For those unfamiliar, the SBA has a loan program known as the “504” program that helps small business owners purchase commercial real estate. This is how it works in a nutshell:
– A conventional lender finances 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’s value falls by 50% or more. (Note: this is happening more than he realizes, especially in areas like CA and FL, where the housing market has been hit hard.)
– A local Community Development Corporation (CDC) finances 40% of the project. This loan is 100% guaranteed by the SBA.
– The borrower contributes 10% of the cost of the project.
In the current recession, I get a lot of calls from distressed borrowers who purchased their commercial property through the SBA 504 program. Often, they are quite concerned about being able to pay their two monthly loan payments (one to the conventional lender, one to the CDC), knowing that missing your monthly payments can lead to a host of problems, including foreclosure.
One trend I’ve been seeing lately is that most of the time, there is no equity in commercial properties for CDC/SBA. Because? Let’s see 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 like this:
As of 1/1/2007:
Property Value $500,000
Conventional Mortgage $250,000
CDC/SBA Mortgage $200,000
Equity in Property $50,000
Now, fast forward 4 years. The AZ real estate market has hit rock bottom and the unthinkable has happened: properties are actually selling for 50% (or less) than they used to. As you can imagine, that changes the situation regarding my property:
As of 1/1/2011:
Property Value $250,000
Conventional Mortgage Balance $235,000
CDC/SBA Mortgage Balance $196,000
Property Equity ($181,000)
The scenario described above is precisely the type of situation that is playing out across the country. The net result? The CDC/SBA cannot foreclose on the thousands of commercial properties because they are worth less than what is owed to the conventional lender. Not that this is a “get out of jail free” card, but at least it’s one less worry a borrower might have.
With all that said, does this mean that a borrower is out of the woods if there is no equity in the property? Certainly not. The CDC/SBA likely has the personal guarantees of the business owner, which means that even if the conventional lender forecloses on the real estate, the CDC/SBA has every right to file lawsuits against the borrower and the personal guarantors. So what choice does a borrower have if he loses his building but still owes millions upon thousands or even millions of dollars to the CDC/SBA? You guessed it friends; the SBA will consider an offer in compromise.
