SBA Loans for Commercial Real Estate

Your First Choice: Rent or Own

Many owners start by asking whether to keep renting. The SBA's terms give you a concrete way to compare the two paths.

If you own, real estate can be financed for up to 25 years, plus extra time for any construction or renovation.^[1] A longer term means a lower monthly payment, though more total interest over the life of the loan.

If you rent and borrow to improve the space, that work is called leasehold improvements (such as new walls in a space you lease). A loan for leasehold improvements can run no more than 10 years. When $500,000 or 30% of the loan (whichever is less) goes into the build-out, the lender must get a copy of your lease. For a 7(a), the lease, counting renewal options only you can exercise, should be at least as long as the loan. For a 504, it must be.^[2]

Each path has a cost. Owning means a bigger project with more checks before closing, such as the appraisal and environmental review covered below. Renting means a shorter payoff on the build-out and a landlord you depend on.

The Occupancy Rule: 51% or 60%

This rule comes from the federal regulation, 13 CFR 120.131, and it applies to both 7(a) and 504 loans.^[3] It applies whenever SBA money purchases or improves real estate, or refinances debt secured by real estate.

The new construction rule has a timeline. You must intend to use some of the temporarily leased 20% within 3 years and all of it within 10 years.^[4]

What counts as rentable space

"Rentable Property" is the total square footage used for business operations. Common areas count. Stairways, elevators and mechanical areas do not. Outdoor space you actively use in the business, such as a contractor's storage yard, can count. Parking does not.

If your business needs someone living on site, the building can include residential space for that purpose, up to 49% of the property. The SOP's example is a livestock operation where someone must be on the premises at all times.

Rules for the space you lease out

Loan proceeds cannot pay to improve or renovate space you lease to a tenant. The rule applies whether the tenant is a business or a household.

You can have up to 1 year after closing to reach the required occupancy, for example when an old lease still has a few months to run.

A 504 is stricter on timing. The CDC cannot send the loan to closing (submit its closing package) unless you will be occupying and operating in the property, or the SBA approved an extension in advance.

Why Investment and Rental Property Is Ineligible

If you want a building mainly to collect rent, an SBA loan is the wrong tool. SBA rules (13 CFR 120.110(c), repeated in SOP 50 10 8.1) say businesses owned by developers and landlords that do not actively use or occupy the assets are not eligible.^[5] It also bars proceeds for property held for later development, sale, lease or investment, and for excess land you won't use right away.

That is why the occupancy rule exists. You may lease out part of a building your business occupies, but the SBA won't finance a building someone else occupies.

The Eligible Passive Company option

Many owners like to hold their building in a separate company and have the business pay it rent. The SBA allows this through an Eligible Passive Company, or EPC: an entity that owns the property and leases it to your Operating Company (OC), the business that runs on site.^[6]

The SOP calls the EPC rule an exception and says every condition is read strictly. The main ones:

• The EPC leases the property directly to the OC, and the OC leases 100% of it. The OC can sublease part under the same 51% or 60% occupancy rule.
• The lease is subordinated to the SBA lender's lien, and its term, counting renewal options only the OC can exercise, is at least as long as the loan.
• The rent can't exceed the loan payment plus the EPC's direct costs of holding the property, such as maintenance, utilities, insurance and property taxes.
• The OC's cash flow has to cover the loan payment and those holding costs.

The rent cap keeps the EPC from becoming a rental business. The EPC holds the title, and your operating business stays the occupant.

Tenant rent and your loan approval

If you lease part of the building, the lender may include that rent in its global cash flow review, the combined look at the cash flow of you and your affiliates. It cannot count anticipated rent from the property in the projected debt service coverage, the test of whether the business's own cash flow covers the loan.^[7] The appraisal also cannot add value to the building because of that rental income.

Your Choice: 7(a) or 504 for the Building

Both programs finance owner-occupied real estate. The full side-by-side is in our SBA 7(a) vs 504 comparison. For a building, these are the points that usually decide it.

The 7(a) path

A Standard 7(a) loan can be up to $5,000,000. Real estate can run up to 25 years. If the loan also covers working capital or equipment, the lender can blend the term (average it by how much goes to each use), or use up to 25 years for the whole loan when 51% or more of the proceeds go to real estate. That 51% option does not apply when the loan finances a business purchase.^[8]

The 504 path

In the usual 504 structure, a bank (the Third Party Lender) provides 50% or more, a CDC provides up to 40% through a debenture (the SBA-guaranteed funding behind the CDC's share), and you put in at least 10%.^[9] The 504 loan runs 10, 20 or 25 years, up to 25 for real estate. The bank loan must run at least 10 years when the 504 loan is 20 or 25 years.

Your share in a 504 goes up in two cases. A new business puts in at least 15%. A limited or special purpose property, one built for a single use such as a car wash, also takes 15%, and 20% when the business is new too.^[10] In both cases the bank loan must be at least 50% of the project.

Two 504 details often help owners. Your contribution can be borrowed, as long as that loan sits behind the bank loan and the 504 loan. And equity in land or a building you already own that is part of the project can count toward it.

For the 7(a) side, the SBA sets 10% down for start-ups and for business purchases. When an existing business purchases its own building with a 7(a), the SOP sets no fixed percentage, and your lender decides based on your equity position. Our SBA down payment guide covers each case.

