SBA 504 Loans: What Are They and How Do They Work?

David Cohn
Mar 12, 2024
SBA 504 Loans

SBA 504 Loans: What Are They and How Do They Work?

Are you a small business owner looking to finance the purchase of commercial real estate —whether it's a warehouse or an office building? There are several loan options, and among the most popular is the SBA 504.

In this blog, we discuss all the basics you need to know about the SBA 504 loans and how it can be applied to commercial real estate transactions.

SBA 504 loan: What is it?

An SBA 504 loan (also known as a CDC/504 loan) is financing available to small businesses in the United States. It is specifically designed to stimulate economic growth and job creation.

By making it easier to purchase or improve significant fixed assets such as real estate or equipment, this type of financing plays acritical role in helping small businesses grow and thrive.

The SBA 504  loan is unique because it involves three parties: a lender (usually a bank), a Certified Development Company (CDC)*, and the borrower.

 *ACDC is a non-profit organization authorized and regulated by the Small Business Administration (SBA) to manage the packaging, processing, closing, and servicing of 504 loans.

The SBA backs these loans, reducing the risk for lenders and making it easier for small businesses to obtain financing.


SBA 504 loan: What can it be used for?

SBA 504 loans are versatile and cover many physical assets to aid in business development.

Business owners can apply for a 504 loan to acquire land or real estate, purchase machinery and equipment, and finance the construction or renovation of buildings.

This includes improving facilities like utilities, streets, and parking lots. In certain cases, the loan can also be used to refinance debt or facilitate a change in business ownership.

It's important to note the restrictions: SBA 504 loans do not support working capital, inventory purchases, or investment in rental real estate.

The financing is strictly for owner-occupied properties — that is, the borrower should be using the commercial property for operational business purposes.

SBA 504 loan: Can you use it to buy commercial real estate?

Yes. One of the primary uses of an SBA 504 loan is for acquiring real estate. This includes buying land, constructing new facilities, or renovating and expanding existing premises.

That said, the borrower's business must occupy at least 51% of the rentable space for existing buildings and 60% for new constructions.

This condition underscores the program's emphasis on promoting owner-occupied business use. Rental or investment properties are not eligible.


SBA 504 loan: What are its features?

SBA 504 loans are notable for their favorable terms because their goal is to support small businesses in securing long-term, fixed-rate financing.

The features of these loans are tailored to accommodate the needs of growing businesses while minimizing upfront costs and providing predictable repayment schedules. Let's break them down:

  • Loan amount -Borrowers can receive loans ranging from $25,000 to $5 million, with specific projects related to energy conservation or small manufacturing qualifying for up to $5.5 million.
  • Repayment terms –This varies based on the expected lifespan of the financed asset. Repayment terms can extend to 10, 20, or 25 years, offering flexibility to match the business's cash flow.
  • Interest rates -The interest rates for these loans are competitive and generally fixed around5% to 7%, and are linked to the 10-year U.S. Treasury notes.
  • Collateral -The financed property or equipment typically secures the loan. Additional collateral may be requested in some instances.
  • Fees: These loans incur various fees, including charges from the SBA, CDC, and the lending institution. These fees are integrated into the total loan amount. The primary out-of-pocket expense is the 10% down payment.
  • Funding speed -The time to funding can vary, typically ranging from 30 to 90 days after application approval.

In addition to these features, a 504 loan requires the borrower to secure hazard insurance on the financed assets. Another standard requirement isa personal guarantee, which commits the borrower to repay the loan in the event of default.

These requirements ensure that both the lender and borrower are protected throughout the loan term, promoting responsible lending and borrowing practices.

SBA 504 loan: How does it work?

Typically, the third-party lender contributes 50% of the total loan amount, the CDC provides 40%, and the borrower adds 10% as a down payment.

This distribution can change when the business is new, or the loan involves a limited or special purpose property, leading to an increased down payment from the borrower and a decreased portion from the CDC.

For a new business OR limited/special purpose property:
  1. Lender: 50%
  2. CDC: 35%
  3. Business owner: 15% 
For new business PLUS limited/special purpose property:
  1. Lender: 50%
  2. CDC: 30%
  3. Business owner: 20% 

The SBA draws a clear line between a new business (operating for less than two years) and a limited or special purpose property (with a unique design or layout limiting its utility). Specialized businesses, such as bowling alleys and hotels, require a greater equity contribution from the borrower due to their specialized nature.

