Can you buy a property with 10-15% down payment? What are SBA loans? Which asset classes qualify for an SBA loan? Can you get working capital on your loan? What kind of real estate investments can you buy with an SBA loan? Is there a prepayment penalty? Can an SBA loan be fixed or variable? Can an SBA loan be assumable? Can the SBA be a second loan on a property? Anne Mino, Senior Loan Officer at LiveOak Bank, shares her knowledge.
Tell us a little bit about yourself.
I am a senior loan officer at Live Oak Bank on our self-storage team. My whole team (there are five lenders, underwriters, closers, and a credit team), all we do is eat, sleep, and breathe self-storage loans. I've been with the bank for about 12 years, and I've been a lender on the self-storage team specifically for about five years. I do consider myself an industry expert at this point, and I love educating people, trying to make access to capital easier, and debunking myths that are out there about financing being difficult to obtain.
SBA is such a great opportunity, especially for people getting started, and some people may not know that this is a huge opportunity. What are SBA loans, and why do they matter?
The Small Business Administration (which is what SBA stands for) is a loan program that was established back in the early 1950s. The entire purpose of it is to help entrepreneurs access capital financing that they may not otherwise be able to qualify for through traditional channels, so through conventional lending and the primary benefits are lower down payments. Think of a 10% down payment, instead of 30 to 40%, which you might see in a conventional loan, and longer repayment terms. For anything that has commercial real estate involved, it is automatically on a 25-year term with competitive interest rates, and then it's easier to qualify. You don't have to have experience in your subject field. In other words, in the self-storage world, if you don't own self-storage. That's perfectly okay, and that's why the SBA enables us to do these loans to anybody who needs them.
We do have one with a 10% down payment. It's a little more painful to get, but nothing compared to CMBS loans, which everybody hates, but the numbers do have to work out the debt service. Please elaborate on the debt service and what the requirements are.
These loans are considered cash-flow-based loans. In other words, we want to see that the cash flow of the business can support the debt. For example, if you're just looking for a land loan, and there is no business attached to it, that's not something that we could do under this loan program. But as long as there's a business attached to it, we're looking at the debt service coverage of that business to pay back the debt. In an ideal world for self-storage, we want to see that in year one, the business can reach 1.15 debt service coverage, which essentially means the business is making its loan payment and then about a 15% profit. And then we want to see it steadily go up from there, and we're very lucky in the regard that we can use a borrower's projections that they've put together to tell us what they're going to do with that business.
As you're aware, in self-storage, there are a lot of turnaround projects, so there may be facilities that are under-occupied, and maybe the owners haven't raised rates in a long time. I don't have to use their numbers necessarily when I'm looking at debt service coverage. Of course, I do want to see what they're doing, but what I care more about is what the new owner is planning to do with that business. And I can base a loan on that increased occupancy, increased rental rates, and then lower expenses.
That is what our situation was. We had found a deal that the owner hadn't raised rent for a while, and you looked at the actual market rent rates, which was incredibly helpful. We also got the ability to grab a few $1,000 to improve the property, which we didn't need at the time. Can you elaborate on that as well?
In general, when we're putting a loan together, we want it to include everything that the business needs. Your total project, which is potentially your 10% equity injection, is going to be your purchase price plus your closing costs, your SBA guarantee fee, and your working capital. So we can give you an extra $300,000 if you need anything. If you're going through and creating a new website, new signage, maybe you're paving, maybe you're painting doors, maybe there's new roofs that are needed, all of that can be funded inside of your loan, as long as it meets the debt service coverage that we talked about just a minute ago so that working capitals can be critical to getting a business up and running and making all the changes that you want to implement. It's a great aspect of this loan.
I believe ours was one year interest only, so that gave us the chance of raising the rents. And it gave us enough time to be able to afford the fully amortized loan.
The lender can bake in an interest-only period if it seems appropriate, as well as give working capital. I like to give my customers the capital up front and maybe do less of an interest-only period simply because it's going to help you pay your debt off faster. But for properties that are a true turnaround, where they're under-occupied, if you need that time, that's easy for the lender to make that decision.
It's really important when you are trying to obtain an SBA loan to find a preferred lender under the SBA loan program. What a preferred lender means is that it's their capital, and it's their credit decision. They don't have to go to the SBA 7(a) program and do what I call asking permission. It's going to be a faster loan process, and you're going to get the expertise that you're expecting under that preferred lender. SBA has certain lenders out there that are the best at what they do and give us the ability to make credit decisions and improve loans without having to get SBA permission.
Would they go to the SBA websites and search for a preferred lender?
Yes, you can go to the SBA website and look for preferred lenders. Live Oak Bank will come up, and that's who I work for. There are other SBA lenders out there, but you want to make sure your lender understands your industry as well. That would be one of the first questions I would ask the lenders. If you're looking for a self-storage loan, how many self-storage loans have you done?