Rates work differently in each program too. Our SBA loan rates guide explains the 7(a) caps and how the 504 debenture rate is set.

Purchasing a Business and Its Building Together

A business purchase on its own is paid off over no more than 10 years. When the deal includes the real estate, SOP 50 10 8.1 gives two structures.^[11]

Option 1: one blended 7(a)

The term is a weighted average of the uses, rounded to the nearest year. The real estate share can be weighted at up to 25 years. The business, soft costs and working capital are weighted at 10. The lender works out the term on the full cost, before your down payment comes off.

Say a $1,000,000 deal is $600,000 for the building and $400,000 for the business. The blend is (600 x 25 + 400 x 10) / 1,000 = 19 years.

Option 2: separate loans

One loan for the business and one for the building. The building loan can be a 504. The building carries the same equity requirement as the business purchase, and your equity is split between the two loans in proportion. If the building loan is a 504, its own contribution rules apply instead.^[12]

When the building is the business

Some businesses can't be separated from their property. For an owner-occupied Special Purpose Property (a building made for one kind of business, like a car wash), the lender may use a term of up to 25 years for the whole loan when 85% or more of the project cost is real estate. Your lender decides whether your property qualifies and documents why.

One more detail helps on bigger deals. The "Business Purchase Price" leaves out the appraised value of the owner-occupied real estate. That price is what triggers the SBA's rules on a business valuation and a Quality of Earnings report (an outside review of the seller's earnings), so putting the building in the deal doesn't push you over those thresholds.

Appraisal and Environmental Review

The appraisal

For a 7(a), the appraiser must be independent and State-licensed or State-certified, follow the Uniform Standards of Professional Appraisal Practice (USPAP), and name the lender as client. The lender cannot use an appraisal prepared for you or the seller, and it can pass the cost to you.^[13] When a business purchase includes real estate, an appraisal is required.

For a 504, an appraisal is required when the property is worth more than $500,000. At $500,000 or less, the CDC may use a simpler evaluation unless the deal triggers an appraisal, for example a sale between family members or a seller lending you part of your contribution.^[14]

For new construction or a large renovation (costs over one third of the property's value), the appraiser values the building as it will be when finished.

If the appraisal comes in low. On a 7(a), a value at 90% or more of the estimate lets the lender close with a written explanation. On a 504, a value under 90% of the estimate means the 504 loan is reduced, or you add collateral or cash, unless the SBA approves it on strong cash flow. Either way, a low appraisal can change your down payment, so plan for it.

The environmental investigation

The SBA requires an environmental investigation of every commercial property pledged as security, and the report must be dated within one year of the date your loan gets its SBA loan number.^[15]

The lender first looks up the industry codes for the property's current and known past uses. A match to the SBA's list of environmentally sensitive industries means a Phase I report (a professional review of the site's history for contamination) regardless of the loan size. Without a match, a loan up to $250,000 may start with an Environmental Questionnaire, and a larger loan starts with the questionnaire plus a records search with risk assessment.

A building's history counts here. A site that was once a gas station, for example, always starts with a Phase I and has extra SBA rules for its tanks, so ask about prior uses before you sign.

Liens and Collateral on the Building

When a 7(a) loan pays for an asset, the lender must take a first lien on it.^[16] In a 504, the 504 loan usually sits in second position behind the bank on the same property.

To decide whether a loan is "fully secured" (backed by enough collateral to cover it), the lender values improved real estate at no more than 85% of market value and unimproved land at 50%. A building often covers much of the loan by itself. If it doesn't, on a Standard 7(a) the lender must generally take available equity in personal real estate of owners who hold 20% or more of the business.

A loan can't be declined only because collateral falls short. The full rules, including when your home comes into play, are in our SBA collateral requirements guide.

Refinancing Commercial Real Estate with an SBA Loan

Refinancing with a 7(a)

The debt must have been current for the last 12 months, or the life of the loan if shorter, and the refinance cannot shift a likely loss from the old lender to the SBA.^[17]

Eligible debt includes loans with a balloon payment (a large lump sum due at the end) or a demand note (a loan the lender can call due at any time), and loans whose term didn't fit the asset. The new payment must generally be at least 10% lower than the old one. Debt with a balloon or demand note is an exception to that test, which is useful because many commercial mortgages end in a balloon.

Refinancing with a 504, no expansion

The debt must be a "Qualified Debt": at least 75% of the original loan paid for fixed assets such as land, buildings or equipment, and it was fully disbursed and secured by those assets at least 6 months before you apply.^[18] The refinance is capped at 90% of the property's value.

Refinancing with a 504 and an expansion

If the project also purchases, builds or improves land, buildings or equipment, a 504 can refinance existing debt up to 100% of the expansion cost. The payment on the refinanced part must come out lower than your current payment.

Whether refinancing makes sense depends on your numbers. Weigh any prepayment penalty on the old loan and the fees on the new one against the lower payment. Many lenders will run both versions for you.

Related SBA Lending Guides

• SBA 7(a) vs 504, the full side-by-side of the two programs
• SBA Collateral Requirements, liens, "fully secured" and your home
• SBA Loan Down Payment, how much you put down by deal type
• SBA Loan Rates, 7(a) rate caps and 504 debenture rates
• SBA Loan Calculator, the monthly payment on your building
• The FUNDED Series, one SBA lending guide per industry