The following article (written by us) appeared in the February issue of The CPR Report (published by Government Loan Solutions). Learn more about this monthly newsletter and read past issues in The CPR Report archives.
Interims & Construction: Third-Party Lenders
SBA 504 loans are designed to lower the risk for small business borrowers who want to buy, build, or renovate commercial real estate. Ten percent of the total project cost as equity is pretty tough to beat. But these loans also lower the risk for banks, especially when banks work with third-party lenders to get these loans closed.
Third-Party Interim/Bridge Loans
The typical 50-40-10 structure of a 504 loan helps make commercial real estate purchases and improvements more affordable for small business owners. The 50% first mortgage is an ordinary commercial loan provided by a third-party lender. The 40% second mortgage is a below-market, fixed-rate bond with an SBA guarantee, and the remaining 10% is equity from the borrower. What we’re concerned with here is the second mortgage piece because an interim/bridge loan is needed until the SBA-guaranteed bond is in place, which can take a month or a year depending on the project.
It’s not uncommon for a bank to originate an SBA 504 loan but decide not to fund the interim/bridge loan. The reasons for this can be external, internal, and/or project-based. Legal lending limits are a common external reason for a bank being unable to fund the interim/bridge loan. Tighter regulations have had an impact on commercial lending, especially to small businesses. Loan policy guidelines are an internal reason. Perhaps a bank would rather not fund the interim/bridge loan because of the property type and/or the borrower’s credit. In these situations, when a bank is unable (external) or unwilling (internal) to provide the interim/bridge loan, a third-party lender can make the loan doable.
Third-Party Construction Management
The most common project-based reason for not funding the interim/bridge loan we hear is the C-word: Construction. Lots of banks and other lenders don’t have a strong appetite for construction, particularly in the wake of the Great Recession. The problem with construction is that it poses all sorts of additional risks for lenders. Managing and monitoring the construction phase of a 504 project requires a specialized skillset in order to properly assess the risks and plan for contingencies. No two construction projects are alike, and they’re often unpredictable.
For example, what’s the vetting process for general contractors? A contractor may have plenty of experience in residential construction, but a five-story office building is a different animal altogether. If the contractor has cost overruns and goes over budget, does the borrower end up with a partially-constructed building? Vetting vendors and putting contingencies in place in an attempt to expect the unexpected are skills that a construction lender must possess. The interim construction period can be tedious, and not all commercial lenders are up for it. A third-party lender with the required skillset can provide the interim construction loan and make a 504 loan doable for both the borrower and the originating first mortgage lender.
Win, Win, Win
Perhaps the best part about bringing in a third-party lender to fund the interim/bridge loan is that most (if not all) are transaction oriented. Mercantile Capital Corporation, for example, only does SBA 504 loans. The bankers who refer loans to us don’t worry about us selling their clients other financial products or services — we don’t offer any. We can provide the interim/bridge loan, the borrower gets the funding he or she needs, and the bank keeps its customer — everybody wins.
If the sticking point for a 504 project is the interim/bridge loan, ask around and get a referral for a reliable third-party lender who can help get the loan to the closing table. You can likely get a list of lenders in your area from a local Certified Development Company (CDC), and some third-party lenders operate nationwide, like Mercantile. Funding more SBA 504 projects will help our economy continue to recover, and we’re all for that.
If you have any questions about how a third-party lender like us can help with interim and/or construction financing, leave a comment below or call us at 1-866-622-4504 or email us at firstname.lastname@example.org.
Many thanks to Jordan Blanchard for reaching out and asking us to contribute to The CPR Report.
– Your SBA 504 Experts