The SBA guarantees 100% of the CDC's loan portion, providing additional security to lenders.

SBA 504 loan: What are the requirements?

The SBA 504 loan criteria combines general SBA loan guidelines and those specific to the 504 program. Here are some of the most important things to note.

General requirements

1. Applicants must run a for-profit business within the U.S. and meet the SBA's definition of a small business.

To qualify as a small business, a company must meet the following criteria:

  • Operate as a for-profit business in any legal structure.
  • Be independently owned and operated.
  • Not hold a dominant position nationally in its field.
  • Operate within the United States or U.S. territories, though some exceptions exist.

The SBA also uses two size standard metrics: the number of employees and the average annual revenue. Generally, a small business has fewer than 500 employees, but the specific limits vary widely across industries. To determine your business size, first, identify your NAICS code. Then, find the size standards that correspond to your code.

2. Applicants must show that they have sought financing else where before applying for this loan and clearly prove that they need the loan.

3. Applicants should not have any delinquency on any federal loans.


504-specific requirements

1. To qualify for a 504 loan, the small business must have a net worth of less than $15 million and an average net income below $5 million for the two years before application.

The financing must be for acquiring or upgrading major fixed assets, either creating jobs or meeting public policy goals.

2. Entities like nonprofit organizations or businesses focused on lending, gambling, or lobbying cannot receive 504 loans. CDCs and banks might also set additional requirements concerning the applicant's credit and financial health.


SBA 504 loan: How to apply

1. Find a lender.

Start by finding a Certified Development Company. CDCs are non-profit organizations that the SBA authorizes to handle 504 loans. They process applications and coordinate financing. The SBA's website lists all CDCs. Once you select a CDC, they will assess your eligibility and help you find a third-party lender. 

2. Gather project information.

Compile details about the asset you intend to buy or upgrade, including vendor quotes and total project costs. This information will help determine your financing needs and down payment amount.

3. Complete the SBA 504 loan application.

This step requires thorough documentation (which varies by lender). You must typically submit business and personal financial records, tax returns, a business plan, and other relevant documents.

SBA 504 loan: How long is the processing time?

The timeline for processing and closing an SBA 504 loan ranges from one to two months post-application. This period can extend for complex purchases or larger loans.

The duration depends on the project's complexity and how quickly all parties can provide and process the required documents.


Get SBA 504 loan guidance from Capital Investors Direct.

Are you planning to purchase commercial property and need financing?

Let Capital Investors Direct guide you through securing an SBA 504loan. This financing solution is ideal for small businesses eager to expand their commercial real estate portfolio. You can secure up to $5.5 million for your project and enjoy flexible terms from 10 to 20 years.

We can help small business owners get an SBA 504 loan for industrial properties, mixed-use buildings, office spaces, retail outlets, etc.

We support commercial real estate projects nationwide, from the 50states to U.S. territories, including 200 MSA Tier I and II cities like Maryland, Texas, Florida, Utah, Colorado, Denver, Chicago, and San Diego.


Advantages of partnering with Capital Investors Direct

With our SBA 504 financing guidance, you can enjoy low up front costs, attractive fixed rates for better financial management, and conserve your capital for growth.

Our bespoke property solutions allow you to buy, develop, or customize properties to suit your business perfectly.

Capital Investors Direct's expertise in SBA 504 loans and dedicated service make us your ideal partner for commercial real estate investments. Reach out today.

SBA loan 504 – Hazard insurance information

Key takeaways:

  • Hazard insurance is required for properties serving as collateral for an SBA loan, with specific rules for SBA504 loans depending on the project's value.
  • This insurance is commercial property insurance, covering the building and its contents and compensating for lost income during repairs.
  • You can get this coverage from business insurance providers.

Hazard insurance is mandatory for securing any SBA loan with property as collateral. It would help if you had this insurance to meet SBA lending standards and protect your business's physical assets. It also helps ensure the loan can be repaid even if the property is damaged by fire, theft, or other covered events.

