By Devin Huber
Over the last several months, there has been a growing buzz in the self-storage industry regarding changes to the Small Business Administrations (SBA) lending guidelines. These new and exciting developments mean self-storage is now eligible for SBA financing, which brings immediate liquidity to the asset class. Its anticipated both smaller facilities as well as ones in secondary markets will accrue the most benefits, given that before now, these two groups have typically only been able to secure financing from smaller, local lenders.
Because the SBA program is so new to the industry, its natural to have questions about program eligibility and how the process works. Additionally, there are a number of misconceptions about SBA loans that lenders are eager to put to rest.
For instance, many believe the U.S. government is the actual lender in an SBA transaction, when its actually participating lenders who fund the loans with a partial guaranty provided by the government. This guaranty allows SBA-approved lenders to offer financing options to borrowers and industries that may otherwise have difficulty securing a conventional loan.
Another point of confusion is many borrowers believe all SBA lenders are the same, but this is not true. There are hundreds of SBA lenders in the United States, but few specialize exclusively in SBA lending.
I recently spoke with George Vredeveld, president and CEO of Quadrant Financial Inc., a large SBA lender, to address many of the questions and misconceptions many in the self-storage industry have about this new lending opportunity.
What changed in the SBA guidelines to now allow self-storage facilities to qualify for financing?
SBA financing is designed for operating companies, commonly referred to as owner-operators. Historically, the SBA viewed self-storage as a passive real estate investment. What it found is most of the individually owned self-storage facilities were in fact being operated and managed by the owner. It was an issue of active vs. passive management and the fact that self-storage facilities are an actual business, as compared to a retail strip center with multi-tenants, which would be considered passive.
Does this mean third-party managed facilities do not qualify for SBA financing?
In general, SBA financing is for actively owned and managed facilities. SBA doesnt specifically preclude a facility from being managed by a third party; however, most SBA lenders will prefer and many will require the owner be actively managing the property. In short, if you have a third-party managed facility, it will be extremely difficult to find an SBA lender to fund the request, even though its technically allowed by the SBA.
When talking about SBA lending, we often hear about two programs, the 7(a) and the 504. What are these programs and how do they relate to self-storage?
Until recently, SBA 7a lending was the only program under which debt refinance was permitted. The recent Jobs Bill (Small Business Jobs Act) made refinancing eligible under the SBA 504 program, but for a limited time frame and with certain specific qualifications. The two programs are really designed for different borrower types.
SBA 7a is designed for borrowers who have multiple uses of proceeds (real estate, equipment, working capital, etc.), who typically have a loan-to-value (LTV) in excess of 90 percent, want to refinance, or have a shorter holding time frame. SBA 7a is a variable-rate program with a three-year prepayment penalty, whereas part of the SBA 504 loan is a 20-year fixed-rate bond, which carries a rather steep 10-year prepayment penalty.
SBA 504 borrowers typically have a long-term holding period, a single use of proceeds (real estate or equipment purchase), and will sacrifice flexibility for an attractive long-term fixed rate. In short, 7a borrowers will sacrifice interest-rate volatility for flexibility and the ability to have higher leverage and multiple use of proceeds. SBA 504 borrowers sacrifice flexibility and limited uses of proceeds for a long-term fixed rate.
Editors note: The U.S. Senate passed the Small Business Jobs Act in September. It will provide small businesses with $12 billion in targeted tax breaks.
Is self-storage a qualified collateral type under both programs?
If the business operation is eligible, which self-storage is, then the collateral is eligible. However, SBA classifies collateral differently. Self-storage will be classified as special purpose, which doesnt impact a borrower on a SBA 7a loan request. On a SBA 504 loan, it reduces the maximum LTV from 90 percent to 85 percent. Furthermore, if the facility is less than two years old, the LTV drops an additional 5 percent to 80 percent LTV (only under SBA 504).
If it sounds too good to be true, it surely is. Can the SBA really lend up to 90 percent of cost/value, and what are the other general terms and underwriting hot buttons for a SBA transaction?
