The days of rock-bottom interest rates are behind us. Driven by global economic recovery and domestic inflation, the Federal Reserve has stated its plan to stop buying long-term securities and has started to increase short-term interest rates.
How these changes will impact a commercial mortgage broker’s small-business clients may not always be clear. But one thing is: Rising interest rates mean that the CDC/504 loan program through the U.S. Small Business Administration (SBA) will be even more valuable.
The CDC/504 program is a lending solution for business owners to buy, expand or refinance major fixed assets such as commercial real estate or equipment.
This program has a history of being a significant economic recovery tool. Since the start of the COVID-19 pandemic, these loans have garnered huge interest. In fiscal year 2021, the 504 program loaned out $8.2 billion, the most ever in one year. This represented a 41% year-over-year increase in volume as more lenders, small businesses and mortgage brokers capitalized on the program. In the current fiscal year, small businesses continue to choose the program for affordable financing to sustain their businesses and create jobs.
The CDC/504 program is similar to SBA’s popular 7(a) program, which lends money to be used to open, acquire, expand or run a business. Naturally, there are differences.
The CDC/504 program includes a fixed rate of interest. Most 7(a) loans offer variable rates, so as benchmark rates rise, so will the cost of the loan. Also, the 504 loan is primarily structured for fixed assets, while the 7(a) loan also can be used to pay for working capital.
The CDC/504 program is a lending solution for business owners to buy, expand or refinance major fixed assets such as commercial real estate or equipment. It can be used to build or upgrade a property, or even streets and parking lots, among other things. The program has a maximum loan size of $5.5 million, and it is designed to make property ownership affordable for small and midsized businesses by offering the best terms on the market.
This financing is a good fit for business owners who want to control their operating costs and retain working capital to grow their companies. During economically challenging times, the CDC/504 program also has supported cash flow and liquidity for small businesses.
Low interest rates
The CDC/504 loan has many borrower-friendly elements, such as the opportunity for 90% financing and a below-market, fixed rate for up to 25 years. Lower interest rates mean more affordable monthly mortgage payments, freeing up capital to improve cash flow and reinvest in the business.
A fixed interest rate can potentially save a small-business owner hundreds of thousands of dollars in a climate of rising rates. Today, business owners that utilize the program will still be enjoying the low rate (3.92% on 25-year loans as of March 2022) far down the road. Alternatively, business owners who try their luck with a variable rate will have fluctuating and unpredictable monthly payments.
Additionally, in times of high inflation, business owners can benefit from the advance rate provided by the 504 program, since the expectation is that future dollars have less purchasing power than current dollars. Moreover, since the interest rate on the loan can be fixed for up to 25 years, this mitigates the risk of rising rates and provides predictability in managing real estate costs.
As the small-business community continues to navigate through the pandemic and economic recovery, the need for liquidity is vital. Businesses need working capital to purchase additional inventory, absorb short-term losses, increase safety measures or possibly invest in an acquisition opportunity.
The CDC/504 program typically requires a minimum downpayment of 10%, enabling the business owner to retain more cash for short-term needs. With the low downpayment, businesses can retain precious working capital to continue to grow. Renovations, equipment, closing costs and soft costs can be financed as part of the total project cost.
There are certain circumstances that require a downpayment of 15%, such as a purchase of a special-use property or if the business has been in operation for less than two years. But this is significantly less than the downpayment required with conventional commercial mortgage financing, which typically ranges from 20% to 30% for multipurpose properties and even as high as 50% for some high-end cooperative properties.
Business owners who take the opportunity to refinance with the CDC/504 program can take cash out for eligible expenses. Up to 20% of the property’s appraised value can be obtained in cash and used to pay eligible expenses such as inventory, utilities, salaries, maintenance and high-interest debt.
Refinancing with this loan program creates an opportunity for small-business owners like no other. The program can reduce monthly mortgage payments and allow borrowers to access cash trapped in equity. The subject property can often cover the equity requirement.
The CDC difference
The CDC/504 loan is a second mortgage in the overall deal. The first mortgage is provided by a conventional lender and represents approximately 50% of the total project cost. The second mortgage is provided by a Certified Development Company (CDC). These are nonprofit organizations that administer loans on behalf of the SBA. About 270 CDCs operate in the U.S. Each of them are regulated by the SBA and charge the same fees.
The first step for mortgage brokers interested in helping small-business clients utilize the program is to connect with a local CDC. Since all CDCs offer the same loan product, it is essential to research what sets the CDC apart from others. The number of years of experience, the annual number of loans approved and client testimonials are excellent factors for choosing a CDC. Establishing a relationship with the right CDC is essential as it will be the small-business owner’s advocate for the life of the loan.
Once a local CDC is identified, the next step is to get prequalified. The CDC can complete the prequalification at no cost or obligation, with a few documents from the business owner. The prequalification process helps the business owner understand the company’s borrowing capacity. Information about the required downpayment and the monthly payments is provided for both the first and second mortgages.
The Small Business Administration name sometimes misleads business owners into thinking that they must not fit the program’s size standards. Program eligibility requires companies to have a tangible net worth of less than $15 million and an average after-tax income of less than $5 million for each of the preceding two years. Most for-profit, privately-owned businesses qualify based on these size standards.
There are alternative size standards that can be used to qualify for the program if a business has a tangible net worth or net income greater than the limits above. Moreover, there is no limit to the size of the project.
In addition, the business must meet specific occupancy requirements. The business must occupy at least 51% of the subject property in purchase or renovation scenarios. For new-construction projects, the occupancy requirement is 60%.
The CDC/504 structure is attractive to conventional lenders since their loan represents only 50% of the overall project cost. While most types of businesses qualify for the program, it is especially desirable for special-use properties such as wineries, hotels and gas stations, since conventional lenders are more reluctant to finance these unique properties and often require a downpayment of 35% or more.
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For any business interested in owning its building, the CDC/504 loan is often the best financing option. Contacting a representative from a local CDC for prequalification is the best way to get started. To help your small-business clients improve their cash flow and retain precious capital, utilize the CDC/504 program while the rates are still low. ●
Kurt Chambliss is executive vice president of TMC Financing, a certified development company (CDC) that has provided real estate financing in Arizona, California, Nevada and Oregon for more than 40 years. TMC Financing offers commercial real estate buyers up to 90% financing by utilizing the U.S. Small Business Administration's CDC/504 loan program. TMC is a top-ranked CDC in the nation, providing more than $10 billion in financing for more than 6,000 businesses.
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