Today’s post is written by Michael Green, Commercial Loan Originator for Counsel Mortgage Group, LLC.
Most people talk about SBA loans as if there’s only one, and that typically being the 7(a). The other equally useful in the right situation is the 504. This doesn’t get much exposure, probably because it’s more complex. I recently had the occasion to review a 504 with a borrower (my client) and a bank BDO. A brief overview of the loan is offered for orientation:
The 504 is really two loans packaged as one. (Now you begin to see why it can be confusing.) Both are backed by real estate – no business only acquisitions using this one. The 1st deed of trust (DOT) backed loan is really a conventional loan made by the bank. This typically to 50% of the total loan. The 2nd DOT back loan is made by the SBA through a Government chartered Certified Development Company (CDC). The SBA loan is actually funded by debentures (bonds) sold in the debt market – hence a market driven rate, not a legislated or statutory rate, e.g., the 7(a). The CDC 2nd funds (up to) 40% of the total loan amount. This leaves the borrowers equity-in to be 10% (or possibly higher). Depending on the use of proceeds (acquisition, construction, etc.) the allocations of participation may vary.
The rates for the two loans don’t have to be, and usually aren’t, equal. Other variables have to do with the term of the two loans and pre-payment penalties. In evaluating the rates you’ll hear the term ‘blended rate”. This is a blending or averaging of the two loans rates and amounts of money funded at each rate.
One of the attractions of 504s is the size of the loan that can be obtained. Not well known is that the SBA guarantee in the case of the 7(a), and the amount of the 2nd funded in the case of the 504 cannot exceed $5mm. However, if the 504 only uses 40% of the total loan amount, the total loan size can be as high as $12.5m.
The 504 can be used for acquisitions of existing businesses with real estate, or construction of new real estate. The loan has a construction (pre-existing development) component that can be used for the construction of a project and upon completion, rolled into the permanent loan.
Pre-funding ahead of the SBA issuance of the debenture is accomplished by a bridge loan from the lending bank. Because the debenture is funded in the future, the actual rate will be unknown until funding is complete. Market movements (volatility) during the bridge funding period in nominal, typically measured in basis points.
For rate-only comparisons today:
504 25-year debenture purchase rate (December’s auction): 3.64%
Lender’s 1st DOT rate: 4.5-4.75%
(The blended 504 rate is somewhere in between.)
7(a) rate: This loan is made by the lender (bank) at a rate not to exceed Prime + 2.75%
Prime today is 4.75%. How much each particular loan is priced over Prime “depends”!!
Generally, if your project doesn’t exceed about $5.8mm (85% LTV of acquisition or construction), you’ll find a 7(a) easier to use, although with a higher rate, but more accommodating (managing) once on the books.) It’s also cleaner to analyze ahead of the decision.
Interested in evaluating your business or CRE acquisition for financing? Give us a call.
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