There are two separate programs for small business administration loans: the 7(a) and the 504. Please note the following explanations tend to apply only to real estate acquisition loans. The SBA also provides loans for working capital, machinery upgrades, as well as others, so if you are discussing SBA loan programs, be aware there are other programs with different terms and loan-to-value ratios.
7(a) loans
The 7(a) program is a conventional loan (usually a bank loan) with 75% of the loan amount guaranteed by the SBA. The loan is completely funded by the lender. The SBA is only guaranteeing a portion of the loan, thereby limiting the risk to the lender. The interest rate is variable; it can be up to 2.75% over the Wall Street Journal prime rate, which is the base rate on corporate loans posted by at least 70% of the 10 largest banks, adjusted quarterly. Loan term is 25 years on a 7(a) loan. The LTV ratio is generally 75% to 85% but is advertised as up to 90%, which applies to other types of investments, not hotels. The fees on a 7(a) are generally 3.5% of the SBA guaranteed amount (75% of the total loan amount), paid directly to the SBA, and documentation fees paid to the lender (typically between $1,000 and $2,000). Prepayment penalties are 5% during the first year, 3% during the second year and 1% during the third year. You may pre-pay up to 25% during the first three years without penalty, but more than 25% will cause penalties on the full prepayment amount, not just the amount that is more than 25%.
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| Howard Mathews |
Lenders who meet certain qualifications with the SBA are given preferred status under the SBA Preferred Lender Program. This gives the lender the authority of loan approval, closing and most servicing and liquidation responsibilities. They do not have to ask the SBA for their approval on each loan. The SBA conducts periodic reviews of the lender to ensure they are following the SBA guidelines. This makes the loan process run much more smoothly and gets your loan approved quicker than working with a non-PLP lender, who would need to submit all loans to the SBA and wait at least two to three weeks for a decision.
Fixed rate loans are sometimes available from SBA lenders but usually at very high rates. Variable loans with a cap or ceiling on the interest rates are also available, but at an additional rate of interest. For example, if the interest rate is variable at 2% over prime and the prime is 5%, your interest rate is 7%. The lender might give you a 5% cap, which doesn’t kick in until your rate reaches 12%, but they will probably charge you an extra rate of at least 1%. Therefore, to get the cap, you will have to pay an annual rate of 8% interest instead of 7%, and the cap won’t kick in until 12%, so we feel that is generally not a good investment.
SBA 504
The 504 program was developed to help businesses purchase real estate or equipment for business use. This program provides long-term financing for major fixed assets, such as land and buildings. Typically, a 504 project includes a variable-rate loan secured with a senior lien from a private-sector lender covering 50% of the project cost, a fixed-rate loan secured with a junior lien from the certified development company (backed by a 100% SBA-guaranteed debenture) covering up to 35% of the cost and a contribution of at least 15% equity from the small business (the borrower or buyer) being helped. These percentages are only accurate for a project with a loan of up to $5 million, although the 504 can be used for much larger purchases. A project of $1 million would be as follows:
- $500,000: Conventional loan, usually variable, 25-year term
- $350,000: SBA 504 portion, fixed rate, 20-year term
- $150,000: Invested by borrower, called the cash injection
The CDC is a nonprofit corporation that works with the SBA and private-sector lenders to provide financing to small businesses. The SBA oversees 270 CDC offices across the nation, each local office has its own territory but recently some offices were given authority within their own state or adjacent states. The CDC coordinates the financing process, and if they hold PLP status, they are able to approve and service the loan in-house without direct approval from the SBA on each individual loan. This speeds up the loan process tremendously, but the CDC takes some financial responsibility for loans which fail so they are very careful to only approve loans with a good debt ratio.
The debentures are sold on the open market, like bonds, and have a fixed rate and a term of 20 years. The rate is determined at the time of the debenture sale, which is usually 60 to 90 days after close of escrow. This means you can only estimate what your actual rate will be, based on the most recent past sale. Since the loan is not actually funded until the debenture sale, the lender providing the conventional first portion also provides what is called a bridge loan to cover the time between close of escrow and funding of the SBA 504 portion. Most of the loan fees can be financed with a 504.
The prepayment penalty on the SBA portion 504 is 10% the first year, 9% the second year, 8% the third year and so on down to 1% in the tenth year, and nothing thereafter. The prepayment penalty on the conventional deed of trust portion is usually a flat 5% for the first five years, but sometimes it can be negotiated down a sliding scale of over the first five years, depending on the lender.
A component of 504 called the SBA 504 Jobs Act Refinancing, which Congress enacted in 2010 as a way for businesses to refinance eligible fixed assets without requiring an expansion of the business, expired in September.
Howard has owned operated or managed over 40 motels and hotels ranging in size from a 22 unit motel in North Lake Tahoe to a 310 unit full-service Ramada Inn in Salt Lake City. With his knowledge of what to do with a property and probably more importantly what not to do, Howard can show buyers the upside potential of a property. His operational expertise can guide a client in turning a distressed or marginal property into a profitable one. Howard can be reached at howard@nhmb.com or 925.634.2299.
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