The SBA 7a program has no LTV requirement. SBA 504 lending is limited to 85 percent LTV on a special purposed property for which self-storage would be classified. Under the SBA 7a program, the government provides a guaranty of up to 75 percent of the loan, which can provide an incentive to the lender to do higher leverage financing.
Remember, SBA is designed for operating, cash-flowing businesses. Cash flow repays debt, so in the SBAs view, cash flow takes precedence over collateral. The critical underwriting parameters are ability to repaydebt-service ratio, management experience, borrowers personal credit, post-closing liquidity and collateral. Real estate can be financed on an amortization of up to 25 years. All SBA loans are fully amortizing with no balloon payments or call provisions. Rates are typically variable tied to Prime with a maximum rate of Prime + 2.75 percent.
What can a borrower expect from the 504 program, and are fixed rates available for this program?
As previously mentioned, the SBA 504 program differs from SBA 7a in a few respects. First, the LTV on a SBA 504 loan ranges from 80 percent to 85 percent. The SBA 7a loan doesnt have a LTV requirement but typically will not exceed 90 percent on a self-storage facility.
The SBA 504 program uses two funding sources. First, a conventional first mortgage is required to be at least 50 percent of the project. Borrowers can expect to receive a three- or five-year adjustable-rate mortgage (ARM) with a 20-year amortization. The balance of the project (30 percent to 35 percent) will be funded by a 20-year fixed-rate bond. Borrower equity is required between 15 percent and 20 percent.
The prepayment penalty on the bond is one of the drawbacks of the SBA 504 program. There are substantial penalties if the bond is paid off within the first 10 years; however, the benefit is a 20-year fixed rate. Borrowers really need to understand their time horizon when deciding between SBA 7a and 504. The two programs are designed for very different borrower profiles.
Can you explain what fees are charged by the SBA and whether these fees, and the soft costs, can be financed?
As of Jan. 1, the fee waiver from the Recovery Bill (American Recovery and Reinvestment Act of 2009) will expire. On SBA 7a loans, the SBA charges a guaranty fee, which is assessed on the amount of the loan guaranteed (75 percent). The fees are graduated depending on loan size. A good rule of thumb is 2.5 percent of the loan amount. SBA lenders will provide the exact fee in their term sheet. These fees can be financed into the loan.
On SBA 504 loans, the SBA assesses a guaranty fee on the bond (100 percent guaranty on the bond). These fees are generally 3 percent of the bond debenture and are financed in the bond. One important exclusion relates to developer fees when the borrower is acting as the developer on his own project. SBA will not allow lenders to finance these fees.
Are there net worth and liquidity requirements or constraints? Is it possible a borrower is too strong to qualify for a SBA loan?
SBA loans are designed for small businesses. The rules were recently changed. A corporation becomes ineligible when its tangible net worth exceeds $15 million or its net profit exceeds $5 million. An individual borrower is deemed ineligible when his personal liquidity (non-retirement assets) exceeds one times the loan amount when loans are over $750,000.
What does the SBA lending landscape look like? Can different lenders really offer different terms, and what does it mean to be a Preferred SBA Lender?
The SBA grants preferred status to banks that have exhibited expertise in SBA lending. This is generally determined by the number of SBA loans underwritten and the corresponding default rate. A preferred lender (PLP) has an advantage over a standard-processing lender, primarily as it relates to underwriting/approval and servicing. A preferred lender has the same approval authority as the SBArubber stamp approvalwhereas a non-PLP lender has to submit directly to the SBA for credit approval. This can add weeks to the approval timeline.
As for rate and terms, the SBA sets certain overall parameters lenders must work within, and while the lenders have the flexibility to set their own rate and terms (within the established parameters), most fall within a fairly narrow range. Nearly all offer variable-rate loans and only a select few offer fixed-rate loans.
Aside from the SBA parameters, lenders are also required to work within guidelines set by their own credit policies, which may impact geographic availability, industry concentrations, loan product, rate, term and overall risk tolerance. The net effect to the borrower is that while many loan features will be similar, each lenders program will likely be unique.
