During the Great Recession of 2008, financing was hard to secure, even for those with a high net worth and experience. In 2010, the U.S Small Business Administration (SBA) made its programs available to the self-storage industry, which was received with great enthusiasm. The adoption of the program by several lending institutions, some specializing in the programs, has allowed many current and prospective self-storage owners to grow and thrive in the industry.
Like other loan types, SBA loans aren't for everyone. But they have been a way for many people to get into the industry who couldn't otherwise. Self-storage deals are often funded conventionally. Conventional loans can be financed by your community bank or the local branch of one of the big banks. However, some of the requirements of these loans prevent people from getting into the business. This is where the SBA can help.
The SBA has two different loan programs: 7(a) and 504. We will cover each below.
SBA 7(a)
The 7(a) loan program, frequently called the SBA's flagship loan program, is a cash flow-based loan. Therefore, the program's primary emphasis isn't based solely on net worth or the project's loan to value (LTV), like some other loan types. Instead, it is based mainly on the project's ability to pay for itself.
The SBA does not make this loan, nor is the SBA's money used to fund the loan. Instead, the individual bank lends their money, and the SBA guarantees part of the loan against any losses the bank might suffer if the loan defaults. This guarantee is like an insurance policy for the bank and allows for better than standard terms and conditions compared to other loans.
The minimum equity requirement of the program is only 10%. However, since each loan and situation are different, a higher equity requirement might be needed for the loan to work. Compared to the equity requirements that many conventional loans require, the 7(a) program is much more flexible. It has helped many people get into the business who didn't have enough equity to obtain a conventional loan.
There are no financial covenants for a 7(a) loan such as maximum/minimum Debt Service Coverage Ratio (DSCR) or LTV requirements to put added pressure on your business. The only way you can have your loan called is if you don't make your payments.
7(a) loans for self-storage are 25-year, fully amortizing loans, meaning that you may never have to refinance and incur the associated extra expenses for closing costs, etc. Some businesses may want to refinance when they are at a point where they are stabilized and have a good solid cash flow because there is usually a local bank that may be able to grant a low-rate conventional loan. This also allows the borrower to possibly take cash out at closing for another SBA loan to grow their business.
Working capital and interest reserves can be added to 7(a) loan requests making them excellent sources of capital for construction projects to help get you to break even as you lease-up. The 7(a) is also a viable option for acquisitions and repairs to an acquired facility.
There is a $5 million cap per guarantor on the 7(a) program. However, some lenders, like Live Oak Bank, can potentially add several million in conventional funds if the project is larger than $5 million. This is called a combo or pari-passu loan, and it is a companion loan with virtually the same terms and conditions as the 7(a) loan. Some banks may not be willing to do this type of loan because it increases their risk and exposure.
Prepayment penalties are required if the loan is paid off in the first three years, but you can prepay up to 25% per year without a penalty. The penalty amounts are 5% for year one 3% for year two and 1% for year three, starting when the loan closes.
There are no origination fees, but there is an SBA fee that is rolled into the loan. There is a formula for calculating this fee, but using a rule of thumb, it is roughly 2.75% of the total loan amount.
This is a recourse loan that requires personal guarantees. Anyone who is at least 20% owner of the project must meet the qualifications required by the SBA. These are:
There are also some other size standards that the applicant business (including affiliates) must meet to show that you aren't 'too big' for an SBA loan. A couple of those are:
SBA 504
The 504 loan program is structured differently. While the 7(a) is funded entirely by the bank, the 504 is funded as follows:
A 504 loan requires a minimum of 10% equity to expand an existing business operating for at least two years. The minimum equity requirement is 15% if it is a new business. Therefore, if it is a new business, you will have to bring 50% more equity than a 7(a) loan. In some rare cases, there could be a requirement of 20% equity for new businesses.
It can take longer for a 504 loan to close because a minimum of three entities must review and approve the loan: the bank, the SBA and a CDC. The CDC is a liaison that facilitates the loan with the SBA and the bank. Sometimes, an additional bank is involved to limit the exposure of the first bank, which may happen when there is a large loan amount. Sometimes a 504 loan will be recommended for construction. As you recall, with the 7(a) loan, you can include the working capital and the interest reserves to get you through lease up until the facility can pay for itself. With the 504, you cannot include these costs in the loan amount, but if the total loan amount meets certain criteria, you can use a 7(a)-companion loan with the 504 to help cover this need. The caveat is that the 7(a) loan, in this case, will have only a 10-year term, which will make your payment higher and could affect your cash flow.
The bank's prepayment penalty amount varies by institution, but the prepayment term is usually around five years for the bank-funded portion of the loan. The prepayment penalty term on the SBA-financed portion of the 504 loan is ten years. There is a formula for calculating the amount on this portion, but the rule of thumb is that the prepayment penalty is based on the interest due the year you want to prepay. It starts with roughly all the interest due that year and declines by 10% per year. i.e., all the interest due in year one, 90% of the interest due in year two, and so on for ten years. There are also only certain times during the year that you can make this prepayment.
The SBA portion of the loan has a fixed rate for up to 25 years, but the bank's portion can be fixed or variable and may be fixed for shorter terms, such as three or five years.
The SBA loans described in this article are excellent options for small business owners, and you should talk with your lender to decide which is best for you. Many successful companies have started with an SBA loan.
Please feel free to contact our lending team with any questions. You can learn more or connect with our team at liveoakbank.com/self-storage.
Anna Taylor is the Head of Self-Storage Lending at Live Oak Bank. Since 2015, Anna has focused exclusively on lending to self-storage entrepreneurs; financing acquisitions, refinances, expansions and new construction projects. With over $300 million of closed loans to date, Anna leverages her industry expertise to provide excellent customer service and empower her customers to reach their professional goals. In her spare time, Anna enjoys spending time with her family as well as playing golf and tennis.
