A relatively new extended-maturity loan option from the U.S. Small Business Administration is heating up the real estate market among small businesses that are anxious to purchase properties while the economy is booming and interest rates remain low.
In April 2018, the U.S. Small Business Administration announced changes to its 504 loan program to allow for a 25-year maturity on the debenture portion of the financing package. A 504 facility is structured in three parts: a bank loan for 50 percent of the amount being financed, up to a 40 percent debenture (or bond) that carries an SBA guarantee, and as little as 10 percent equity funded by the borrower. Previously, the SBA-backed debenture was available with 10- and 20-year maturities. Now that longer 25-year maturities are available, businesses can effectively borrow more funds.
That’s especially true now because interest rates are low and there is very little difference between short- and long-term rates — an unusual circumstance that is called, in financial parlance, a flat yield curve.
When the SBA announced the 25-year debenture a year ago, it said that businesses should expect there to be about a 65-basis point (0.65 percent) difference between the interest rate accruing on 20-year debentures compared to the new 25-year debenture. However, thanks to the flat yield curve, the actual difference has been far less than that, averaging less than 20 basis points (0.2 percent). For example in March, the 20-year debenture was priced at 4.586 percent while the 25-year was priced at 4.741 percent, a difference of only 15.5 basis points (or 0.155 percent).
The longer maturity and low rates mean that businesses can either borrow more funds or enjoy lower monthly payments than would be the case with the shorter, 20-year maturity. For example, in the case of a $1 million property purchase, the SBA would fund $400,000 of the purchase with its debenture, plus fees. Based on a 25-year maturity, the debenture would have a significantly lower monthly payment than would be the case with a 20-year maturity — $2,347 monthly under a 25-year term rather than $2,625 with a 20-year term.
Previously, businesses seeking a lower down payment and 25-year maturity on a real estate purchase were restricted to the SBA 7a loan program. SBA 7a loans do not offer the same low long-term interest rates as 504 loans, often carrying interest rates as high as prime plus 2.75 percent with regular rate adjustments. Additionally, the fees on 7a loans are typically higher since SBA dictates that banks collect a guaranty fee which is not negotiable.
In most cases, 504 loans are a good fit for businesses that have operated for two years or more and have adequate income to demonstrate the ability to repay the loan, but need a lower down payment in order to qualify for the loan. Funds can be used to purchase commercial real estate provided the owner will occupy at least 51 percent of the space, but it can also be used to provide permanent financing after construction or to buy other fixed assets such as factory equipment provided certain requirements are met.
Since the new 25-year maturity was announced, small businesses have been lining up for 504 loans. At my bank, we have seen applications from all manner of businesses, ranging from trampoline parks and climbing gyms to an auto repair business, a storage facility and even an architect’s office, to name just a few.
One recent example is Systems MD, an IT service and consulting firm that provides network and computer systems consulting services to a wide variety of business and governmental agency clients throughout New Mexico and Texas. Due to the company’s strong growth, Systems MD needed to hire more employees in order to continue to expand and meet client demand, but they were out of space in their current office building in Albuquerque.
So, they purchased a new building that had the extra space they needed, gave the space a refresh, and chose to utilize the SBA 504 25-year program to provide the permanent financing. For Systems MD, choosing the SBA 504 loan over a conventional bank option saved more than $115,000 in down payment; and the 25-year repayment option, saved them about $280/month when compared to the 504 program’s 20-year option.
Not only did they get the space they needed, the funds they saved on down payment allowed them to hire several additional employees to take on more client work. The result is a company that is providing more high-paying jobs in Albuquerque while providing valuable services to its client base, which is also growing.
With interest rates remaining at historic lows and the U.S. Federal Reserve has recently pressing the pause button on additional rate hikes, this is as good a time as any for small businesses to lock in their real estate financing for the next 25 years.