Mike O'Donnell | Jul. 08, 2020

Does it make sense to refinance my commercial real estate loan with an SBA 504 loan?

With lots of news on the roll-out of different iterations of the U.S. Small Business Administration’s (SBA) Paycheck Protection Program (PPP) and SBA’s Economic Injury Disaster Loans (EIDL), the little-known SBA 504 loan program has become even more little-known of late, which is a shame because for any small business that owns their own office space, industrial building, manufacturing facility or retail location, the 504 program could be the BEST long-term financing option to explore as they rebuild activity post-COVID-19.

In case you haven’t heard of it before, the SBA 504 program was created by Congress in 1986 to make it much easier and less expensive for a small business, when it is ready, to finance the purchase or construction of the space that they primarily operate their business out of, with less money down and at a lower fixed interest rate than would otherwise be available through traditional bank financing or any of the other SBA loan programs.

The simple and supportable premise being that owner-users of commercial properties help build stronger communities and thus create more sustainable, living-wage, local jobs.

The SBA 504 program can help a small business buy or build their own location with typically just 10% down. Rather than pay rent to an often absentee or out-of-state landlord, the small business effectively pays rent to themselves when they own their own building, which also provides a source of retirement income for the business owners once they are ready to step down in twenty, thirty or forty years from now.

And of all the different SBA options, the 504 program is truly the only one that isn’t dependent on on-going taxpayer subsidy support either. The program pays for itself through the modest closing costs financed and included in the funded 504 loan amount.

When the last “great” recession hit, Congress expanded the SBA 504 program to allow a small business to incorporate some refinancing into a 504 loan but only if they were also expanding, which wasn’t happening very much in 2009. Then in 2012, for a very short period of time, Congress experimentally allowed the 504 program to be used to refinance existing standalone debt on commercial properties owned by a small business.

This short-lived but incredibly popular Refinance 504 option was eventually made permanent in the Consolidated Appropriations Act of 2016 and now that we are in the midst of another “great” recession, every small business worth its salt ought to be looking to free up as much cash flow as possible as the nation works towards reopening again.

Which brings me back to the answer to the question posed as the subject header of this ramble...

YES, if you owe money on a building or commercial space that your small business primarily occupies (your small business needs to occupy at least 51% of the available square footage), you’d have to have rocks in your head not to explore the 504 Refinance option because it has the potential to allow you to conserve precious cash.

Let me explain how it might work using a few simple examples, being an essentially simple soul (sole?) myself.

Let us assume you owe $1 million to a bank on a building or condo that your small business primarily occupies (51%+) and the estimated appraised value is $2 million:

  1. If the objective is to restructure the existing $1 million loan, this could simply be done by having the bank earn a CRA credit and reduce its loan amount to $500,000 and add an SBA 504 loan for $500,000 into the mix. The June 504 Refinance interest rate was 2.603% fixed for 25 years (and there are also 20-year and 10-year fully amortizing terms available). The rate on the bank loan won’t be that low but overall the small business is likely to free up a decent amount of cash flow through a restructure like this.

  2. If the objective is to consolidate several business-related obligations including a loan on a property the small business primarily occupies, it is also possible to use the 504 Refinance option to do this as well. Using this same example, if the small business also has a loan with an outstanding balance for $200,000 on vehicles and trucks, the $1 million commercial building loan plus the $200,000 vehicle loan could be restructured as a $600,000 bank loan plus a $600,000 SBA 504 loan, with that same June interest rate of 2.603% fixed for the next 25 years.

    In every 504 structure, the bank loan must be equal to or greater than the 504 loan, and as long as the new total debt doesn’t exceed 90% of the appraised value of the property (or 85%, in the case of a special or single use property like a car wash or hotel) and the 504 loan doesn’t exceed 40% of the appraised value, commercial mortgages and other eligible business obligations can be rolled together into a more advantageous, longer-term, lower-cost debt structure.
  3. It is also possible to use the 504 Refinance option to cash-out equity that a business might have in their building. Adding onto the above example, if the business owes $1 million on their property, $200,000 on vehicles AND wants to get $200,000 equity out of the property to help with payroll over the next 18 months, that is also possible. In this case, the structure would look like a $700,000 bank loan plus a $700,000 504 loan, with that same June interest rate of 2.603% fixed for the next 25 years. (A much better interest rate and almost as long a term as an EIDL loan!)

    When there is a cash-out element under the 504 Refinance, the maximum permissible loan-to-value (LTV) ratio moderates from 90% to 85% (and 80% in the case of a special purpose or single use property). In this example the bank loan and 504 loan add to $1.4 million or a 70% LTV, which means that should the business have needed to tap into additional equity to provide for working capital / cash flow needs over the following eighteen months, that option was there as well. Cash-out for business expenses may not exceed 20% of the appraised value of the property notwithstanding.

In these examples, I’ve presented a few of the routine scenarios we at Colorado Lending Source often encounter with the 504 Refinance program.

There are a few guardrails around the 504 Refinance that qualifies eligibility, and the most important of these are as follows...

  • The business must have been in operation for at least two years;
  • The debt being refinanced must be a commercial loan and needs to have been in place for at least 24 months and must have been current (no 30-day past dues) during the one-year period prior to the date of the 504 Refinance application;
  • The debt being refinanced may not be an existing SBA loan;
  • The cash-out option allows a business owner to tap into some equity they have in their building to fund any ordinary business expenses (e.g. payroll, professional fees, utilities, inventory, etc.) that were incurred but not paid at the date of the application for a 504 Refinance loan and/or will become due for payment within 18 months after the date of the 504 Refinance loan application;
  • No cash-out expenditures under the 504 Refinance option may be used for capital expenditures; and,
  • Traditional 504 loan program regulations otherwise apply to the 504 Refinance program.

So, there you have it in a proverbial nutshell. And the 504 Refinance program really isn’t hard to access, especially when you are working with the incredibly professional crew at Colorado Lending Source.

Accordingly, if you have a balloon payment due on your commercial real estate loan, if you are paying more than 3% on your building loan, and ESPECIALLY if you are looking to free up more cash to help you ride out this pandemic storm, perhaps it is worthwhile checking out the 504 Refinance program?

I know I would.

Contact us to learn more!