When it comes to financing a commercial real estate purchase, there are a number of different loan options available to small business owners. Two of the most popular options are SBA 7(a) loans and SBA 504 loans. This article outlines SBA loans' commercial real estate applications and the pros and cons of each.
SBA loans, backed by the Small Business Administration, can generally be used for purchased, provided the small business will occupy all (or, in some cases, most) of the property, whether it's an industrial warehouse or a small office building.
What Is an SBA 7(a) Loan?
An SBA 7(a) loan is the most popular loan guaranteed by the Small Business Administration. While 7(a) loans can be used for acquiring owner-occupied commercial real estate, they can also have many other purposes, including funding working capital, buying a business, and even startup costs.
Loan amounts for SBA 7(a) financing go up to $5 million, and, when used for real estate, loan terms are up to 25 years. This type of financing has a fixed interest rate and is non-recourse, meaning that you as the business owner are not personally liable for the loan.
Pros and Cons of SBA 7(a) Loans
There are a number of advantages and disadvantages to taking out an SBA 7(a) loan. Some of the advantages include:
SBA 7(a) loans are typically easier to qualify for than other types of loans.
They can be used for a variety of purposes, including the purchase of commercial real estate.
They have terms of up to 25 years for real estate, which can make them easier to repay.
They may be difficult to get if you don't have a strong credit history, though this is not a hard requirement.
Significant paperwork is required by the SBA.
They cannot be used for investment properties.
When to Choose an SBA 7(a) Loan
If you're looking for a loan for the purchase of commercial real estate, an SBA 7(a) loan could be a good option. These loans are typically easier to qualify for than other types of loans and can be used for a variety of purposes. However, it's important to keep in mind that 7(a) loans may not be used for investment properties and can have significant documentation requirements.
What Is an SBA 504 Loan?
An SBA 504 loan is also guaranteed by the SBA. 504 loans are designed specifically for the purchase of commercial real estate or heavy equipment. Unlike the SBA 7(a) loan, SBA 504 loans can be used for both owner-occupied and investment properties — under certain conditions.
With an SBA 504 financing package, the structure differs greatly from a 7(a) loan. A bank or other lender will fund 50% as a conventional first-position mortgage. Second, an SBA-approved Certified Development Company, also known as a CDC, finances 40%. Finally, the borrower is typically required to inject 10% of the capital into the project.
Loans can range up to $15 million dollars with terms of 25 years. While this financing instrument requires a significant amount of paperwork and can be a lengthy process, the main selling point is that SBA 504 loans offer interest rates below market rates — and they’re fixed.
Pros and Cons of SBA 504 Loans
There are several upsides and downsides to taking out an SBA 504 loan. Some of the advantages include:
SBA 504 loans are specifically designed for the purchase of commercial real estate.
The loans’ interest rates are extremely competitive, at below-market fixed rates.
They can be used for investment properties, so long as the business occupies most of the asset.
Some of the disadvantages of 504 loans include:
SBA 504 loans require the involvement of a CDC, which often lengthens the process.
They may not be used for working capital, consolidating debt, or purchasing inventory.
There are significant paperwork requirements.
When to Choose an SBA 504 Loan
If you're looking for a loan to purchase commercial real estate for your business, an SBA 504 loan can be a solid option. These loans typically have lower interest rates than other types of financing and can be used for both owner-occupied — and investment properties, with some conditions. However, it's important to keep in mind that 504 loans are only available through the CDC and require a significant amount of paperwork and time, so they may not be ideal for every situation.
Although both loan types are backed by the SBA — and thus offer better terms than many other financing options for owner-occupied commercial real estate — they have significant differences in how they work and what they can be used for.
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