In order to grow financially and operationally, small businesses often seek financial assistance.
Entrepreneurs exploring financing options can look no further than the SBA 504 loan. Because this resource is meant to be a valuable tool for attaining real estate, heavy equipment, and construction assets, it requires careful attention to its collateral requirements. It is important to read the fine print during the SBA loan process to ensure the 504 loan is used to its full potential.
What are SBA Loan Collateral Requirements?
If you’ve participated in any kind of loan agreement, you have most likely considered its collateral. Collateral serves as security for the lender if the borrower defaults on the loan, meaning the borrower does not repay the loan within the agreed time frame.
While providing guarantees on certain loans like the 504 loan program, the SBA does not actually fund the loans itself. Instead, it works with approved lenders to mitigate the risks they face when financing small business projects.
As mentioned above, SBA 504 loans are designed to help businesses purchase fixed assets such as real estate and heavy equipment. These loans are normally structured with three parties involved:
- The business owner contributes a minimum of 10%.
- A reputable lender or bank puts down up to 50%.
- The Certified Development Company (CDC) provides the remaining 40%.
Due to the long-term nature and substantial amounts involved in 504 loans, collateral proves essential in securing fixed asset financing.
SBA 504 Loan Collateral Requirements
But what are the 504 loan’s specific collateral requirements?
Well, that varies. That depends on the lender’s policies and the financed asset type. For example, a multi-million dollar real estate project involving a three-story building will not have the same requirements as a single piece of factory-grade equipment. Generally speaking, the assets acquired with the loan proceeds for the loan. In the case of our example, both the building and equipment themselves act as collateral.
Interestingly, SBA 504 loans are considered “fully collateralized” as the assets being financed are pledged as security. Furthermore, personal guarantees from the business owners are typically required. But this does not mean that additional possessions will be seized as collateral. In fact, “SBA 504 loans never take large business assets as collateral (except special-use properties). Instead, they primarily rely on the financed property as collateral, cutting the need for excessive collateral requirements. This feature further lowers risk and fosters accessibility for businesses with limited assets.” Learn the six super Real Estate benefits of the 504 loan here.
Special-Purpose Properties: Why They Matter
A special-purpose property, otherwise known as a special-use property, is a type of real estate that is designed, built, or adapted for a specific use or purpose, often related to a particular industry or business. These properties are tailored to meet the unique operational requirements of a particular business, and their layout, features, and design are optimized to serve that purpose effectively. These properties are typically used as collateral for their inherent value, business viability, or other factors.
Special-purpose properties are not easily adaptable to other uses due to their distinct design and features, which are customized to the needs of the business they were created for. These include:
- Hotels and motels
- Restaurants
- Movie theaters
- Gas stations
- Hospitals and medical centers
- Data centers
- Schools and educational facilities
- Churches and places of worship
- And more
When it comes to SBA 504 loan collateral, here’s the main requirement: special-purpose properties require an additional 5% equity.
SBA 504 loans finance fixed assets for long-term use, such as real estate and heavy equipment. For businesses that require specialized properties, using a special-use property as collateral can align with the long-term investment nature of the loan. The requirement for additional equity acts as a safeguard for both the lender and the borrower, ensuring that the property’s specialized nature remains valuable and functional in the long run.
Closing Thoughts
As with any financial decision, the small business owner must do their due diligence—that means thoroughly researching and understanding the collateral requirements associated with SBA 504 loans. Consulting with SBA-approved lenders or Certified Development Companies like 504 Capital can give valuable insights into the loan process. Most importantly, they can propel entrepreneurs to make informed decisions about their business financing needs.
Don’t wait; get a headstart on your SBA 504 loan today with the experts at 504 Capital.
