SBA 504 Loans

Get to Know SBA 504 Loans

Gerri Detweiler • March 15, 2022

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How Do 504 Loans Work?

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 the 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: 

Lender	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, specifically 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.

How to Get a 504 Loan 

The best way to start your search for one of these loans is to connect with a CDC lender with significant experience in 504 loans. Thanks to the pandemic, many of us associate the term “CDC” with the Centers for Disease Control. But here, CDC refers to a Community Development Corporation or Community Development Company, which is a non-profit organization focused on supporting businesses that may have trouble getting access to capital.

Similar to most other SBA loan programs, these loans are not made by the U.S. Small Business Administration. Instead, the business owner must work with a participating lender; in this case a CDC lender. In addition, a few for-profit CDCs have been grandfathered into this particular program. (Currently Disaster Loans are the only loans business owners apply for directly at SBA.gov.)

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

The CDC lender can help you identify lenders for the private lender portion of the loan. CDCs who do a significant number of these loans will have a network of lenders who can work with borrowers in different industries and with different qualifications.

What Can You Use an SBA 504 Loan for?

CDC loans are most often used to acquire real estate. Businesses may use SBA 504 loans to purchase real estate and fixed assets, as well as to improve or renovate real estate and fixed assets to be used in the business. Specifically, SBA guidelines describe these acceptable uses:  

• Acquire land (by purchase or lease) as part of an eligible project;
• Improve a site (e.g., grading, streets, parking lots, landscaping) including up to 5 percent for community improvements such as curbs and sidewalks;
• Purchase one or more existing buildings;
• Convert, expand, or renovate one or more existing buildings;
• Construct one or more new buildings; 
• Acquire (by purchase or lease) and install fixed assets;
• Refinance certain outstanding business debts; and/or
• Finance a Lender’s Other Real Estate Owned (OREO)

504 loans may be used to refinance certain commercial loans for owner-occupied properties, including SBA loans. Cash out of up to 20% of the appraised value may be available. This has made these loans very popular recently as businesses have used 504 loans to refinance with low, fixed-rate loans and access funds for working capital or business growth at the same time.  

The SBA guidelines also describe ways funding from these loans may not be used, and in the case of real estate, they may not be used for iInvestments in real or personal property acquired and held primarily for sale, lease, or investment. There are occupancy requirements that must be met, depending on whether the loan is for an existing property or new construction.

How to Qualify for an SBA 504 Loan 

Businesses must meet a number of qualifications to get a 504 loan, 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. 

In addition to these general small business requirements stated, there are some specific requirements the business must meet.

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 lenders may have minimum credit score requirements. Credit reports are only required for the small business owner 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. 

The loans themselves work like property loans, and a down payment is generally required. Unlike consumer mortgages that usually have 30 year terms, the repayment periods for the 504 program are typically for 10, 20 or 25 years.  

CDC Loan Interest Rates

There will be two interest rates on these loans. One is the interest rate for the CDC portion of the loan and the other is for the portion of the loan made by the third party lender (the bank or other financial institution). The interest rate on the private lender portion will vary and may in part be based on borrower qualifications.

For the CDC portion of the loan, rates are attractive but the formula itself is complicated. 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.) Find current 504 loan rates here.

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

You can prepay a 504 loan. 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.) There is no prepayment penalty to pay it off early in the second half of the loan.

SBA 504 Loan Pros and Cons

If you need a large loan to purchase property or other fixed assets for your business or to expand, a 504 loan may fit the bill. You may also be able to use a 504 loan to refinance other commercial loans. You’ll get  access to larger amounts of funding for property, machinery, and other expensive, long-term assets. The most notable perk is that, if you qualify, you can access higher loan limits at a lower cost and smaller down payment compared with many conventional loans.

A major drawback of the program, however, is that a large loan often requires more documentation and a better credit rating than smaller loans. It may also feel like you’re waiting 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 Consider Alternatives to SBA 504 Loans

If you need a loan primarily for working capital, the SBA 7(a) loan is a better fit. 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, a SBA Microloan or SBA Small Loan may be more appropriate.

You’ll likely 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 SBA Express Loan, which is made to streamline the application process and provide a quicker decision for working capital needs. 

Finally, if you aren’t going to be using the property you buy or renovate primarily as a place for your business, but want 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 Companies

A limited number of SBA-approved CDC lenders across the country can make these loans. In addition, there are non-CDC lenders who partner with CDCs to make these  loans. The following lenders have a good reputation for making the SBA loan application process simple and are accustomed to the 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.

TMC Financing

Consistently a top 5 CDC making 504 loans California, Nevada and Arizona, TMC Financing is currently the number one 504 lender in the U.S. Specializing in these loans since 1981, it has extensive experience helping businesses successfully navigate these loans. In addition to making the CDC portion of the loan, it has myriad lender contacts to help business owners find the right lender for the private lender portion of the loan. Its website also offers helpful information for prospective 504 borrowers.

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. 

CDC Small Business Finance Corp

CDC Small Business Finance Corp is a mission-driven top five 504 lender serving businesses in California, Arizona, Nevada and Michigan. It also offers alternative commercial loans in California, and credit blind loans for entrepreneurs of color in Detroit among other products.

Wells Fargo

Wells Fargo is often on the list of top SBA lenders nationwide. Its 504 Loans are available to those looking for longer-term financing and that have a tangible net worth of under $15 million as well as an average net income of below $5 million. The maximum loan amount is $6.5 million for the Wells Fargo portion of the loan and up to $5 million for the portion from the CDC. Get up to 25 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.

SmartBiz

While it does not participate in the 504 program, SmartBiz 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.