As a small business owner contemplates the shift from leasing to owning, and thus takes the initial steps to build wealth outside of his or her business, the question of how much building can be purchased comes up. In the previous article on this subject ("Create Wealth Outside Of Your Small Business, Part 1"), I covered the most extensively used financing options: The Small Business Administration's "7a" and "504" programs.
There are other ways to finance that building purchase, although perhaps not as effective. To completely cover the topic, I would like to briefly describe a couple of other options: "Conventional" commercial and small business real estate financing.
Conventional Commercial Real Estate Loans
This is what would be considered "traditional" commercial real estate financing and offers a small business owner perhaps the best interest rates available (although I will make the case in a later article that "rate" is one of the least important aspects in this type of lending).
This type of commercial real estate loan looks at the property as if it was purely an investment. The property is treated as the sole source of repayment for the debt and the potential income of the building for that repayment is "marked to the market." This means that comparable lease rates are used to determine how much money is available to service any debt used to acquire the property. The minimum down payment is usually around 25% of the purchase price, assuming there is sufficient cash flow to service that size of a loan. Lenders prefer multipurpose properties and make loan reductions on properties that are for special purposes (automotive, hospitality, etc.).
Another aspect of these types of loans is that they rarely "fully amortize" and usually call for repayment ("balloon") after 10 years. But, since they typically have a 25 year amortization and carry pretty hefty prepayment penalties, the owner is usually stuck with a refinance of approximately 80% of the original balance after making 10 years of payments!
So from a small business owner's perspective, this is not the best way to build wealth using the business. The large down payment is a significant drain on the business' working capital and the inability to pay off the loan quickly makes the loan option almost indistinguishable from leasing.
Conventional Small Business Real Estate Loans
The private sector is constantly coming up with new ways to provide solutions to the small business person. This method of financing blends some of the positive aspects of SBA and Conventional financing. The business owner can still get up to 90% financing on the purchase price of a facility, occupancy requirements are usually lower than SBA financing (sometimes down to 25% of the facility), and in some situations there are even "Stated Income" programs available, reducing the paperwork burden on the borrower. Finally, they are usually structured as a single loan, unlike the SBA 504 program, which is a combination of two loans.
The down sides to these programs are that they usually carry a higher rate and do not cover as many property types as the SBA 504 program. Also, the stated income versions frequently have reduced loan amount maximums or lower loan-to-value targets.
So while the programs are not perfect, they fill the gaps between the Small Business Administration offerings and traditional commercial financing. In the next article, we will cover strategies for using your small business to build wealth outside of the business operation itself.