Whats the process and time frame for SBA loans?
The SBA has taken tremendous strides to streamline its process and really empower PLPs to act on the SBA's behalf. Because this is a government program, we find the biggest challenge is setting appropriate expectations on the front end and helping the borrower prioritize what documentation needs to be provided.
There are some additional forms required to be signed at application, but the way SBA loans are underwritten is very similar to a conventional loan, minus the focus on leverage. When dealing with an experienced SBA lender, you can expect an approval within 10 business days of submitting a complete application, and closing to occur within 45 to 60 days of a signed commitment.
Are construction or expansion loans available?
SBA has no prohibition against expansion or new construction. In fact, it supports startups and expansions because they drive economic development. The bigger challenge is in the banking environment overall. The state and federal regulators are requiring banks to limit their exposure to real estate loans, especially construction loans. Projection-based expansion or true ground-up construction loans are difficult to obtain in this banking environment.
What is the difference between SBA loans and United States Department of Agriculture (USDA) Business and Industry Guaranteed Loans? Is self-storage eligible for USDA?
Yes, self-storage is eligible for USDA financing. There are substantial differences between the programs. USDA requires the property be in an eligible location, typically in markets where the population is less than 50,000. USDA requires loans to be no more than 80 percent LTV, and there must be a 10 percent to 20 percent tangible net worth on the balance sheet.
USDA loans can be amortized over 30 years, and its possible to obtain a 30-year fixed rate. USDA financing will be applicable to those borrowers in much smaller markets who have a strong balance sheet and may desire a longer-term fixed rate or have a loan request in excess of $5 million, which is the maximum loan for an SBA 7a loan.
What should a prospective borrower look for in an SBA lender, and what is the role of the mortgage broker? Is he paid by the lender or the borrower?
The mortgage broker, if well-versed in the self-storage industry, can play a critical role in helping to gather and identify critical documents every SBA lender will require. Each lender has its own policy regarding payment of mortgage-brokerage fees.
Two things are important here: First, SBA prohibits the bank from charging the borrower an origination fee. Second, most SBA lenders will compensate the broker directly to minimize borrower costs. If the mortgage broker uses a lender that will pay him directly, the borrower is essentially getting the broker services for free.
The SBA landscape is tough terrain for a borrower to navigate solo. Despite SBA having the same rules for every bank, each SBA lender may approach the self-storage industry differently. I strongly recommend working with a PLP.
Its also imperative to understand how a particular bank uses the SBA program. Self-storage borrowers should inquire about the SBA lenders expertise in real estate lending, and should choose a lender who has a large average SBA loan size and is consistently in the top 50 SBA lenders in the country. There are many national lenders who offer a ton of SBA loans. However, their average loan amount is $200,000 or less. Clearly their specialization is not in real estate lending. As a comparison, there are a number of top 50 SBA lenders who maintain an average loan amount north of $1 million. These lenders will tend to have more experience in working with larger real estate deals such as those found in the self-storage industry.
It is my hope Mr. Vredevelds responses have helped operators better understand SBA financing and how it relates to self-storage. Clearly, SBA loans are a viable financing source for storage facilities. It would appear the liquidity provided will help our industry stabilize and flourish. With new opportunities for refinance, acquisition and disposition, its obvious SBA lending is here, is available, and just may be right for your next financing requirement.
Devin Huber is a principal at The BSC Group, a Chicago-based commercial real estate financing firm, where he supports self-storage owners nationwide with their lending needs. To reach him, call 312.207.8232; e-mail [email protected]; visit www.thebscgroup.com.
George Vredeveld is president and co-founder of Quadrant Financial Inc. (a subsidiary of First Chatham Bank), which lends nationally and is actively offering SBA 7a, SBA 504, USDA and conventional small-business loans through a series of loan origination offices in many major U.S. markets. To reach him, call 513.281.5625; e-mail [email protected].