By Noel Cain
When the governments Small Business Administration (SBA) announced self-storage as an approved property type for loans in the fourth quarter of 2010, it raised tremendous interest within the industry. Questions abounded regarding the details of the programs, and many potential borrowers wanted to know specifics.
There are two types of SBA loans available to the self-storage industry: SBA 7a and SBA 504. SBA 7a is a variable-rate program with a three-year prepayment penalty. Its designed for borrowers who:
- Have multiple uses of proceeds (real estate, equipment, working capital, etc.)
- Typically have a loan-to-value (LTV) in excess of 90 percent
- Want to refinance
- Have a shorter holding period
SBA 504 is a fixed-rate program that carries a rather steep 10-year prepayment penalty. Its borrowers typically have a long-term holding period and a single use of proceeds (real estate or equipment purchase).
In short, 7a borrowers are willing to take on interest-rate risk in exchange for proceed-use flexibility and additional leverage. SBA 504 borrowers sacrifice flexibility and have limited use of proceeds, but are able to secure long-term fixed-rate debt.
The process for acquiring an SBA loan is unknown to most self-storage borrowers. To better understand it, lets look at a real recent transaction to see what works, what doesnt and the factors that affect the outcome.
First, consider the basics of our case study. The transaction was an acquisition of a facility by a first-time owner. The total project cost was slightly over $1 million, and the borrower was required to put down equity equal to 25 percent, with the remainder financed through the SBA 7a program. The property is an older facility that has recently undergone a significant facelift, modernizing it with above-average technology upgrades including a sales kiosk.
The facility is in a secondary market in the Midwest, and while the borrower is not in the same city, he intends to make frequent visits to actively manage it. This active role of the owner is an important distinction in the SBA world, as the program is intended to fund small-business owners actively involved in their enterprise, not investors seeking passive income streams.
The loan was structured with a Prime-based rate that resets quarterly and a fully amortizing 25-year loan with a prepayment penalty during the first three years. This structure is fairly standard in SBA 7a lending. The borrower originally requested an advance rate of 80 percent; however, since he was a first-time owner and geographically distanced from the property, the lender required cash equity of 25 percent (75 percent LTV).
A unique characteristic of the SBA 7a program is the borrower is able to structure a small amount of working capital into the transaction. This ensures he has some additional funds to access for unforeseen expenses and acts as protection for the borrower and lender. In addition, the SBA 7a program allows capital for expansion, property improvement and debt consolidation, though this particular borrower did not take advantage of it.
Overall, the SBA loan program was a good fit for this borrower as it let him access a high level of debt considering his relative inexperience in the industry. To provide an additional level of credit support, he was required to pay down a portion of his personal debt and pledge a portion of the equity in his home as collateral. The additional structure protected the lender against perceived risks from a new owner while extending leverage thats somewhat uncommon in the current market, even for experienced owners.
The loan process took four and a half months from beginning to end, but there were some unusual occurrences that likely added four to six weeks to the transaction. Typically, 7a loans take a minimum of 90 days to close; but as with any loan, SBA or otherwise, its always prudent to allow up to six months from the start of the process.
Similar to that of other commercial loans, the documentation process involved with an SBA loan can be daunting. In this case, as in all SBA loans, borrowers were required to submit:
- Three years of personal tax returns
- Three years of business tax returns
- Personal financial statement
- Business debt schedule
- Authorization to release financial information
- History of business form
- Statement of personal history
- IRS form 4506-T
In addition, the standard, property-specific financials such as rent rolls and monthly profit-and-loss statements were also required. Hiring an intermediary will expedite the process and help ensure the proper documents are completed in a timely manor.
The underwriting for the SBA 7a process is similar to that of most bank loans. Lenders are focused on the viability of the property being financed and the financial wherewithal of the borrower.
The lender in this case wanted to ensure the subject property was able to positively cash flow on its own merit. The borrower had other sources of income, which, in combination with the income from the property, more than covered all debts (personal and business) at a ratio of greater than 1.25 to 1.0. In general, a borrower with contingent liabilities and limited alternative sources of income will have a tough time financing through the SBA 7a program.
Its also important to consider the type of lender you work with. Certain lenders have preferred status with the SBA, which allows them to fund a deal after approval, foregoing additional steps in the process. Other lenders have to approve the transaction internally and then submit a complete underwriting package to the SBA for its approval. The latter may take longer to close, as the SBA approval depends on the workflow of the SBA office.
As is common with most real estate transactions, a closing officer handles the closing process with disbursement directed through a title company. In this case, there were a number of insurance requirements and assignments coordinated with the borrowers insurance agent. The borrower also had to coordinate with the state to secure new business licenses, which prolonged the closing.
Overall, the process was successful, though it took longer than anticipated and was not without its ups and downs. The SBA 7a program lived up to its billing as a flexible program that could be creatively structured to allow a first-time buyer to acquire a facility with long-term debt at a reasonable equity level. While SBA lending is not a fit for every deal and every borrower, the self-storage industry will benefit from having an additional capital source available for owners to access.
Noel Cain is a vice president with Chicago-based The BSC Group. He advises clients on debt and equity financing and loan-workout services for all commercial property types. He has significant experience in underwriting and cash-flow modeling as well as due diligence and site analysis. For more information, visit www.thebscgroup.com .