A-Active Building Project, Part 2: The Loan Process

Fall 2003 Once we found a piece of land we liked, so the next step was to finance the purchase. I went to my banker and said “I don’t want to spend more than $750,000 on this project and I didn’t want to tie up all my cash with a large down payment. I wanted to leverage this project as much as I could.” He talked about conventional bank financing for commercial real estate, but that didn’t excite me. A lot of times banks are not looking to finance commercial construction projects for more than 15 years. You might get lucky and get someone to stretch it out to 20. Banks want 20 percent down as a minimum and most want more - as much as 25 percent. That ties up a lot of cash. You could always borrow against it but, why would you want to borrow against your equity when you can preserve your own money.

I asked my banker what other financing options were available. He said for a company the size of A-Active we should look at an (Small Business Administration) SBA 504 loan package. It’s a 10, 40, 50 deal. So a project owner puts in 10 percent of his own cash, SBA backs 40 percent of the loan by selling it as a debenture on Wall Street and the borrower gets a fixed, low rate for 20 years. Then the bank backs the other 50 percent of the deal which can be a fixed or variable rate product. Right now we are working on a variable rate because interest rates are still so attractive. It is important to make sure you have a locked in fixed rate option to that variable portion of the loan. The nice part about the SBA is that the loan is fixed rate form the beginning at a point to point & a half below bank rates. Right now is a good time for this product.

There are two disadvantages with the SBA 504 loan. One is that it is fee heavy on the front end. We will pay as much as three points to close on that 40 percent of that loan. That’s about two points higher than my bank. The upside is that the fees can be rolled into the financing amount minimizing the impact on the project. The difference in the interest rate usually breaks even in about seven or eight years into the loan. So the extra fees you pay are offset by a favorable fixed rate for 20 years.

The second disadvantage is that the SBA 504 has an early payoff penalty. This feature provides for a penalty that is based on a declining scale of 1/10th of whatever the interest rate is. So, if I have six percent interest rate, for the first year, the penalty would be .6% a penalty of 5.4 percent; then 4.8 then 4.2 all the way down to 10 years until it would zero. So I can pay it off early, but with a penalty until year 10. These are really the only two negatives that I could identify with this type of financing. When we started this project, we did not have our financing in place. So we started without the bank and bought the land with our own cash and credit. Before we secured our financing, we had tied up close $200,000 of our own cash and credit, but we relinquished that debt as soon as we closed on our loan. Being able to self finance the beginning of the project gave us the flexibility and agility to move on things as we needed to preserve the best deal. The Land Purchase was one of them.

Keep checking back to www.pctonline.com for the next article on the A-Active Building Project, which will focus on Kordek’s decision to build with steel and detail some of the customizations that were added.