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The U.S. Small Business Administration (SBA) offers a few different types of business loans to finance the purchase, improvement or renovation of real estate. SBA 504 loans are specifically designed for financing real estate and other fixed assets, but the 7(a) loan can also prove to be a viable option.
SBA real estate loans can be tough to qualify for; but they also have some of the best interest rates, making them more than worth the effort and time you’ll need to dedicate to the application process.
How Much Do You Need?
Types of SBA real estate loans
The Small Business Administration offers loan programs aimed toward encouraging entrepreneurship and small business borrowing. While it doesn’t give out loans itself, the SBA guarantees a large portion of the loans made by banks and other approved lenders. These partial guarantees incentivize lenders to provide small business owners with long-term, low-interest loans for which they otherwise wouldn't qualify.
There are two SBA loan programs in particular that provide financing to business owners who need capital to purchase high-value assets like real estate. These are the CDC/504 loan program and the SBA 7(a) loan program. Let’s learn the ins and outs of these SBA real estate loan options so you can decide which can best address your commercial real estate needs.
SBA 504 loan program
The primary type of SBA loan for real estate is the SBA 504 loan. The purpose of SBA 504 loans is to spur job creation and community development. They are specially designed for businesses seeking to fund major assets like real estate or equipment. These loans feature low, fixed interest rates, long-term financing and small down payments.
An SBA-approved certified development company (CDC) and a bank will work with the borrower on a 504 loan. CDCs are nonprofit organizations that are certified and regulated by the SBA. In most cases, the bank provides 50% of the total funding for the project. The CDC, which is fully backed by a 100% SBA guaranty, will provide 40% of the project costs. You would contribute the remaining 10% as a down payment.
Let’s take a look at the details of this SBA real estate loan.
SBA 504 loan rates and terms
SBA CDC/504 loan rates are some of the best out there. The repayment term is 20 or 25 years for real estate (there is also a 10-year term that's typically reserved for equipment financing). Generally speaking, SBA 504 loans can range anywhere from $50,000 to over $20 million. The maximum amount on the CDC portion of the loan is $5.5 million.
The portion of an SBA 504 loan that the CDC guarantees will come with a fixed interest rate ranging somewhere from 3.5% to 6%. The interest rate on this portion of your 504 loan won’t fluctuate with the market over its term. The interest rate on the rest of the loan that’s provided by the bank, however, can fluctuate with the market over its life. Keep in mind that the CDC and bank can charge fees that increase your total loan cost.
This 10% down payment is the main selling point for SBA 504 real estate loans. Compared to standard commercial real estate loan terms, the 10% down payment is really low. Startups and special-use properties will have to make a higher down payment.
SBA 504 loan uses
Though CDC/504 loans tend to be conflated with real estate, they are really designed for anything that you log under "property, plant and equipment." This means you can use them for purchasing or renovating commercial real estate or for purchasing equipment.
These are some eligible uses for SBA 504 loans:
The purchase of existing buildings.
The purchase of land and land improvements, including grading, street improvements, utilities, parking lots and landscaping.
The construction of new facilities or modernizing, renovating or converting existing facilities.
The refinancing of debt in connection with an expansion of the business through new or renovated facilities.
The purchase or upgrade of equipment and machinery.
You can’t use an SBA CDC/504 loan to refinance the pre-existing debt or for working capital; so if you’re looking for a more versatile loan, then consider the SBA 7(a) loan program.
SBA 504 loan eligibility
For starters, you'll need to fulfill the minimum requirements for SBA 504 loans:
You must be a for-profit company with a tangible net worth less than $15 million and your average net income should be less than $5 million after taxes for the previous two years.
You must operate in the United States.
You must be deemed able to repay the loan from your projected operating cash flow and provide the SBA with a personal history from all principals in your company.
You must have management expertise and a feasible business plan.
You must be able to show that you'll create jobs or meet other public policy goals.
The real estate that you're financing must be at least 51% owner-occupied (60% for new construction).
If you meet these criteria for a 504 loan, you can apply for this SBA real estate loan through an approved lender or a CDC. The lender or CDC might have additional eligibility criteria, such as a minimum credit score and minimum revenue requirement.
How to apply for an SBA 504 loan
Applying for an SBA 504 loan can be time-consuming and require a bunch of paperwork, including the following documents:
Business and personal tax returns for the previous three years.
Personal credit history.
Personal financial statement.
Personal budget analysis.
Business financial statements.
Business debt schedule.
Interim financial statement.
Accounts receivable and accounts payable aging.
Complete business plan.
Purchase agreement (if you're buying property).
You'll also be expected to show documentation about how you'll meet job creation or public policy goals.
SBA 7(a) loan program
The other option for SBA real estate loans is the SBA 7(a) loan program. These loans serve more general funding purposes—you can use your financing for a wide range of business needs, not just related to real estate or equipment.
While the CDC/504 program is the immediately obvious choice when you’re thinking about SBA real estate loans, don’t discount the 7(a) program. You should especially consider the 7(a) program if you need working capital along with real estate financing. A 7(a) loan has a simpler structure than a 504 loan. You will work directly with a bank or other private lender on your SBA 7(a) loan.
