SBA vs. CMBS: Finding the right fit

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By RUSHI SHAH

For new construction and borrowers with only 10 percent to 20 percent to put towards a purchase or refinance, SBA loans are often the best or only option. However, once you have a few years of positive cash flow under your belt, or want the benefits of more sophisticated financing, an experienced intermediary can open the door to capital market financing options that insulate you and your property from future market changes and position you for ongoing success.

SBA vs. CMBS Underwriting
The key difference between an SBA-backed loan and a non-recourse CMBS conduit loan is both SBA 504 and 7(a) loans require all borrowers with 20 percent or more interest in the asset to personally guarantee the loan. Conversely, capital market lenders that combine loans into pools to be sold to bond investors on the secondary market as Commercial Mortgage Backed Securities (CMBS) focus on the asset. Except for “bad-boy carve-outs” that trigger in cases of fraud, CMBS financing eliminates the need for unnecessary contingent liabilities on your personal balance sheet that might prohibit your ability to add to or refinance your overall portfolio.

SBA underwriting scrutinizes your experience, credit background and global cash flow, and includes scrubbing three years of tax return data for both you and your property. SBA lenders prioritize your global cash flow in order to ensure you will have sufficient income from other sources to support the debt if your property’s cash flow comes up short. This is good for borrowers with satisfactory credit and solid sources of outside income, but bad for borrowers who have filed bankruptcy, defaulted on a government loan, lived beyond their means or who must direct all of the property’s cash flow to support the debt.

Conversely, CMBS underwriting evaluates how much net cash flow the property could generate if taken over by a third-party management company, and gives you credit for any one-time expenses, non-recurring expenses, extraordinary expenses and capital expenditures. It focuses on your property’s recurring cash flow, cost basis, location, quality, franchise agreement and overall ability to service the bond holders, and may even allow some past personal blemishes. Unlike SBA, CMBS loans also allow you to layer mezzanine debt to increase leverage, as well as free up any trapped equity in your property by taking cash out (typically tax-free, but consult your tax advisor).

Manage Risk and Increase Long-Term Cash Flow
Long-term, fixed-rate CMBS loans are typically paid down over 30 years, compared to 20 or 25 years for SBA loans. This longer amortization, combined with the ability to maintain today’s low rates for up to 10 years without recourse, equals lower payments and increased ongoing cash flow.

If you prepay your loan, CMBS bond investors want the same rate of return they would have received if you paid through maturity. As a result, the cost to prepay a CMBS loan is dependent upon interest rates at the time of prepayment and the pre-payment structure outlined in the loan docs. Virtually all SBA loans secured by real estate carry a prepayment penalty – for 504 loans there is a 10-year prepayment, while 7(a) loans carry a 3-year 5 percent, 3 percent, 1 percent step-down prepayment penalty.Unleash Borrowing Capacity

Because SBA financing is directly tied to you as a person, the amount you can borrow is capped. As a result, for many borrowers the winning strategy may be to use CMBS financing to create capacity for additional SBA financing – especially if you are building a new hotel and have no choice but to seek SBA debt. Paying off an existing SBA loan using a non-recourse CMBS loan not only creates SBA borrowing capacity for new projects, it makes your balance sheet look more attractive to other lenders (as there are no personal guarantees on the loans) and brings you to a new level of sophistication as a borrower.

For both SBA and CMBS loans, having an experienced intermediary quarterback your transaction can significantly streamline the transaction, shorten your time to closing and improve your results. ■

Rushi Shah is CEO at Conlon Capital, a commercial mortgage banking firm formed by a merger with Aries Capital, which specializes in CMBS and other non-recourse lending solutions. Over the past 26 years, the Conlon and Aries teams have collectively funded over $8B for hotel, multifamily and other commercial properties. Shah held previous positions at Northern Trust and is a member of AAHOA’s Founding & Allied Member Committee. Shah holds an MBA from The University of Chicago’s Booth School of Business.

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