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What's the Difference? SBA 7(a) and 504 Loans in Commercial Real Estate
For small business owners looking to acquire commercial property, the SBA offers some excellent financing choices — learn the differences here.
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.
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.
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.
What are the key differences between SBA 7(a) and 504 loans?
The key differences between SBA 7(a) and 504 loans are primarily in how they're used. The 7(a) allows you to use the funds from the loan for working capital, which you can't do with the 504. The 504 is larger, and has terms that are better suited to land and real estate projects that are large enough to be handled by multiple lenders. The 7(a) favors start-ups and small business owners looking to work with a bank, credit union, or other traditional lending institution. Eligibility requirements for the 7(a) are straightforward, and are designed to encourage lenders to approve small business owners for projects small and large. There is no minimum loan amount for the SBA 7(a), and the loan can be used for nearly any legitimate business purpose. Some of the terms of the SBA 7(a) are based on the amount of the loan, but banks generally ask for a 10% down payment from the borrower.
What are the advantages of SBA 7(a) loans for commercial real estate?
The advantages of SBA 7(a) loans for commercial real estate include:
- They 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.
For more information, see What's the Difference? SBA 7(a) and 504 Loans in Commercial Real Estate and 3 Ways the SBA 7(a) Loan Can Help Entrepreneurs with Owner-Occupied Commercial Real Estate.
What are the advantages of 504 loans for commercial real estate?
The advantages of 504 loans for commercial real estate 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.
For more information, please see What's the Difference? SBA 7(a) and 504 Loans in Commercial Real Estate and SBA 504 Loan.
What are the eligibility requirements for SBA 7(a) loans?
The SBA 7(a) loan has some basic eligibility requirements, including:
- Your business must operate for profit. Nonprofits and not-for-profit businesses are not eligible.
- You must also have some equity in the business — this could mean you already have a profitable business, or you could use your own personal equity as collateral.
- If you have any alternative financial resources, you must have used them first. For example, if you have a personal savings account or are able to get a personal loan, then you must first pursue those options before applying for an SBA 7(a) loan.
- The business owner cannot be on parole.
- You must be doing business in the U.S. or its territories.
In addition, the business must meet the SBA's size standards for its particular industry, have fewer than 500 employees and less than $7.5 million in revenue each year for the previous three years, and must not be involved in lending, real estate, or speculation.
What are the eligibility requirements for 504 loans?
The eligibility requirements for 504 loans include the following:
- Your business must be worth $15 million or less.
- You must operate as a for-profit entity (nonprofits are not eligible).
- You must meet SBA size requirements that pertain to small businesses. Note that size requirements vary by industry, so there is no one-size-fits-all answer here. You can find the current business size requirements set forth by the SBA here.
- Your average net income for the preceding two years prior to applying for the 504 program must be $5 million or less after income taxes.
- You cannot be engaged in passive activities.
- You cannot be engaged in speculative activities.
- You must meet job creation requirements, or, alternatively, meet community development or public policy goals.
- You cannot purchase and then hold real estate. Real estate purchased with the loan must be utilized for business needs.
- You cannot be engaged in any form of lending.
- You cannot have defaulted on a federal loan previously.
- You cannot be involved in any sort of political activity or lobbying activity.
- You cannot be involved in any form of gambling, nor can you operate a casino.
- The loan must be repayable from cash flow generated by the project in question.
- You must be able to provide the SBA with personal histories for all principals in your company.
- You must have a business plan, and it must be deemed feasible.
- You must plan to occupy at least 51% of the building if it is an existing structure, and 61% of the building if it is new construction.
Note that many businesses that qualify for 7(a) financing will also qualify for 504 financing, but not all, due to the more stringent requirements.
What are the maximum loan amounts for SBA 7(a) and 504 loans?
Disadvantages include:
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:
Some of the disadvantages of 504 loans include:
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.
SBA Loans for Commercial Property: Terms Comparison
Conclusion
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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