This article is part of an ongoing series designed to walk those newer to the industry though ground-level finance basics.
The Small Business Administration (SBA) is a federal agency dedicated to providing small businesses with support and resources, helping to provide funding important to the aspiring hotel owner. While the SBA itself does not lend any money, they provide certain guarantees to lenders who provide funds to small businesses in accordance with strict guidelines. The following isn’t exhaustive but is meant to provide insight into the process.
The SBA’s loan programs exist to provide funds for small businesses that wouldn’t otherwise be able to find financing. Anyone hoping to use SBA financing to secure a hotel must understand the SBA’s “credit not available elsewhere” requirement. Basically, the borrower’s net worth and income have to be small enough that the SBA believes that borrower wouldn’t readily find financing through alternative means.
Specifically, the borrower’s net worth is not to exceed $15 million, and the average two full fiscal year net income is not to exceed $5 million. If a group of investors come together to purchase a hotel, the same rule applies. Occasionally, when borrowers with some assets combine their resources to acquire a hotel, those combined resources can exceed the “credit not available elsewhere” test. This in itself may result in disqualification for an SBA loan and force a borrower to seek more conventional financing. It’s important to work with a lender or mortgage banker with SBA-program experience, as that person will help the borrower navigate the very specific requirements for SBA loans.
KNOW YOUR ROLE
The next thing to know about SBA loans is that personal guarantees will be required for all owners with a 20% or more share. This personal guarantee means that if the investment falls apart – like, say, a global pandemic shuts down the hotel – the borrower remains personally liable for the loan payments. Legally, the lender can collect the value due from the personal property of the borrower.
There are limitations to this and, as the pandemic made clear, many lenders don’t want to foreclose on loans and would prefer to make alternative arrangements with their borrowers. However, the purpose of this article is to educate the novice investor as to certain fundamentals of SBA loan programs. It’s better to know these things going in than to find out after the fact.
Next, it’s important to understand the basic parameters of the SBA 504 loan program, the most common form of hotel financing. Every 504 loan has two lenders holding separate pieces of the loan. Certified development companies (CDC) are nonprofit corporations certified and regulated by the SBA to package, process, close, and service 504 loans. The only thing CDCs do is issue debt on 504 loans. They typically fund 40% of the loan. The SBA sets the interest rate that CDCs charge as CDCs have no discretionary control over the interest rate.
The CDC portion of the loan will have a long-term fixed rate. The interest rate may differ slightly based on how long of a fixed term the borrowers get for that 40% portion of the loan. Because the term is typically fixed for a longer period, the CDC portion will also have a pretty steep prepayment penalty.
BREAK IT DOWN
SBA loans are attractive to borrowers mainly because of the low down-payment requirements – potentially as low as 10%, but that may be slightly higher for a hotel loan. With 40% from a CDC and 10% from a borrower, that leaves 50% of the financing to a bank in most situations, but there are exceptions. The lender considers their exposure limited on an SBA loan, as they’re financing a smaller portion of the loan. The lender will offer a shorter term for their part of the loan and the interest rate may be fixed or adjustable.
There will be some additional fees with every SBA transaction, and it helps to know what to expect. If using the services of a mortgage banker, there will be a fee. The CDC will be charging a processing fee, and the lender may charge certain fees, such as an underwriting fee, or a commitment fee. Much of these likely will be rolled into the loan amount and paid during the life of the loan.
Additional fees to expect include an appraisal report, environmental reports, title and escrow, and attorney fees. Thirdparty reports are paid outside of the loan, and funds typically will be collected for these purposes at the time of loan application. Sometimes borrowers try to save funds by using previously completed thirdparty reports, but lenders typically require the reports to have been completed within the last six months of the transaction.
There are a lot of moving pieces with any commercial real estate loan, and with SBA loans in particular. It helps to have a guide to navigate the process. The services of a reputable mortgage banking firm can transform This article is part of an ongoing series designed to walk those newer to the industry though ground-level finance basics. a difficult and complex process into a simple and easy one. Whether a borrower chooses to utilize a mortgage banker or go it alone, it’s important to understand the basic outlines of the SBA 504 program.