SBA 504 Loans

Get to know SBA 504 Loans

Gerri Detweiler • February 17, 2021

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What is an SBA CDC 504 Loan?

The SBA defines a project that may be funded by a 504 loan as “the purchase or lease, and/or improvement or renovation of long-term fixed assets by a small business, with 504 financing, for use in its business operations.” This may include real estate acquisition and expansion projects, as we’ll describe shortly. 

A 504 project has three main partners. Generally: 

• A Certified Development Company (CDC) provides up to 40% of the financing through a 504 debenture (guaranteed 100% by SBA); 
• A third party lender provides 50% or more of the financing; 
• The borrower contributes at least 10% of the financing. 

The SBA describes the typical structure as follows: 

	Standard Financing Structure	New Business OR Limited or Special Purpose Property	Both New and Limited or Special Purpose Property
Third party lender	50	50	50
CDC/SBA	40	35	40
Borrower	10	15	20

In no case can more than 50% of the total project cost come from the Federal sources. The maximum SBA debenture amount is typically $5 million though there are a few exceptions (Small Manufacturers and Energy Eligible Public Policy Projects) that permit debentures of up to $5.5 million. (The minimum SBA debenture is $25,000.) 

A new business is one that has been in operation for 2 years or less at the time the loan is approved. A business that has been in operation (generating revenue) for more than 2 years at the time the loan is approved may be considered a  new business if it is a change of ownership that will result in new, unproven ownership/management and increased debt unrelated to business operations.

Limited or special purpose properties may include bowling alleys, funeral homes, gas stations, car washes, nursing homes, golf courses, wineries and more. 

The borrower’s contribution doesn’t have to be all in cash. Equity in land previously acquired or equity in land and buildings that will be part of the project may be part of their contribution if, for example, the business is adding a new building to the same property. 

What is a debenture? A debenture is an obligation issued by a CDC and guaranteed 100% by SBA, the proceeds of which are used to fund a 504 loan. In other words, it’s the funding mechanism for the SBA/CDC portion of the loan.

What is a CDC lender? 

Thanks to the pandemic, many of us associate the term “CDC” with the Center for Disease Control. But here CDC refers to a Community Development Corporation, which is a non-profit focused on supporting struggling communities. Similar to other SBA loan programs (except disaster loans), the business owner who wants to apply for one of these loans must work with a participating lender; in this case a CDC lender approved by the SBA. (Note, you’ll sometimes see a CDC referred to as a “Community Development Company.” In addition, a few for-profit CDCs have been grandfathered into this particular program.)

The SBA approves CDCs that participate in this program and requires them to adhere to its guidelines.

SBA 504 CDC loan requirements 

Businesses that apply for an SBA loan must meet a number of requirements, including that they: 

• Be a for-profit business located in the U.S.;
• Meet SBA small business size standards for their industry;
• Meet a “credit elsewhere” test which essentially means the business cannot get similar financing elsewhere;

Certain types of businesses are not eligible for these loans, including businesses engaged in legal gambling, pyramid schemes, life insurance companies (though life insurance agents may be eligible), those involved primarily in lobbying or speculative businesses, apartment buildings and mobile home parks and others are generally ineligible. 

A background check will be required for all owners with at least 20% ownership and certain criminal records may disqualify the applicant. If an owner has caused a prior loss to the government (an unpaid federal tax lien not in a repayment plan, for example, or a defaulted student loan not in rehabilitation) the application may be rejected. Lenders must use a system called the Credit Alert Verification Reporting System (CAIVRS) to identify delinquent federal debt and/or prior loss. 

Financial Requirements

When it comes to a 504 loan application in particular, the lender must evaluate the cash flow of the applicant as the primary source of repayment, and not rely on the liquidation of collateral to evaluate the application. Lenders must review, among other things:

• The pro forma balance sheet which must include the loan proceeds, use of the loan proceeds, and any other adjustments such as required equity injection or stand-by debt.
• A financial analysis of the ability to repay the loan based on historical income statements, tax returns (if the loan is for an existing business) and a minimum of 2 years’ projections.
•  A ratio analysis of the financial statements including comments on any trends and a comparison with industry averages. 
• Description of the owners’ and managers’ relevant experience in the type of business and any experience the CDC has with that business.  
• An analysis of the collateral, including an evaluation of the collateral and lien position offered as well as the liquidation value. 
• The applicant’s credit history— both personal credit of the owners— and the business credit of the business. There is no minimum credit score required but most lenders have minimum credit score requirements of 650-680 or more. Credit reports are only required for the small business that is applying and owners and affiliates who are guarantors. (Credit reports are not required on non-guarantor affiliates.) 
• Other relevant information (for example, if the application involves a franchise, the success of the franchise).

The business must be current on all federal, state and local taxes, including but not limited to income taxes, payroll taxes, real estate taxes and sales taxes. 

It’s also important to note that individuals who own 20% or more of the business must provide an unlimited full personal guarantee. Spouses may have to sign a guaranty as well if they own at least 5% of the business (and their ownership with their spouse’s totals at least 20%). A non-owner spouse, must sign off on appropriate collateral documents.

Economic Development Objectives

To qualify, the business must meet at least one economic development objective which may include job creation or retention; energy savings, sustainability or renewable energy; assist businesses adversely impacted by a base closing and other specific situations. 

Generally you can’t use one of these loans to relocate out of a community if that means a net reduction of one-third of its jobs or a substantial increase in unemployment in any area of the country (with a few exceptions.)

If you want to use one of these loans to acquire or renovate a property, it must be at least 51% owner-occupied. However, for new construction the requirements are steeper: you must occupy at least 60% and work up to 80% occupancy over ten years. For that reason, it’s not designed for buying a property that will be primarily rented out to others for a profit.  

