As a small business, making the decision to purchase your own building is a major milestone. If you’ve been leasing a space, purchasing a building might actually lead to a lower payment each month—and there’s nothing quite like the satisfaction of knowing that you’re building equity every time you write a check.
Securing a commercial real estate loan can be a daunting process, but in most cases it’s necessary to make building ownership possible. If you’re struggling to secure financing for a commercial real estate property or aren’t sure where to begin, the SBA can help with viable options to purchase the best possible property for your business, with attractive loan terms designed specifically with small businesses in mind.
Read on to learn everything you need to know to get started with an SBA loan.
What is an SBA Loan?
The U.S. Small Business Administration (SBA) is a government organization that is designed to specifically support small businesses. You might know them as the administration body behind the Paycheck Protection Program (PPP) Loans that helped countless businesses make it through the COVID-19 shutdown.
The SBA is best known for its robust loan program. The program works by partnering with lenders and community development organizations to sponsor loans for small businesses that meet specific criteria. This sponsorship helps reduce risk for lenders, while making it easier for small businesses to secure a loan—a win-win situation for local business owners and financial institutions.
To qualify for an SBA loan, your business has to meet specific size standards by industry, conduct business in the United States, have equity invested from the owner, and not have any other financing options available for use.
There are two primary types of SBA loans that can be used for real estate purchases, each of which has its own perks and qualifications: an SBA 504 loan, and an SBA 7(a) loan.
SBA 504 Loan
An SBA 504 loan is the primary type of loan used for major real estate purchases. 504 loans are reserved for the purchase of physical assets that are considered “property, plant, and equipment” from an accounting perspective—this includes real estate and major equipment. 504 loans are a popular option because of their favorable rates, long terms, and extremely low down payments.
504 loans are restricted to very specific purposes: if you’re purchasing real estate, it must be at least 51% owner occupied, and you must demonstrate a solid business plan that shows how the property will be used to create jobs or meet another public policy goal.
One requirement of a 504 loan is partnership from a local non-profit certified development company (CDC). In addition to the SBA’s criteria, you’ll have to meet your CDC’s requirements for a loan, which vary from one to the next and might include minimum revenue, a minimum credit score, or other specific criteria. This can make an SBA 504 loan a bit more of a challenge to qualify for.
The qualification process is absolutely worth the effort when it comes to applying for a 504 loan. Interest rates are currently fixed between 3.0% and 6.0% for a loan term 25 years as well as a matching 25 year amortization schedule. Loan amounts can range anywhere from $50,000 to $20 million. Plus, the down payment is only 10%—making it more realistic to come up with a down payment than a traditional mortgage for commercial real estate, which typically is between 20% and 35% of the overall purchase price.
SBA 7(a) Loan
The SBA 7(a) loan is an extremely popular option because it can be used not only for physical assets, but also for other purposes. If you need working capital in addition to a loan for commercial real estate, you can get both in a single SBA 7(a) loan. Other items such as inventory, furniture, fixtures and equipment can also be part of the overall loan proceeds.
SBA 7(a) loans are capped at $5 million, and do not have a minimum loan amount. That said, banks and other SBA lenders tend to avoid loans that are too small. In 2020, the average SBA loan amount was $533,075. When used for real estate, SBA 7(a) loan repayment terms are capped at 25 years, and typically have an interest rate between 7% and 9%. The down payment is slightly larger than on a 504 loan—typically between 10% and 20%, and still significantly lower than a traditional commercial mortgage.
SBA 7(a) loans are popular because they’re so versatile. The loan funds can be used to:
- Purchase or construct real estate
- Buy machinery, equipment, or other property
- Conduct leasehold improvements
- Expand, acquire, or start a business
- Provide working capital
- Refinance existing debt
Pros and Cons of SBA Loans
As with any major business and financial decision, you need to carefully weigh your options and understand all factors about the product you choose. With the facts in mind, here are our main pros and cons of choosing an SBA loan for your commercial real estate purchase:
Pros of SBA Commercial Real Estate Loans
There are a wide range of benefits to SBA loans for commercial real estate. Primarily, small businesses appreciate the longer loan terms and lower interest rates. Plus, you’ll see the following benefits:
- Lower down payments make the goal of owning property more attainable in a shorter amount of time: no need to save up for years.
- You’ll pay some lending fees as you would for any bank loan, but the lower annual percentage rate will offer savings that easily offset those fees.
- The longer repayment term of up to 25 years means your monthly payment will be significantly lower than most other commercial real estate loans.
Cons of SBA Commercial Real Estate Loans
There’s no reward without some risk, and there are some downsides to choosing an SBA loan:
- The application and underwriting process is extensive, and can move slowly—as the old saying goes, it “moves at the pace of government.”
- There are stricter rules about how you can use the money from an SBA loan.
- SBA real estate loans can also only be used to finance properties that are primarily owner-occupied, and can’t be used for an investment property or a “fix and flip” project—in essence, the property you purchase has to be a part of the future of your business.
It’s important to be aware that there are prepayment penalties for SBA loans. It’s also important to note that prepayment penalties aren’t unique to SBA loans, and you can expect some form of prepayment fee on almost all commercial real estate loans (that’s why we did not list this as a specific con of SBA loans).
For SBA loans, the prepayment penalties break down like this:
- In the case of 504 loans, you’ll pay a maximum prepayment penalty of one year’s worth of interest if you repay the loan in the first half of the repayment term.
- For 7(a) loans, you’ll pay a penalty if you prepay 25% or more of the loan’s outstanding balance on a loan with a term of 15 years or longer, to the tune of 5% in the first year, 3% in the second year, or 1% in the third year.
- In both cases, prepayment penalties decrease the further you get into the loan repayment period.
Making the Most of an SBA Loan
Qualifying for and maximizing an SBA loan doesn’t happen in isolation. It’s extremely helpful to have a trusted partner who is an expert in not only the SBA process as it applies to real estate, but is familiar with the local market and has established relationships with a local lender.
At Barkett Realty, our commercial real estate experts are well-versed in the SBA lending process, and we have a finger to the pulse of commercial real estate in Tampa Bay. We’re happy to offer advice about qualifying for an SBA real estate loan, and help you find the perfect property to call home for your business. When you’re ready to get started, don’t hesitate to get in touch!