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Mike O'Donnell | Feb. 28, 2020

When is it better for a Colorado-based small business
to own rather than rent their space?

Colorado is a fairly entrepreneurial state. We have 167,643 firms with employees plus 517,350 non-employer establishments (typically sole proprietors, gigs, side-hustles and the like). The number of non-employer businesses is growing at a faster rate than the number of firms with employees, which reflects a national trend given how much easier it is in this quasi-technological era for people to test out or explore being entrepreneurs from coffee shops and kitchen tables across the length and breadth of Colorado, before leaving the safety net of employment elsewhere.

Let me add, parenthetically, that the IRS tells us that the average non-employer business in the U.S. generates gross revenues of $57,947.59 per year and has a net income of $15,733.84, so the vast majority of these businesses are what I would consider part time hustles.

Only about 5,000 non-employer establishments in Colorado will morph into a business with employees during any one year, so for most non-employee establishments, the journey towards entrepreneurship is an ongoing one.

We also know that each of the 18,283 new small businesses with employees that launched in Colorado last year created an average of 3.8 new jobs, which more than offsets the number of jobs lost when older firms contracted and downsized in the state. And this has been the case for 23 out of the last 26 years, which has made Colorado the entrepreneurial state that it is.

You might be interested to know that by the time these new firms that just launched are five years old, they will likely have 7.6 employees, twice as many as originally although by then only about half of those firms will still be with us.

 Survival rates are relatively predictable in Colorado, and elsewhere, for small businesses with employees. Bureau of Labor Statistics (BLS) data, which is my favorite source for most of the numbers in this article, show that for every new business with employees launched in Colorado since the end of the great recession, around 54.4% will still be here in five years’ time and around 36.5% will be here to celebrate their tenth anniversary.

The tenth-year anniversary celebration is a critical benchmark for a small business because once they get past this milestone, the likelihood of them continuing in business improves significantly. Of course, they might be sold or merge with another firm or choose another path, but just under half of all the businesses here in year ten, will likely still be here in year thirty. And that is pretty impressive.

Which finally gets me to the point of this article...

In Colorado, as of today we have 77,313 businesses with employees (46.1% of the total) that are at least ten years old. And by year ten, the average business in Colorado will have 11.4 employees.

Using the ancient and somewhat lost art of deduction, knowing how many employees a company has, it is possible to estimate the size of the facility that houses or is needed to house those employees. Over the last decade, the workspace area typically allocated to an employee has been shrinking, in response to all sorts of factors, and has dropped from 225 square feet per employee in 2010 to somewhere in the150 to 175 square feet per employee range today, depending on whether or not the small business subscribes to the sardine school of employee seating plans.

This means that a ten-year-old business with 11.4 employees will occupy a 1,710 to 1,995 square foot facility. If the lead entrepreneurship team within that ten year old firms is any good at future planning, and let’s presume for the sake of the argument that they are, or they wouldn’t have made it to year ten, the BLS data shows that they will gradually grow over the next ten years ending up with around 19.3 employees by year twenty and the need for a facility in the 3,500 to 4,000 square foot range.

So when is the best time for a small business, which has become fairly well established by year ten, to explore owning their own space rather than paying rent? And what options are available to help them finance that investment?

The answer to the first question is easy. If you have made it to year ten or are well on your way there, every small business ownership team should definitely explore options associated with owning their own space, whether that is a commercial condominium or a free-standing building.

With the inflation rate in Colorado at twice the national average, every year a business delays making that purchase decision, will cost more in the long run. And buying a space bigger than you need today, so you can rent out some of it while you are growing into it, is a no-brainer. Why wouldn’t you? is a better question to ask.

With regard to financing options, there may be more than you are aware of to consider...

  1. A commercial real estate loan from a regular financial institution is always an option. This typically requires the small business to come up with a down payment of between 20% and 30%. If you are looking at a $2,000,000 building, you will need to have between $400,000 and $600,000 to put down, which is quite a lot to save up, and if it has to come out of business operations can severely hamper the future growth of the business.

    Nonetheless, if you can come up with the necessary down payment, banks will usually be willing to lend the balance using a fully-amortizing loan over 20 or 25 years, like you might have on your home, or by providing a shorter term loan with a balloon payment due at the end of a five or seven year term (which means you have to pay off the remaining balance all at once at the end of that term). Interest rates will be higher than residential mortgages, likely in the 6% range today, and won’t usually be fixed for very long, unlike on your residential mortgage loan. The interest rate you get and how long that rate is fixed will depend on what you are able to negotiate with your bank and, of course, how much you put down. There may be prepayment penalties and there are always additional costs and fees associated with every commercial real estate transaction because of appraisal, environmental, survey costs, and the like.

  2. Small Business Administration (SBA) loans offer other options to consider and they have two different types of loan programs that can help finance a primarily owner-user building. Both will typically require a smaller down payment than what is required by a bank, credit union or commercial mortgage backed security lender.

