By Bruce Hurta
Small business owners sometimes face challenges with financing single-purpose (or special-purpose) real estate from which they operate their businesses. The reason is because of the limits a special purpose design places on the marketability and value for the lender in the instance of a foreclosure on the property. Because collateral is offered by a borrower to enhance the lender’s chance of recovery on the loan if the borrower defaults on payments, marketability of the collateral can detract from the quality of the loan application for the lender’s approval. The SBA government-guaranteed loan program for small businesses is a suitable alternative for small businesses seeking the best financing for their small business property. Because an SBA loan is classified as a business loan, rather than a real estate loan, the lender tends to rely more upon the financial performance of the business and the credentials of its owners than it relies upon the value of the collateral. The U.S. Small Business Administration makes it very clear that the SBA loan program is not a collateral-driven loan program. While offering valuable collateral is helpful in gaining approval for an SBA loan, collateral is not always required to approve an SBA loan.
Examples of single or special purpose properties include, but are not limited to the following:
- Preschool and child daycare facilities
- Gas stations, truck stops, and convenience stores
- Car washes
- Assisted living and nursing facilities
- Skating, bowling, and other entertainment venues
As you can see from this short list of specialized facilities, they are designed to primarily accommodate only one type of business. For another type of business to operate there, additional construction costs and expenses would be required to modify the facility. Potential buyers, in the case of a foreclosure, would be limited by this condition. As a result, some banks and other types of lenders will require higher down payments and stricter underwriting guidelines for financing special purpose properties.
This condition, among other challenges faced by small business borrowers, is one of the reasons the SBA government-guaranteed loan program exists. The partial government guaranty, which the lender receives for originating an SBA loan, allows the lender to assume more risk in the transaction. As a result, SBA loans provide lower down payments, longer repayment terms, and easier qualifying criteria than conventional bank loans. The small business owner, who might have been precluded from real estate ownership due to more restrictive guidelines for single-purpose properties, is often now able to enjoy the benefits of small business real estate ownership. Those benefits can include:
- Eliminating business risk caused by future rent increases or non-renewal of a lease
- Owning improvements made to the property rather than giving them to the landlord
- The opportunity to build equity in an asset over time by paying down the principal balance on the SBA loan and realizing market increases in the value of the property
- The possibility for future rental income if the business is sold and the real estate is retained
In the final analysis, an SBA loan will be approved based upon evaluating the following five criteria:
- Business cash flow
- Business owners management experience
- Business and owners credit record
- Amount of owners’ equity in the business
- Collateral offered for the loan
With an SBA real estate loan, the four offsetting factors above help mitigate the risk of taking special purpose real estate as collateral, and these four criteria can help the SBA lender accomplish loans which conventional bank lenders might not be able to offer.
You can learn more about SBA lending and small business finance on Bruce’s blog at brucehurta.wordpress.com. For more information about SBA real estate loans for small businesses, contact Bruce Hurta, Business Lending Manager at Members Choice Credit Union, at 281-384-2595 or by email at [email protected].