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Need Money to Buy or Build Self-Storage? Learn Why an SBA Loan Could Be Your Solution

If you’re seeking money for a self-storage development or acquisition, a Small Business Administration loan could be the solution. Learn about options, borrower eligibility, fees and more.

Terry Campbell

February 26, 2022

6 Min Read
Need Money to Buy or Build Self-Storage? Learn Why an SBA Loan Could Be Your Solution

During the Great Recession, financing was a challenge for many self-storage owners and investors. Loans were hard to secure, even for those who had cash, a high net worth and lots of experience.

In fall 2010, the U.S. Small Business Administration (SBA) made its lending programs available to the self-storage industry. This move was received with great anticipation, but the results were less than impressive because many banks lacked SBA experience. Since then, several banks have chosen to specialize in these programs, allowing borrowers to thrive.

While SBA loans aren’t the perfect fit for all owners and investors, they’ve made it possible for many to enter the industry who couldn’t otherwise have done so. The SBA has several programs, but the two most popular for self-storage are 7(a) and 504. The following provides an overview of each, including eligibility, fees and more.

SBA 7(a) Loans

Frequently referred to as the SBA’s “flagship” program, 7(a) provides a cash-flow loan. Unlike with some other loans, the main emphasis isn’t solely on your net worth or the loan-to-value (LTV). Rather, it’s mostly focused on the ability of a project to pay for itself.

In this program, you aren’t borrowing money from the SBA. In fact, a bank lends the money, while the SBA guarantees part of the loan against any losses the bank might suffer if you default. It’s like an insurance policy for the bank, allowing for competitive terms and conditions. Here are some other things you should know about the 7(a):

The minimum equity requirement is only 10%. Compared to the conditions of many conventional loans, 7(a) is more flexible. It’s helpful for self-storage owners or investors who don’t have enough equity to obtain a conventional loan.

There are no financial covenants. Well, there’s one: You must make your payment each month. The only way you can have your loan called is if you default. But there are no covenants such as debt-service coverage ratio or LTV requirements to put added pressure on your business.

It offers favorable refinance options. For the self-storage industry, 7(a) is a 25-year, fully amortizing loan, which means you never have to refinance and can avoid the associated closing costs. However, most owners will refinance when the business is stabilized and they have solid cash flow because there’s usually a local bank that’ll offer a low-rate conventional loan. This gives them the opportunity to take cash out at closing and use it to get another SBA loan to build or buy their next facility.

You can get more money. The 7(a) is great for construction projects because working capital and interest reserves can be added to help you reach breakeven as you lease up. It’s also viable for acquisitions and related repairs.

A companion loan is available. There’s a $5 million cap per guarantor on 7(a), but some banks can add up to several million in conventional funds to help finance a larger project. Called a pari-passu loan, it’s basically a companion loan with the same terms and conditions. Just be aware: Some banks might not be willing to do this because it increases their risk.

Prepayment penalties are three years. However, you can prepay up to 25% per year without a penalty. The penalties are 3% for year one, 3% for year two and 1% for year three. And it starts on the day the loan closes.

There are no origination fees, but there is an SBA fee. Each borrower pays a fee that’s rolled into the loan. There’s a formula for how it’s calculated but, using a rule of thumb, it’s roughly 2.75% of the total amount. The actual number depends on the loan specifics.

This is a recourse loan that requires personal guarantees. Anyone who owns at least 20% of the project must meet these minimum qualifications:

  • You must have good credit. Usually, each bank sets their minimum threshold.

  • You must be a U.S. citizen.

  • You can’t have defaulted on any other government guaranteed loans or caused a loss to the government.

  • You can’t be on probation, parole or incarcerated.

Some banks have further requirements, such as no bankruptcies. There are also other size standards the applicant business (including affiliates) must meet to show that they aren’t “too big” for the SBA. For example, the maximum tangible net worth may not exceed $15 million, and the average net income after federal income taxes (excluding any carryover losses) for the two full fiscal years before the application date may not exceed $5 million.

SBA 504 Loans

The 504 loan program, also popular for self-storage, is structured differently. While 7(a) is financed entirely by the bank, the 504 is funded 50% by the bank, 30% to 40% by the SBA with the assistance of a certified development company (CDC), and 10% to 20% by the borrower’s equity.

A 504 loan also requires a minimum of 10% equity for an expansion of an existing business that’s been operating for at least two years. If it’s a new business, the minimum equity requirement is 15%. Therefore, you’ll need 50% more equity than with a 7(a) loan. In some rare cases, there could be a requirement of 20% equity for new businesses.

Also, it can take longer for a 504 loan to close because three entities—the bank, the SBA and the CDC—must review and approve it. The CDC is a liaison that facilitates the loan with the SBA and bank. Sometimes there’s an additional bank involved to limit the exposure of the first, but this usually only happens when there’s a large loan amount.

A 504 loan could also be an option for self-storage construction. As you recall, with the 7(a), you can include the working capital and the interest reserves to get you through lease-up until the facility can pay for itself. You can’t include this with 504. But if the loan isn’t too large, you can use a 7(a) companion loan to help cover this need. The caveat is the 7(a) loan in this case will have only a 10-year term, which will make your payment higher and could affect your cash flow.

The prepayment for a 504 loan is 10 years for the SBA portion. There’s a formula to calculate this but, in general, the penalty is based on the interest due the year you want to prepay. It starts with roughly all the interest due that year and declines by 10% per year, i.e., all the interest due in year one, 90% of the interest due in year two and so on for the 10 years. There are also only certain times during the year when you can make this prepayment. The bank’s penalty is basically up to them and is likely going to be somewhere around five years.

Finally, the SBA portion of the 504 loan has a fixed rate for up to 25 years. The bank's portion can be fixed or variable and may be fixed for shorter terms such as three or five years.

SBA loans are great options to support your self-storage investing goals. It’s highly advisable to talk with your lender to decide which program is best for you.

Terry Campbell is executive vice president for the self-storage lending division at Live Oak Bank, which offers a variety of lending programs including Small Business Administration loans. He’s held various roles with several industry companies and is a partner in self-storage facilities. Terry also contributes articles to industry publications and is a presenter for storage conferences and webinars. To reach him, call 910.202.6933, email [email protected] or connect with him on LinkedIn.

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