FEATURE ARTICLE, OCTOBER 2008

SMALL LOANS, LARGE STIMULUS
Lenders can access small-business loans, such as the 504 loan program, that can help the struggling economy.
Christopher G. Hurn

Images of foreclosure notices and long lines of customers waiting to withdraw their savings from troubled banks will certainly help mark this year as one of the roughest years for the financial services industry since, arguably, the Great Depression. Real estate lending in particular has seen steep declines for both residential and commercial properties.

But there’s an interesting and noteworthy exception to the decline in real estate lending that has gone relatively unnoticed, and it is taking place in the small-business sector. Small businesses are one of the key drivers for the recovery and the growth of our national economy. Believe it or not, this bright spot comes from none other than the oft-maligned U.S. Small Business Administration (SBA). While most SBA loans are down significantly, reflecting the overall decline in lending, the federal agency’s loan program that enables businesses to buy or enhance their own commercial real estate is actually posting some surprising results. The 504 loan program is down by a mere 3 percent from last year in the SBA Southeastern region.

The reasons behind the surprising performance of this underutilized loan program in the Southeast during today’s challenging lending climate illustrates the problems that have plagued it for years in these markets. While the loan program has been widely accepted and promoted by banks and lenders on the West Coast and Midwest, where 504 loans are now down from 5 to 22 percent as a reflection of the overall market, the majority of the major East Coast banks and lenders have not embraced the loan program. The 504 loans are not as profitable for banks as conventional commercial real estate loans or even the larger SBA 7(a) lending program, and borrowers who would be better suited with a 504 loan have been sold other financing options by lenders.

The lack of financial incentive for the banks and commercial lenders to promote and use the 504 loan program caused it to go underutilized since its inception. Every year, more than $1 billion of available 504 loan program funds goes unused. For fiscal 2007, the program had $1.2 billion left for loans that went unused by borrowers. Unlike the 7(a) program, which is also oftentimes offered by lenders over the 504 to the detriment of the borrower, the 504 program has never approached its funding limit.

How it Works

The 504 loan covers 90 percent of the total project cost, opposed to the 70 to 80 percent offered with conventional commercial loans. The typical breakdown of the funds in a 504 loan is 50 percent from a bank or other private lender, 40 percent from the SBA and only 10 percent from the borrower.

Business owners can reduce their initial capital outlay by as much as $1 million in some circumstances by leveraging the 90 percent loan-to-cost financing that the loan program offers. This lower down payment makes it possible for business owners to afford the initial capital outlay for their acquisition or construction project without disrupting their operations. The 504 also enables the borrower to include renovation, closing and other soft costs along with furniture, fixtures and equipment into the financing package.

The portion of the 504 loan that is funded by the SBA represents the least expensive financing available in the commercial mortgage industry for small businesses—6.78 percent (fixed for 20 years) as recently as August 2008. The blended rates for the entire loan are often significantly lower than those of conventional loans and can be fixed for the duration of the 20- to 25-year amortizations. In addition, borrowing from the SBA 504 program does not preclude business owners from also applying for funding from the SBA 7(a) program for working capital, inventory and other needs. The average 504 loan is for approximately $500,000, but projects can range from $200,000 to $20 million.

504 loans are available to almost any type of for-profit small and mid-size business in the United States. Exceptions include financial services providers, passive real estate investors, companies having a tangible business net worth greater than $8.5 million, or companies with net profits after taxes that averaged more than $3 million during the past 2 years. As an SBA lending program, the 504 loan requires applicants to demonstrate job creation, export potential, or other economic-development or public policy goals. These goals are easily met for the vast majority of applicants. The funds must be used for capital expenses, including land, buildings, construction and equipment. Owner occupancy requirements are 51 percent of the total square footage for acquisition loans and 60 percent for new construction financing. Multiple businesses are able to jointly pool 504 financing if they meet occupancy requirements. The loans require the same amount of documentation and due diligence as ordinary commercial loans, and approval processes are also comparable to conventional loan processing.

Changes Ahead

Congressional leaders have taken notice of the decline in SBA lending and what it portends for the national economy. The Small Business Lending Stimulus Act, which is currently being debated in the Senate, would reduce fees for SBA loans and open the 504 loan program for borrowers to refinance out of higher-interest conventional loans. This legislation appears lost in committee for the foreseeable future. Its components, particularly those relating to the 504 program, could potentially do more for the economy than the bailout projects that were recently crafted. By opening the 504 loan program to refinances, thousands of small-business owners across the country will gain access to loans that are substantially better than even the most competitive conventional loans for commercial real estate. By significantly lowering their monthly commercial mortgage payment, business owners can use the funds to add employees and resources to grow their businesses and, in turn, fuel our national economy. Lenders have yet to notice that this simple solution can have an immediate impact and cost the government virtually nothing.

It will take more than the refinance option and a slight reduction in loan fees, however, to enable the loan program to reach its ultimate potential. Small-business owners nationwide need to be made aware of this option for owning rather than leasing their space. The savings in interest payments as well as in the 504 loan’s substantially lower initial downpayment requirement are significant, but the greater long-term benefits stem from owning commercial property that can continue to generate income even after a business owner retires.

The loan program’s benefits can only be effectively promoted by the banks and lenders that business owners first turn to for commercial real estate financing. These financial institutions must become more willing to work with small-business owners and the SBA to generate greater awareness and usage of the loan program. The entrepreneurial spirit that drives the small-business economy must be rewarded if we are to have continued growth. Programs like the 504 create wealth for risk-taking small-business owners who owe their success to both their aspirations and their acumen.

Christopher G. Hurn is the president and CEO of Orlando-based Mercantile Commercial Capital.

©2008 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.