If you’re considering getting a commercial loan to purchase or renovate a building for your company, the U.S. Small BusinessAdministration’s (SBA) 504 Loan Program could be a viable option.

“We call it the ‘Smart Choice Commercial Loan’. It’s also known as the 504 loan,” says Chris Hurn, President of Mercantile Commercial Capital, LLC.

On the SBA website, the 504 loan is touted as providing small businesses with long-term, fixed-rate financing and interest rates that are favorable to bond market rates.

To be considered a small business, SBA requires that the business have a net worth under 7 million and the net profits, after taxes, less than 2.5 million. The loan, among other things, can be used to purchase commercial real estate—renovations, land and improvements including: grading, fixing streets, utilities, and parking lots. It can also be used to construct new facilities, modernize, renovate, or convert existing ones.
Hurn calls this type of loan the industry’s “best-kept secret”. “It is 90 percent loan-to-cost. That’s very different from what most banks will do in the commercial world. Most banks will do anywhere from 70 to 80 percent loan-to-value,” says Hurn.

Hurn says the difference between loan-to-cost and loan-to-value is significant. He says, “the purchase price or the appraised value (whichever is less) when you’re financing loan-to-value is used. However, when loan-to-cost is used, “We actually take a look at the total project cost and whatever that number is, we finance 90 percent of it, in most cases,” explains Hurn.

That means things such as architectural and engineering fees, renovation expenses, other costs related to the project, and closing costs are being wrapped into the loan-to-cost and 90 percent of that total cost can be financed. This helps to reduce the out-of-pocket costs to the commercial buyer.

“It’s a huge advantage in that the down payment is usually half to a third of what ordinary commercial banks are requiring for a conventional loan,” says Hurn. He adds, “We’re actually financing more of the total project costs to the business owner/entrepreneur.”

The SBA website states, “A typical 504 project is structured with fifty percent of the project costs provided through a private-sector lender. This senior loan is usually for a 10-year term at a fixed or variable rate, depending on the relationship with the lender. Forty percent of the project costs are financed with a fixed-rate debenture secured with a junior lien from a SBA Certified Development Company (CDC). The debenture is backed by a 100 percent SBA-guaranty. And the final 10 percent of the project cost is provided by the purchaser.”

Hurn says that is yet another reason he really likes this loan program. “It is actually a bond that’s placed on Wall Street every single month. About 300 to 400 million dollars- worth of these bonds are sold every month on Wall Street. It’s a second mortgage on owner-user commercial property and because it has the government guarantee on it, the investors of these bonds … will accept a lower yield on these bonds than they would for corporate junk bonds, for instance. That yield the investors are getting is effectively the interest rate that the borrowers for [the SBA 504] program are paying,” says Hurn.

“This interest rate on the second mortgage of these 504 loans is the least expensive financing that small business owners can get in the market for commercial real estate. It usually averages between 100 and 150 basis points below ordinary bank financing—not only that it’s fixed for 20 years but in the commercial real estate world it is very difficult to get fixed-rate money for longer than 10 years,” says Hurn.