SBA 504 vs. 7(a): which one fits your building?

Most owners arrive at this question already knowing the headline: you can buy with roughly 10 percent down. True, usually, and it is the single biggest reason owner-occupied purchases pencil for businesses that could never write a conventional 25 percent check. What the headline leaves out is that there are two programs behind it, and they behave differently once the deal gets specific.

The 504, in plain terms

A 504 is not one loan. It is two mortgages stacked on the same property, closed together:

• About 50 percent from a bank or credit union, in first position.
• About 40 percent from a Certified Development Company, a nonprofit licensed by the SBA, in second position, funded by a debenture.
• About 10 percent from you.

The CDC portion is the part people care about: it carries a fixed rate over a long term. That is the structural argument for a 504. On a 20 or 25 year fixed second, the largest slice of your occupancy cost stops moving, permanently.

The borrower contribution rises in two situations. If your business is a startup, or the building is special-purpose, expect 15 percent. If it is both, expect 20 percent. "Special-purpose" is a real category, not a judgment call, and it covers things like car washes, bowling alleys, gas stations and cold storage. If you are buying a generic flex or office building, you are almost certainly in the 10 percent case.

The tradeoff is what a 504 can pay for: fixed assets. Real estate, and long-lived equipment. Not working capital, not inventory, not the goodwill in a business acquisition.

The 7(a), in plain terms

A 7(a) is one loan from one lender, with a portion guaranteed by the SBA. The maximum is $5 million. Because it is a single instrument with broad permitted uses, it can do things a 504 cannot:

• Fund real estate and working capital in the same transaction.
• Finance a business acquisition where real estate is only part of the value.
• Refinance certain existing debt.
• Work on deals where the property or the borrower does not fit 504 rules.

Real estate terms can run up to 25 years. Rates are commonly variable, tied to a published base rate plus a spread, though fixed-rate 7(a) loans exist. Variable is the important word: on a 25 year hold, a floating rate is a materially different risk profile than a fixed CDC debenture.

What both programs require

Two rules apply across the board and catch people out.

Occupancy

For an existing building, your business must generally occupy at least 51 percent of the rentable square footage. You may lease the balance to tenants, and that income is frequently what makes the payment comfortable. For ground-up construction, the requirement is higher.

This is worth planning around rather than backing into. A 6,000 square foot building where you need 3,200 square feet works, and the remaining suite helps carry the note.

It is your business being underwritten

Conventional commercial lending looks primarily at the property. SBA lending looks hard at the operating business: cash flow, debt service coverage, management experience, and personal guaranties from owners of any material stake. Clean books and two to three years of consistent tax returns move this process faster than anything else you can control.

What "10 percent down" leaves out

The down payment is not the only cash you need at closing. Budget for:

• Closing costs, appraisal, environmental and title work.
• SBA guaranty and CDC processing fees, which are commonly financed into the project but still show up in the total.
• Any deferred maintenance the inspection surfaces that you are not able to negotiate onto the seller.
• Moving and any build-out the space needs for your operation.

None of that changes the fundamental case. It does change the number you should have liquid before you go under contract.

How it usually goes in practice

The businesses we have taken through owner-occupied purchases in Erie and the surrounding towns tend to follow the same sequence: get pre-qualified with a lender before touring, so the search is bounded by a real number rather than an ambition; identify a building where the occupancy math works with a leasable remainder; then run lender, appraisal and closing on one timeline rather than three sequential ones.

The flex units we have closed at 3000 Airport Dr near the Erie Municipal Airport ran from 2,500 to 6,250 square feet, at roughly $196 to $250 per square foot. That is the practical range a small business is working within when it buys its own space in this submarket.