By Chris Lehnes, Vice President, CIT Small Business Lending Corporation

Regardless of the project, securing financing is a critical element of a commercial real estate transaction. Except on rare occasions when the buyer has sufficient liquid assets for an all-cash deal, or when seller financing is available at favorable terms, two financing options are available: conventional financing and Small Business Administration (SBA) financing.

Conventional financing is an attractive option when lenders offer aggressive interest rates and long loan terms. However, conventional loans often have low maximum loan-to-values (LTVs) that may either require a larger down payment (20% to 30% or more) than the buyer can afford or will deplete the small business of the precious capital it needs to grow. In addition, much like seller financing, conventional loans often carry balloon payments. This can mean that after 5 or 10 years the small-business owner must seek new financing, incurring additional fees. If this search takes place after a year when revenues are down, finding financing at similar terms may be difficult.

SBA Financing – A Smart Solution

More than ever, commercial real estate professionals are turning to SBA lenders to provide financing for clients purchasing buildings for their businesses. For many small-business owners seeking a high LTV and long repayment term, an SBA loan may be the best answer to their needs. In fact, thousands of small business owners take advantage of SBA loans every year for financing owner-occupied commercial real estate. Properties financed can vary from an industrial building or office/warehouse to a retail building or office condominium. Or perhaps, the owner wants to purchase land, and then build from the ground up.

The 7(a) and 504 programs are the most popular and most heavily utilized SBA programs, particularly for transactions involving commercial real estate.

SBA 7(a) Program

Under the 7(a) program, a lender (bank or non-bank) extends a loan directly to a small business while the SBA guarantees a portion of the loan. Up to 90% financing (10% down payment) with a fully amortized term up to 25 years is typical. Interest rates are variable, based upon the Prime rate, with spreads set by the lender. Typical spreads are 1.50% to 2.50% over prime, with lower rates to businesses with stronger historic debt service coverage. 7(a) loans may be used not only for the construction or acquisition of commercial real estate, but also for inventory purchase, working capital, and the acquisition of furniture, fixtures, machinery and equipment.

SBA 504 Loan Program

Under the 504 program, two separate loans are granted: 1) A lender extends a conventional loan, typically for an amount equal to 50% of eligible project costs, with a fully-amortized term of 20 to 25 years, and 2) A Certified Development Company (CDC) makes a loan, typically for 40% of eligible project costs, with a term of 20 years. The buyer injects the remaining 10%. If the property is considered “special use” (such as a restaurant or, hotel), the buyer will be required to inject an additional 5%. Start-up businesses require another 5% cash injection. Both variable and fixed-rate options are available. Unlike 7(a) loans, 504 loans may be used only for fixed asset purchases, such as land and building, machinery, and equipment.

Frequently Asked Questions

What is a “small business?” The vast majority of for-profit businesses are eligible for an SBA loan. Under the 7(a) program, the determining factor of whether a small business is “small” is based on either the number of employees or gross revenue, depending on the industry. For example, wholesale businesses with up to 100 employees are considered small businesses. Manufacturers may employ up to 500 to 1,500 employees, depending on the specific industry. Retail and service businesses with annual revenues of up to $6 to 20 million, again depending on the specific industry, are eligible. For the 504 program, a small business is defined as one with a net worth of less than $7 million and net profit of less than $2.5 million annually (two year average).

What is the maximum SBA loan amount? The 7(a) program has a maximum loan amount of $2 million. Under the 504 program, lenders typically lend up to $3 to 4 million, with the CDC lending up to $2 million, for total financing of up to $6 million.

How long does it take to obtain SBA financing? There is a misconception that SBA loans take a long time to approve and to fund. Frankly, some SBA lenders are simply quicker and more efficient than others. For the best service, look for lenders who have departments which specialize in SBA. Upon receipt of a complete application, most SBA lenders typically make a credit decision in 5-10 business days. Funding usually ranges from 30-60 days. Construction loans and loans on properties with environmental issues may take longer.

Is it hard to apply for an SBA loan? SBA loans require less paperwork than most small-business owners realize. Aside from business and personal tax returns and financial statements, there are a handful of fill-in-the-blank type forms that are not difficult to complete. Some lenders offer websites with automated SBA loan applications to ease the process. In addition, most major SBA lenders have representatives who will meet with small business owners at their place of business to assist with the paperwork.

What type of collateral is required? Typically, the purchase property provides sufficient collateral for the loan. Personal guarantees of all key managers, and owners of 20% or more of the small business are required and may be secured by second or third mortgages on their residences.

The First Step - Recommending the Right Lender:

When recommending a source for SBA financing, it is important for commercial real estate agents to remember that the level of service and credit philosophy employed varies widely among SBA lenders. One of the more important considerations is whether the lender is a Preferred Lender, a special designation under the SBA’s Preferred Lender Program (PLP), which gives the lender authority to make decisions on behalf of the government.

It is also important to find out about the reputation of the lender in approving SBA loans, their timeliness in funding and, most importantly, the satisfaction level of their customers. Perhaps the simplest way to differentiate between lenders is to determine which ones specialize in SBA loans, as opposed to those making a few SBA loans to accommodate their customers.

For more information, visit the SBA’s website, www.sba.gov , to find SBA lenders in your market.