As commercial mortgage professionals enter 2022 with optimistic feelings about the coming year, it’s hard to ignore the lingering effects of the COVID-19 pandemic, particularly in the small-business community. The health crisis hit small businesses hard and many are still struggling to get back on track.
To help businesses access cash and gain more stability, the U.S. Small Business Administration (SBA) has made its CDC/504 refinance loan program available to a broader pool of businesses under the Economic Aid Act. A CDC is a certified development company, which is a nonprofit corporation that has been certified by the SBA to administer CDC/504 loans and contribute to the economic development of a community.
Last year, the CDC/504 program — which offers fixed-rate loans of up to 25 years at below-market interest rates — experienced increased demand and unprecedented loan volume. Due to its success, the program ran out of funds before the end of the fiscal year on Sept. 30, 2021. While it gained traction in 2021, with the number of loans and dollar volume nearly doubling from the previous fiscal year, it remains underutilized and unknown to many small-business owners, mortgage brokers and lenders.
In today’s economy, small businesses need capital and long-term stability. Recently passed legislation has made it even more attractive to refinance commercial real estate debt into a low-interest, high-leverage CDC/504 loan. Plus, rates have been at an all-time low. The 25-year rate was consistently below 3% for much of 2021. And this refi program also is a fantastic way to generate cash for a client’s business.
Program basics
The CDC/504 program offers attractive, government-backed loans of up to $5 million for most major fixed assets, with an opportunity for 90% loan-to-value financing and a below-market, fixed interest rate. SBA 504 loans are frequently used to buy an existing building or construct a new one, modernize a property, refinance existing debt or purchase equipment with a service life of at least 10 years.
CDC/504 debt refinancing comes with three major advantages. The first, as mentioned, is that it offers business owners a below-market rate. The second is that the downpayment requirement can be as low as 10% and is often fulfilled with existing equity. Lastly, borrowers can access cash trapped in their real estate and use it toward business expenses.
Small-business owners can obtain up to 20% of their property’s appraised value in cash. These funds can be used for various business expenses — including salaries, rents, utilities, credit-card payments, repairs and inventory — which may be just what your clients need.
When a project involves cash out, there are caveats. The maximum loan-to-value ratio is 85%. Cash-out funds also must be supported with 18 months of future operating expenses.
Expanded eligibility
Many of the program’s eligibility requirements remain the same as in the past. This includes the rule that 85% of the original loan must be for 504-eligible purposes. The business must operate for profit, be at least two years old and occupy at least 51% of the building. Additionally, the Economic Aid Act, which was implemented in December 2020, added some new regulations that have widened the pool of eligible small businesses.
There are a few impactful changes to the program. One is that the existing debt must be at least six months old (reduced from two years) before the SBA application date to be eligible for refinancing. Second is that the new regulations allow for the refinancing of government-backed debt, such as existing SBA 504 loans and 7(a) loans. A caveat to this is that the original lender must be unwilling or unable to modify the current repayment schedule.
Additionally, the Economic Aid Act eliminates the requirement that the borrower must be current on all payments for no less than one year. The SBA expects a CDC, in its credit analysis, to consider whether the applicant is present on all amounts due as well as their history of delinquency.
The act also drops the condition that refinances that don’t involve a business expansion are only available when the CDC/504 loan program has zero subsidies (meaning that loan fees will sufficiently cover any defaults). The previous cap that prohibits CDCs from processing new refinance loans which exceed 50% of the prior year’s dollar volume was eliminated. And an alternate job-retention standard was reinstated. All existing jobs, measured on a full-time equivalent basis, can be counted as jobs retained by the refinancing project.
Small-business advocate
The CDC/504 loan has a unique structure that consists of a traditional bank loan of up to 50%, an SBA loan obtained through a CDC of up to 40% and a 10% equity contribution from the borrower. Startup businesses and single-purpose facilities require a slightly higher downpayment of 15%.
This low-equity contribution helps the small-business owner to conserve working capital while the bank takes on relatively little risk, making these institutions more likely to lend at reasonable rates to a greater range of small businesses. The program serves as a path for borrowers to get out of high-interest loans or mortgages with variable rates, short terms and balloon payments.
Some of the nuances of the program can be tricky, which is why CDCs administer 504 loans. They are nonprofit organizations certified by (but independent of) the SBA. There are roughly 270 CDCs around the country, each with a specific regional focus. CDCs are designed to help mortgage brokers and small-business borrowers determine eligibility and create the most optimal financing package.
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Reach out to a local CDC during the initial stages of putting together a refinance package. Experienced CDCs can explain the details of the new legislation to potential clients and determine their eligibility. This year is the perfect time for commercial mortgage brokers to expand their offerings and inform small-business borrowers about the improvements to the CDC/504 loan program. ●