Understanding hazard insurance for SBA loans

Hazard insurance offers financial protection against damage to insured buildings caused by accidents or natural disasters. The SBA requiresthis insurance to ensure quick repair of any damage, maintain the property's value, and protect the lender's security.

The industry typically refers to this coverage as "commercial property insurance." It safeguards the buildings your business owns orleases and their contents, including valuable inventory and equipment. Additionally, it compensates for lost income during repair periods.


When is hazard insurance necessary for SBA 504 loans?

  • For SBA 504 loans exceeding$500,000: You'll need hazard insurance on all assets used as collateral. This could include the real estate you're buying or improving and any equipment or machinery financed with the loan proceeds.
  • For SBA 504 loans of $500,000 or less: You'll need hazard insurance to cover the specific commercial property acquired, improved, or refinanced with the loan funds.

In short:

  • Large loans (over $500,000):Insure all collateral.
  • Smaller loans ($500,000 or less):Insure the specific real estate financed with the loan. 

How do you obtain hazard insurance for an SBA loan?

Business insurance providers typically offer commercial property insurance products that meet the SBA's hazard insurance criteria. Many insurers allow applicants to get quotes and even buy policies online quickly.


How much does hazard insurance for SBA 504 loans cost?

It depends on your property's specific details. For illustration purposes, a commercial property insurance policy with a $60,000 limit might cost around $67 per month, with a $1,000 deductible.

Be sure to compare multiple quotes to find the best coverage at favorable rates. Experts recommend including "business interruption "insurance in your policy, which can help cover lost income following a disaster.

Adequate hazard insurance is crucial not just for meeting SBA loan requirements but also for smart business management. It adds a layer of financial security by protecting your assets against unforeseen damages and ensuring you can continue operating.


SBA loan 504: Personal guarantee information

Most SBA loans require a personal guarantee. This requirement makes you legally liable for your business's debt in the event of a default. In such cases, lenders can seize your assets to recover the loan amount and mitigate their losses.

Lenders often insist on personal guarantees to reduce the risks of lending to small businesses. Below is a detailed look at personal guarantees in the context of SBA loans.


Personal guarantee requirements for SBA loans

The SBA typically mandates an unlimited personal guarantee from:

  • Anyone owning 20% or more of thebusiness
  • Spouses with significant ownership– If your spouse co-owns at least 5% of the business, and your combined ownership is 20% or more, they might also need to guarantee the loan
  • Trusts holding 20% or more of the business
  • Trustors of a revocable trust with a 20% or more stake in the business

If no single person or entity owns 20% or more, at least one owner must issue an unlimited personal guarantee


Unlimited vs. limited personal guarantees

Applying for an SBA loan usually involves offering an unlimited personal guarantee. However, for those who own less than 20% of the business, a "limited" personal guarantee may suffice. Let's discuss the differences between these two types of guarantees:

  • Unlimited personal guarantee -This guarantee commits you to repay the entire loan if your business cannot. Lenders can directly seek repayment from you without pursuing other sources first. Lenders might use SBA Form 148 or an equivalent form for this guarantee type.
  •  Limited personal guarantee –A limited personal guarantee caps the amount lenders can demand from you if your business defaults. This cap could be a specific dollar amount, a loan percentage, a timeframe, the proceeds from certain collateral, or the pledged community property or spousal interest. Lenders often use SBA Form 148L (or an equivalent document) to outline the conditions of a limited personal guarantee, with the specific terms detailed in the authorization. 

You must settle the debt according to the guarantee's terms upon the lender's written request. Like unlimited guarantees, lenders don't have to exhaust other repayment sources before approaching you.


SBA loan collateral vs. guarantee: What's the difference?

Personal guarantees and collateral are securities for SBA loans, though they function differently.

  • A collateral refers to a specific asset used as security for the loan. If your business defaults on the loan, the lender can seize the collateral to recoup their losses. This could be equipment, inventory, or real estate financed with the loan proceeds.
  • A guarantee is a promise to repay the loan with your assets if the business fails. No specific asset is tied to the guarantee. Instead, you're personally liable for the loan amount. The lender can pursue your personal assets, such as your car, house, or savings accounts, to satisfy the debt. 

SBA loans typically require personal guarantees for majority owners (20% or more ownership). Collateral requirements depend on the loan amount (often for loans exceeding $50,000).