If you rent your business location and are using the 504 loan to acquire fixed assets, keep in mind that an assignment of lease and Landlord’s Waiver must be obtained either when a substantial portion of the loan proceeds are to be used for leasehold improvements or a substantial portion of the collateral consists of leasehold improvements, fixtures, machinery, or equipment that is attached to leased land or premises. The waiver may be a stumbling block to getting one of these loans. 

Missed out on PPP & EIDL? Nav can connect you with small business loans right for your business.

The loans themselves work like property loans, and a down payment is generally required. Unlike longer mortgages, however, which can be repaid in 30 years, the SBA loan terms for the 504 program are between 10 and 20 years. You can imagine that makes for some pretty large payments! 

Can a borrower use the 504 proceeds as a disaster loan? A qualified purchase of real estate or fixed assets may be a good fit for the 504 program, but don’t discount loans given to those in qualified disaster areas. These loans are often easier to qualify for and have more generous loan terms. 

CDC Loan interest rates

Interest Rate: The interest rate for 10, 20, and 25 year 504 debentures is based on market conditions for long-term government debt at the time of sale (in other words, the sale of these debentures to investors.) Rates are attractive but the formula is complicated. You can get more information on the current 504 rates here. The portion of the loan made by the third party lender (the bank or other financial institution) will have its own interest rate. 

There are a number of fees that may be charged, including a processing fee, closing fee and underwriter’s fee. Fees are typically rolled into the loan which means you’ll ultimately need to repay them. So be sure you understand the total cost! 

You may prepay a 504 loan in full (not partially). Borrowers who prepay during the first half of the term of the 504 Loan must pay a prepayment premium, which is similar to a prepayment penalty in different terms. (There is a specific formula. Your lender can provide you with details.) 

SBA 504 loan pros and cons

Their most notable perk is that, if you qualify, you can access higher loan limits at a lower cost when compared to many conventional loans.

A major drawback of the program, however, is that a large loan requires more documentation and a better credit rating than smaller loans. There’s also a long time between your initial application and final loan closing. It’s not quick money, and it’s not available for most non-profit corporations.

When to use SBA 504 loans, and when not to use them

If you need a large loan to purchase property or other fixed assets for your business or to expand and a traditional bank loan is not an option, a 504 loan may fit the bill. It gives you access to large amounts of cash and is designed for property, machinery, and other expensive, long-term assets. If you plan on using loan proceeds for working capital, however, the SBA 7(a) loan is a better fit. 

You’ll also be discouraged by the 504 process if you need cash quickly. This is not the option for those looking for fast loan funds to help with operating expenses. Instead, try the express version of the SBA 7(a) loan program, which is made to streamline the application for a much simpler application process and a quicker outcome and possible road to working capital (just one to two months from start to finish.) 

Likewise, if you only need a very small amount of cash financing – something along the lines of tens of thousands of dollars – or you are a start-up business, an SBA microloan is more appropriate. Note that not all banks that offer the 504 loans are microloan or express loan providers. Finally, if you aren’t going to be using the property you buy or renovate primarily as a place for your business, but choose to rent it out to others, you won’t qualify for the SBA 504 loan. There are certain industries that SBA 504 lending partners won’t give money, too, as well – and these can vary by lender. SBA 504 loan proceeds can be used for debt refinancing only in very limited circumstances.

SBA 504 loan companies

There are a limited number of SBA-approved CDC lenders who can make these loans. In addition, there are non-CDC lenders who partner with CDCs to make these loans.These three lenders have a good reputation for making the SBA loan application process simple, however, and are accustomed to the cumbersome paperwork and documentation requirements that 504 financing requires. Since they do SBA loans often, they can guide you through the process and help you avoid common pitfalls when putting your application package together. 

SmartBiz

While not participating in the 504 program, this company facilitates loans of up to $5 million to qualified businesses through the SBA 7(a) program to be used for commercial real estate. The loan rates are variable, ranging from the Prime rate, plus 1.50% to 3.75%. Small business owners get between 10 and 25 years to repay the loan. 

Additional eligibility requirements include a two-year minimum business history, personal credit scores of 660 or higher, sufficient business and personal cash flow that can be demonstrated by three years of tax records and financial reports. As part of the SBA program, the applicant must also be free from delinquencies or defaults of any previous government or SBA loans. The prequalification process can be done online, with only a soft pull on your credit report, which won’t affect your score! 

Celtic Bank

Celtic Bank is a trusted partner in the SBA 504 loan program, offering this popular real-estate loan as one of many financing options available. They offer loans of up to $10,000,000 at a term of up to 25 years. Like all banks, they require collateral for loans of this size, accepting commercial real estate, equipment, and machinery as security for repayment terms. 

Their loans come in both fixed rate and variable options, depending on your credit history. They require applicants to be owner-operated and for-profit companies, as dictated by the SBA; their financing isn’t available to convenience stores, gas stations, or hospitality businesses, as well as any non-profit organizations. 

Wells Fargo

This private lender handles many SBA 504 loan applicants throughout the year, and they have favorable terms for a variety of businesses. Loans are given to those looking for longer-term financing who have a tangible net worth of under $15 million. They prefer businesses with an average net income of below $5 million, as well. Borrow up to $6.5 million for the Wells Fargo portion of the loan (the other portion comes from the CDC.) Get up to 20 years to repay real estate and 10 years for machinery or equipment. Pay lower loan fees than some other financing options on your fixed or variable-rate loan.

• Be a start-up, newly established, or growing for profit small business concern or, a non-profit child care center.
• Qualify as a small business under SBA size standards. 
• Cannot be in an ineligible industry (similar to 7(a) requirements).
• Must be a U.S. citizen, lawful permanent resident or non-citizens lawfully in the U.S. with a work permit.