Both programs, backed by government legislation, played a big part in retaining small business success and creating new opportunities for small business concerns. A very strong characteristic of these loans is that the lender is protected with a government guarantee. While the borrower does pay significantly higher fees and closing costs compared to conventional commercial loans, the interest rate will offset the costs over time. A good thing about SBA loans is that closing costs can be financed with the loan.
Borrowers of SBA loans 7(a) and 504 loans saw a complete waiver of the closing fees and related fees last year, but the funds utilized to do so ran out by the end of 2010. Both 7(a) and 504 loans have different costs associated.
SBA 7 (a) closing costs
Closing costs include:
• Origination Fee, 1% in some instances
• Guarantee Fee, 1.75% – 3.75% depending on the loan amount
• Appraisal Report, usually $3,000-$5,000
• Environment Report, $1,800 to $2,000 for a Phase I Report
• Title Fee, shared with seller
• Attorney fee, approximately $2,500 – depends upon lender
• Packaging Fee, approximately $2,500 – depends upon lender
SBA 504 closing costs
All of the fees are added to the loan amount in the case of the 504 loan. This allows the borrower to amortize the costs during the term of the loan. Generally all the closing fees are included as a percentage of the cost, they include:
• Origination Fee, 1% in some instances
• Bank Loan Fee, 0.5% of 50% of the loan, this is paid to the bank which pays the fee to the SBA’s representative
• Guarantee Fee, 0.749% on acquisitions and 1.043% on refinances
• CDC Processing Fee, 1.5% of 40% of the loan
• Funding fees, 0.25% of 40% of the loan
• Underwriting Fee, 0.375% – 0.4% of 40% of the loan
• Reserve, .5% of 40% of the loan
• Fee on interim loan, 1% of 40% of the loan
• Servicing fees, will be included in the interest rate
• Title fee, shared with buyer
While the fees may seem like they would make SBA financing undesirable to small business owners, the fact that borrowers can reach a loan of up to 90% of the purchase price with long term fixed rates makes SBA financing a good deal. Any borrower considering financing with SBA should know that they should hold on to the property for at least 5 years to reach the benefits of the low fixed rate and absorb the costs of all the up front fees.
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New SBA guidelines greatly expand the ability for borrowers to refinance and purchase commercial real estate
Commercial borrowers are now able to refinance existing loans on owner occupied properties to 90% using the Small Business Administration’s 504 loan program, thanks to a new law enacted on September 27, 2010. This law brought about significant changes to the SBA’s lending guidelines. Most significantly, SBA loans now create opportunities for overleveraged property owners to refinance into lower rate stable, long-term commercial mortgages.
The 504 program recognizes that dropping property values have made refinancing difficult for many property owners. Accordingly, owner occupied properties can now be refinanced up to 90% of the appraised value OR 100% of the outstanding mortgage, whichever is less.
To help properties that are overleveraged, the SBA now permits borrowers to use additional collateral, such as a home, equipment or another commercial property, to use as part of their 10% required equity.
SBA 504 loans were primarily used to purchase commercial real estate by small business owners who occupied at least 51% of their property. The funds can now be used to also refinance properties, including debt acquired in support of the commercial real estate project such as machinery, equipment and leasehold improvements, plus eligible refinancing costs and prepayment penalties.
In addition to the refinance component, the SBA is seeking to reach more middle market companies by increasing several of the borrowing thresholds for the 504 program. Now qualified companies with a tangible net worth of $15,000,000 (up from $7,000,000) or less will qualify for an SBA loan as long as their last two-year average after-tax net revenue is under $5,000,000 (up from $2,500,000). The SBA’s share of the 504 loan has increased to $5,000,000, except for manufacturers who can finance up to $5,500,000.
The SBA’s 504 program’s current lending terms:
90% leverage with two loans; a first loan at 55-65% leverage offered by a conventional lender on conventional loan terms (variable, 3, 5, 7 and 10 year fixed loans with 20-25 year amortization periods) and a second loan, which is a fixed 10 or 20 year debenture (4.894% for 10 year and 5.93% for 20 year in March 2011). The borrower is required to bring the remaining 10-15% equity to the project.
In a controversial and widely criticized move, the SBA 504 refinance program initially could only be used to refinance loans that were due on or before December 2012 with a balloon payment. This requirement left out many property owners with loans due beyond December 2012, including many of the 5+5 year loans written in 2006 and 2007 that are due for a rate adjustment this year but don’t have immediate balloon payments. Now, with a change that will be published in The Federal Register by April 6, 2011, all loans will be available for refinance as long as they otherwise meet the additional eligibility requirements.
There are a number of requirements for borrowers to qualify to refinance under the 504 program:
- The property must have been financed more than 24 months prior to a refinance.
- The loan has a balloon payment.
- The borrowing business has continued operations over the previous 24 months.
- The refinance cannot be used to take out an existing government loan, such as other SBA 504 or 7A loans or USDA loans.
- The loan to be refinanced must be current for the last 12 months.
- The loan to be refinanced must have been used to purchase real estate, or if improvements, only those eligible under 504 guidelines.
The SBA does not lend any funds directly. Rather, the SBA works with a Certified Development Company (CDC), which is a private, nonprofit corporation. The CDC secures the second lien debenture, which is 100% guaranteed by the SBA.
At present, applications to use SBA 504 refinance funds must be approved by the SBA before the end of September 2012. The SBA estimates 20,000 businesses could be eligible to receive assistance with $15 billion in financing, increasing to $30 billion with leverage offered by the banks.
Elizabeth Braman, JD, MBA, CCIM is president of Los Angeles-based Watermark Financial, Inc., a commercial real estate financing firm. Contact her at email@example.com.
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