For those who aren’t familiar, the SBA has a loan program known as the “504” program which assists small business owners in purchasing commercial real estate. Here’s how it works in a nutshell:
– A conventional lender funds in 50% of the project. This debt is not guaranteed by the SBA. In theory, the lender has little chance of losing money on the loan unless the property value falls by 50% or more. (Note: this is happening more than you think, especially in areas like CA and FL where the real estate market has been hit hard).
– A local Community Development Corporation (CDC) funds 40% of the project. This loan is 100% guaranteed by the SBA.
– The borrower puts in 10% of the project cost.
In the current downturn, I get many calls from distressed borrowers who acquired their commercial property via the SBA 504 program. Often times, they are quite concerned with being able to afford their two monthly loan payments (one to the conventional lender, one to the CDC), knowing that failure to make their monthly payments can lead to a slew of problems, including foreclosure.
One trend that I’ve been observing lately is that more often than not, there is no equity in commercial properties for the CDC/SBA. Why? Let’s look at an example.
Let’s say I bought a commercial building in Arizona 4 years ago for $500,000, and financed the purchase with an SBA 504 loan. In general, my situation would have looked something like this:
|As of 1/1/2007|
|Value of Property||$500,000|
|Conventional Mortgage Balance||$250,000|
|CDC/SBA Mortgage Balance||$200,000|
|Equity In Property||$50,000|
Now, let’s fast forward 4 years. The bottom has fallen out of the AZ real estate market, and the unthinkable has happened: properties are actually selling for 50% (or less) of what they used to. As you can imagine, that changes the situation with respect to my property:
|As of 1/1/2011|
|Value of Property||$250,000|
|Conventional Mortgage Balance||$235,000|
|CDC/SBA Mortgage Balance||$196,000|
|Equity In Property||($181,000)|
The scenario outlined above is precisely the type of situation that is unfolding all over the country. The net result? The CDC/SBA can’t foreclose on the thousands of commercial properties because it’s worth less than what’s owed to the conventional lender (in the example above, there is in theory $15K in equity, but certainly not enough for the CDC to justify foreclosing). Not that this is a “get out of jail free” card, but at least it’s one less worry that a borrower might have.
With all that said, does this mean a borrower is off the hook if there is no equity in the property? Certainly not. The CDC/SBA likely has the personal guarantees of the business owner, which means even if the conventional lender forecloses on the real estate, the CDC/SBA has every right to pursue judgments against the borrower and personal guarantors. So what option does a borrower have if they lose their building but still owe hundreds of thousands or even millions of dollars to the CDC/SBA? You guessed it folks; the SBA will entertain an Offer In Compromise.