Let’s take a look at what this SBA-guaranteed commercial real estate loan has to offer small business owners:
SBA 7(a) loan rates and terms
Through the SBA 7(a) loan program, lenders can lend up to $5 million. Although there's no minimum loan amount set by the SBA, lenders tend to shy away from smaller loan amounts—the average 7(a) loan amount in the fiscal year 2019 was $446,487.
When a borrower uses a 7(a) loan to finance real estate, the repayment term is a maximum of 25 years. SBA 7(a) real estate loans require higher down payments than 504 loans, typically around 10% to 20%.
The interest rates on SBA 7(a) loans range from about 7% to 9.5% but vary with the prime rate based on economic fluctuations. Make sure you check the latest SBA loan rates before applying for a loan. The SBA and the bank you're working with will also charge some fees.
SBA 7(a) loan uses
While you can choose to earmark funds toward purchasing land or buildings, you can also use a 7(a) loan for business renovations, building out a leased property, capital expenditures like meeting payroll expenses and to help with everyday operating costs.
The funds from an SBA 7(a) loan can be put toward any of the following uses:
Expand, acquire, or start a business.
Purchase or construct real estate.
Refinance existing business debt.
Provide working capital.
Construct leasehold improvements.
SBA 7(a) loan eligibility
SBA 7(a) loans will typically be available to business owners with a personal credit score of at least 650, over two years in business and a history of profitability.
You'll also need to meet the SBA's definition of small, which varies based on industry. Any real estate financed with the 7(a) loan must be at least 51% owner-occupied.
How to apply for an SBA 7(a) loan
In order to apply for the SBA 7(a) real estate loan, you’ll need to compile the following documents:
Voided business check.
Business and personal tax returns for the last three years.
Business debt schedule.
Real estate appraisal.
Valuation of any other collateral (if you're also applying for working capital).
There are other forms and documents you might need to provide—like SBA form 1919 or SBA form 912. The bank might also have additional documentation requirements.
Pros and cons of SBA real estate loans
The advantages and disadvantages of SBA real estate loans mirror those of SBA loans as a whole—they’re great to have but hard to get. Here's why SBA loans are some of the most coveted business funding options around:
Low interest rates
The interest rate for SBA loans will vary depending on the lender, type of loan and loan amount, but SBA loans typically come with some of the lowest interest rates on the market. The SBA and individual lenders do charge fees, but the annual percentage rate (APR) is low even when those are accounted for.
Long repayment terms
You'll have 20 to 25 years to pay back your SBA real estate loan, which translates to a very low monthly payment. This makes it easier for your business to manage large investments in real estate without disrupting your cash flow too much.
For all their benefits, SBA loans aren't perfect. Here are some drawbacks to keep in mind:
Lengthy application and underwriting
SBA real estate loans typically aren't the fastest way to access capital—it can take one to three months to receive funding. The SBA loan application is also more time-consuming than other types of loan applications and requires a lot of documents.
To better prepare before talking to a lender, you might want to take a look at the SBA’s loan application checklist to make sure you have all your ducks in a row. If you meet the loan criteria, you’ll then work directly with an approved lender who will help guide you through the application process.
No options for investment properties
SBA real estate loans can only be used to finance properties that are primarily owner-occupied. If you want, for example, a fix and flip loan, you cannot use an SBA loan for that purpose. Investment properties do not qualify for SBA loans.
Both the SBA 7(a) loan and SBA 504 loan come with prepayment penalties should you decide to pay off the loan early. The prepayment penalty on an SBA 504 loan applies if the loan is paid off during the first half of the term (e.g. the first 10 years on a 20-year loan). The penalty is equal to one year's worth of interest during the first year, declining by 10% per year (to zero after 10 years).
For SBA 7(a) loans, prepayment penalties apply when a borrower prepays 25% or more of a loan’s outstanding balance on a loan that has a term of 15 years or longer. The fee declined from 5% in year one, 3% in year two and finally, 1% in year three.
Although prepayment penalties are a downside of SBA real estate loans, you can expect prepayment fees on virtually all types of commercial real estate loans.
The bottom line
With all this information on SBA real estate loans—including SBA 504 loan rates, SBA 7(a) loan requirements and everything in between—laid out, what’s the small business takeaway?
SBA real estate loans offer excellent terms and rates but come with strict eligibility requirements. If you are one of the qualified few who are able to secure an SBA real estate loan, then you have two options to look into—the real estate-specific SBA 504 loan or the more versatile SBA 7(a) loan.
To choose between these two SBA real estate loans, you’ll need to decide what you want to prioritize—do you want funding specifically for purchasing real estate, or do you want funding that can go toward many different types of business investments? For the former, SBA 504 loans are a good pick. For the latter, we suggest an SBA 7(a) loan. SBA 504 loans are also a better option for larger real estate purchases and for businesses that meet job creation and public policy goals.
Whichever option you end up choosing, SBA real estate loans will help you buy that next building, office space, warehouse or other property that you need to grow your business to the next level.
This article originally appeared on Fundera, a subsidiary of NerdWallet.