    The first of these is the self-styled flagship SBA program is known as the Guaranty or SBA 7(a) loan program. This program allows a bank or other regulated lender to make a commercial real estate loan to you with a down payment as low as 10%. They can do this because in addition to your personal and business guarantee, the SBA itself will also guarantee a percentage of the loan the bank makes, which mitigates some of the risk they might otherwise incur by making a larger loan to your business on commercial real estate. You, as the borrower, pay the fees associated with securing that government guarantee. The larger the loan, the larger the fees are as a percentage of the loan amount. Many banks prefer to use this program because it is a more profitable program to the bank than the other SBA program. The fact that the government is there to help out if the loan doesn’t work out makes the bank’s regulators happy.

    The loan term can be up to 25 years, but no balloon payments are allowed so at least there is some predictability there. Interest rates are likely to vary although some larger lenders will fix interest rates for the life of the loan in certain circumstances.

    I’m less of a fan of this loan program than the other SBA program because (a) the lender will typically attach a personal residence (or two) in addition to the building they are helping finance, and, (b) the SBA 7(a) program is being supported this year by taxpayer funds. As someone who can still remember the wide-reaching impacts of the great recession, I personally don’t like to see taxpayer funds being used to help for-profit banks, especially given that in the third quarter of 2019, FDIC insured institutions nationwide reported aggregate net incomes of $57.4 billion.

  3. The second type of Small Business Administration loan program is known at the SBA 504 loan program and it is the only economic development focused, public/private partnership program the SBA offers.

    On a typical transaction, a bank will provide 50% of the financing and take the first mortgage on the property. A private nonprofit entity like Colorado Lending Source can provide up to 40% of the financing in the junior position, and the small business will have a down payment of usually10%. The SBA 504 loan is the 40% share, and this is funded from a monthly bond sale on the market in New York. The SBA’s role is to attach the full faith and backing of the U.S. government to the bond instrument, so it is highly sought after by institutional investors. And the more demand there is for this bond, the lower the interest rate the small business borrower pays.

    The bank doesn’t get a guarantee on their loan but because they are only financing half the value of the property, they are in a solid position as the senior lender. However, if the loan officer at the bank is incented by commissions or bonus structures based on the dollar volume of the loans they book, the SBA 504 loan option may not be an option the lender leads with as they might be able to make a lot more money by doing a larger loan.

    The interest rate on the 504 portion of the loan is fixed for the life of the loan, for up to either 20 or 25 years. When the February 2020 SBA 504 bond was sold, the 25-year fixed rate was 3.463%, which is a lower rate than you can get on most residential mortgages. The fees are also less on a 504 loan than on a 7(a) loan, and can be rolled into the loan, along with appraisal, environmental, survey costs, etc. Personal residences are almost never attached.

    As a consequence, a 504 loan is usually a much better option for the small business than a 7(a) loan. The SBA 504 loan program is also self-supporting in the sense that fees paid to access the program fully supports the program, so no taxpayer funds are diverted to the SBA 504 loan program.

    Comparing the SBA 504 program to the SBA 7(a) program on a $2 million building purchase with a $1.8 million (90%) loan financed over 25 years with a 10% down payment, assuming a bank loan at 6% under both programs and 3.463% for the 40% share on the 504 loan, a small business borrower will pay $3,168,538 in principal, interest and fees over the lifetime of the loan using the 504 option versus $3,565,164 in principal, interest and fees over the lifetime of the loan using the 7(a) options, assuming bank interest rates don’t change.

    Both numbers are scary large but if the lead entrepreneurial team at a small business can save around $400,000 over the life of their loan by making an informed financing choice, choosing the 504 option would be the way to go.

  4. Another source of commercial real estate financing that is becoming more popular these days, mostly with investors, is commercial real estate crowdfunding. This is where a group of individual investors, known as a syndicate, pool their money to invest in a real estate project that perhaps you, as the small business owner, introduced to them and into which you have invested some of your own money as a down payment. In most commercial real estate crowdfunding deals investors will get regular rental income distributions, although these may be deferred in favor of a defined holding period of around three to seven years, at the end of which the property is sold and profits distributed. This is reasonably analogous to paying rent to a landlord and getting booted out at the end of your lease although depending on your down payment investment in the project, some of the rent goes back to you, as will a portion of the profits when the property is sold. Investors will typically want a higher return on their investment than you will pay to a bank on a commercial real estate loan. So if you have 10% to use as a down payment, you would be much better off in the long run working with the SBA 504 loan program.


So, there you have it in the proverbial enigmatic nutshell. The SBA 504 loan program is the only SBA commercial real estate financing program that strictly defines a borrower’s down payment. It can be used to help finance projects ranging in size from $60,000 (the minimum 504 loan is $25,000 and maximum financing share is 40%) to $20 million plus. The intent of the program is to minimize the borrower’s out-of-pocket costs so funds can stay in the business to help it grow and add employees, allowing the business to make that purchase decision sooner without having to save up 20% to 30% as a down payment. A business must occupy at least 51% of the space of the building they are purchasing to make it eligible for the SBA programs but having a tenant in a portion of the building can help with servicing the debt on the whole building. Wall Street sets the interest rate for the 504 program so a small business is able to access the same capital market as a big business might, to help finance the purchase. Interest rates are incredibly low at present. AND, the program is self-supporting, so it isn’t being subsidized by taxpayers.

Why are you still renting your space rather than owning it?