Can SBA do loans for any asset class in real estate?
Yes, as long as it's a cash-flowing business and it must be owner-occupied, not retail, office, they're non-applicable. If you're a veterinarian, let's say you buy a strip center, and it owns some other real estate, it is okay as long as 51% of that strip center is going to be used by your veterinary practice. Same thing with storage. Let's say you had a storage facility, and there was another retail component on the property. That's fine, and still SBA eligible, as long as the storage makes up more than 51% of the total square footage.
For offices, it's the same thing. I would have to occupy office minimum of 51% of my office building. And for multi-family, which is similar to self-storage because we are the operators, would we automatically qualify?
Multi-family does not, as they don't touch anything with residential real estate at all, even though multi-family is considered commercial.
Let's talk about prepayment and the rates. Are they variable? Do we have a choice?
You do have a choice. The rate is determined by the lender, and it's typically going to be dependent on the strength of the guarantors, the strength of the deal itself, and then the size of the loan. Those are the three parameters. I get calls all the time, and people will maybe throw an offering memorandum at me and say, "Hey, what would my rate be on this deal?" What I can give you, in concrete matters, is loan terms, and then the rate is again going to be determined by the lender based on those factors. In general, we base our SBA rates on the Wall Street Journal prime index. Just to give you an idea, Wall Street Journal Prime today is at seven and a half, so your rates are going to be seven and a half plus whatever spread the lender puts on top of that. It could be 25 basis points. It could be one point, and again, it gets determined during the underwriting process or the early stages when you start working with your lender.
Loan term-wise, it's standard across SBA loans. There are two types of SBA loans: 1) 7(a) is a 25-year, fully amortizing loan with no balloon payment. That's one of the big differentiators in this SBA loan program versus conventional. Most conventional loans are going to have a five-year balloon, so you're going to be forced to refinance or do something different with your debt at that five-year mark. These are fully amortizing, with no balloon payments and no calls or covenants. In other words, if you don't meet certain debt service coverage requirements in the first couple of years, the bank can't come in and take your property, which is also really important. Again, 10% down, as far as the prepayment penalty, is set by the SBA, and it's a three-year downward adjusting penalty. You would pay in year one; you'd pay 5% of your principal in a penalty, then it goes down to 3% in year two, and then 1% in year three. We don't often see our customers refinancing or selling in those first two years. It doesn't happen a lot, but I do have customers who sell their property in year three. They pay that 1% of the principal, and they're doing so because they're selling for such a good price that it's worth it to them to do that.
The 7(a) max is out at around 5 million. If you have a project over 5 million, that's kind of where we transition over into the 2) 504 product, which is a little bit different. Still, 25 years, fully advertising note, and can support projects up to 14 million. That's kind of a much larger deal size. Under that product, 35% of the loan is the SBA portion, and that portion is on a fixed rate for 25 years. That can be very attractive. The rate is historically lower than market rates. And today, the rate is, I think, 6.2, maybe 6.3. It does change, but it's historically much lower than others, and again, it's fixed for 25 years. If the acquisition is over 2 million, I'll present it both ways. I'll give out a 7(a) term sheet and then a 504 term sheet. And then we kind of look at them together and talk about pluses and minuses because there are advantages and disadvantages to the two programs.
On the 504 side, the way it works is that 50% is a traditional bank loan. Your rate and term are going to look very similar to what I quoted you on the 7(a) side, so a 25-year term. Rates are going to be Wall Street Journal prime plus a spread three-year prepayment penalty downward adjusting 35% is that SBA portion that's a fixed rate for 25 years, no balloon payment. And then, if you don't already own storage under the 504 program, the SBA asks for a 15% equity injection instead of 10%. That can be a disadvantage to the program and the reason why somebody may want to stick in the 7(a) world, but if you do own storage already, we can usually get away with a 10% equity injection on the 504.
Which one would be the first loan, primary, is it your bank, the 50%?
Yes, let's say it's Live Oak Bank. Live Oak Bank would be the 50% portion of the loan, and then the SBA 35% is behind us, and they are willing to subordinate. In the future, let's say you're unhappy with your rate. You can refinance the property, and the SBA will subordinate to the new lender. That's a really good feature, and it's also assumable. Let's say the property gets sold. They want to hold on to that 35% that's fixed at 6.25, let's say. It's assumable by the new borrower as long as they qualify for it. We can read that they're going to cash out our piece, pay us off, and the buyer can hold on to the SBA piece, which is very attractive.
I also wanted to highlight that conventional loans are typically 20-year loans, and these are 25, so your amortization is longer, and your payment is smaller, depending on the interest rate.
Absolutely, yes, good distinction.
Anne Mino
anne.mino@liveoak.bank
www.liveoak.bank