Getting started in any business is a pricey endeavor, and real estate investing is no different. It's crucial to figure out your financial options as early as possible – the need for better cash flow and more access to working capital is a constant one for small businesses. Banks only offer so many options, however, and it can be hard to find all the available opportunities for your business, especially with favorable CRE rates. Thankfully, there are CRE loans that can help ease the financial burden via The Small Business Association (SBA). They offer commercial real estate loan options that you should have on your radar: SBA Loans.
SBA Loans are excellent solutions for small businesses, and there are two you should consider for your needs: SBA 504 CRE and SBA 7(A) CRE. The type of loan your company benefits from the most will vary based on several factors, including:
- Your purpose for the money
- The size of your business
- Whether or not the money is for purchasing large assets
What are SBA 504 CRE Loans?
The SBA 504 CRE loan program, also called the Certified Development Company program, is meant to help businesses finance the purchase of fixed assets at lower CRE rates than market value. Those assets can be large machinery or commercial properties, such as large office buildings or warehouses at below-market rates. These CRE loans are distributed in percentages to three participants:
- A borrower (a minimum of 10 percent)
- A bank (50 percent)
- The nonprofit Certified Development Company (CDC) at 40 percent
This practice is called the 50-40-10 model. There's also the option for the borrower to put down a higher percentage, which adjusts the model. Loan amounts start at a minimum of $125,000 with a maximum that can go over 20 million dollars.
The SBA 504 loan is best suited for businesses hoping to expand to a new building, move offices, or add new departments or building additions that require expensive equipment or heavy machinery.
What are the qualifications for an SBA 504 CRE Loan?
- Your business's net worth cannot exceed 15 million.
- The business's two-year average net profit (after taxes) cannot have exceeded $5.0 million.
- The owner must occupy at least 51 percent of the purchased building.
- For loans needed for equipment, that equipment must have a 10-year useful life.
The purchased assets can serve as collateral for the loan.
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What are SBA 7(A) CRE Loans?
The SBA 7(A) loan is a CRE loan with the primary purpose of funding an expansion or renovation. It's much smaller in scale than the SBA 504, carrying a minimum of 50,000 dollars and a much lower maximum borrowing amount of 5 million dollars.
SBA 7(A) loans are backed by a private lender and a contribution from the Small Business Administration. This loan is a better fit for a business if they aren't just making real estate moves with the loans. These loans work great for working capital, typically having the shortest loan period.
If used to purchase equipment or a business, the funds can have a loan period of 10 years. The longest period, 25 years, is reserved for specific types of real estate investment. These loans can be hard to qualify for and require a 10 percent down payment but remain highly sought after due to their favorable commercial real estate terms and great variable interest rates.
What are the qualifications for an SBA 7(A) Loan?
- As with the SBA 504 loan, it must be a small business.
- Those with more than 20% ownership of the business must provide a personal guarantee.
- Annual sales must not be out of the range of $750k to $33.5 million (this pertains to retail, service, and agricultural industries).
- For wholesale or manufacturing companies, employees must be within the range of 100 to 1000.
- The owner must occupy at least 51 percent of the building if it is an existing building that has been upgraded or renovated.
- If the loan supports new construction, the owner must occupy at least 60 percent of the building.
- All assets must be for the direct benefit of the business.
- The borrower's residence will be pledged for the loan unless proven unnecessary by the bank.
The differences between the SBA 504 CRE and SBA 7(A) Loans
While both the SBA 504 CRE and the SBA 7(A) are loans offered by the Small Business Administration (SBA), they have significantly different advantages. The SBA 504 CRE loan's structure and scale are larger than its sister loan — if your project is massive in scale, this loan offers enough money to cover the costs in most cases, and Certified Development Companies are set up nationwide to facilitate economic growth.
The SBA 7(A), on the other hand, is meant to serve those looking for increased working capital, for a much smaller amount, closer to 5 million — becoming the primary choice for businesses needing less money but more options (repairs, renovations, payroll, etc., not just real estate).
How do you decide between the two CRE loans?
The most significant deciding factor is cost and purpose: how will your business use the money, and how much do you need? Urgency and timeline are also crucial factors. A few key questions to ask yourself:
Do you or any partners have a personal residence? The SBA 7(A) loan will consider your partners and their assets — a personal residence could be required as collateral. If this is a concern, the SBA 504 is a safer route.
Can you handle hefty fees? The fees for the SBA 7(A) rise with the size of the project — for loans over a million, rates can be as high as 3.75 percent (legal review fee, servicing fee, bank-portion fee, CDC fee). If fees are a concern, the SBA 504 loan may be better suited.
How much down payment can you handle? The SBA 504 loan requires less of a down payment than the SBA 7(A), even for the same project size — a meaningful factor for businesses that can't handle a large upfront cost. For larger projects, the SBA 504 is attractive since it allows for much more money to be borrowed, plus a fixed interest rate.
Conclusion
Funding can be tricky, especially when finding optimal commercial real estate terms. Having a clear understanding of your options for a commercial real estate loan will help you avoid headaches and financial gaps along your investment journey. While these two loans aren't for everyone, they should show up on your radar as you search for your specific solution.