Commercial real estate financing is especially important for franchisees because owning the land beneath one’s business is still one of the quickest ways for a small- business owner to create wealth and grow a business. U.S. President Franklin D. Roosevelt once said that real estate is “about the safest investment in the world.” Some might disagree, given the recent housing bubble and economic woes, but FDR’s words still ring true for those who go about it the right way.
Why Franchisees Should Own Their Commercial Property
Today’s economic environment may cause a lot of franchisees to second-guess commercial property ownership, but now is actually a near perfect time to purchase one’s own commercial property. Owning is almost always financially smarter than leasing. It’s the reason home ownership continues to be such a strong ideal (and why you probably own your home). A mortgage payment that builds equity is preferable to paying a landlord.
Speaking of building equity, commercial property as an asset class has appreciated an average of 3.5 percent per year during the past 50 years. This is a long-term investment that will pay off substantially down the road, regardless of what the Wall Street rollercoaster does during the next several months.
Something else to consider is how cumbersome real estate expenses can be. Of course, real estate appreciates over time, but rent also increases an average of 2.5 percent per year. With the right financing, it’s often possible to lower monthly real estate expenses by owning instead of leasing. This is a pretty big deal when put in perspective. Real estate is generally one of the largest expenses for any business, and getting those costs under control by taking advantage of fixed interest rates gives a franchisee freedom to better allocate resources and grow his or her business.
For franchisees who don’t intend to operate the franchise business forever, commercial property ownership allows them to become the landlord after the business is closed or sold. Retaining the commercial property through an eligible passive concern or EPC creates passive income that can help ensure a worry-free retirement.
The Right Financing for the Job
If a franchisee plans to own his or her commercial property, there’s a strong chance the purchase won’t be a cash transaction. That means the franchisee will need to secure financing. Right now, it’s not exactly easy for franchisees to get commercial property financing from conventional commercial lenders. However, there are alternatives to ordinary bank financing, and SBA loans in particular are filling the void.
The SBA has two flagship loan programs, the 7(a) and the 504. The 7(a) is what most commercial lenders refer to when talking about SBA financing. This loan is perfect for business acquisitions, start-up capital, working capital and partner buy-outs. Two downsides to 7(a) loans are that they are fully-collateralized (some business owners end up with a second lien on their home to satisfy this requirement) and have variable interest rates.
The Best-Kept Secret
The SBA 504 loan, on the other hand, was created specifically to finance commercial real estate and heavy equipment (or furniture, fixtures and equipment referred to as FF&E). These loans feature lower down payments than conventional commercial financing (as little as 10 percent down as opposed to 20-30 percent); longer amortizations (up to 30 years, which keep monthly payments low); and below-market, fixed interest rates (which keep monthly expenses consistent). Another big perk of 504 loans is they deal with total project costs rather than just a purchase price or an appraised value (conventional financing generally deals with the lesser of these). The total project cost can include the purchase price of the property, any construction/ renovation costs, FF&E, soft costs and closing costs. Rolling these traditionally out-of-pocket expenses into the amount to be financed leaves more capital available to deploy elsewhere in the business.
The 504 program is a tremendous tool for franchisees who want to own their commercial property (arguably the best available), but it’s not usually the first option commercial lenders present. Part of the reason for this is that the lender stands to make less money on a 504 loan than they would on a 7(a) or a conventional loan. A 504 loan is structured in three parts: a commercial lender provides a first mortgage for 50 percent of the total project cost, a Certified Development Company or CDC provides a second mortgage for up to 40 percent of the project, and the franchisee is responsible for the remaining 10 percent equity. From a conventional lender’s perspective, it’s more lucrative to lend 70 percent or 80 percent rather than just 50 percent. But the 504 program’s lower down payment and better terms are in the best interest of the franchisee.
Lingering myths surrounding the SBA have also held back the 504 program. Some business owners and even some commercial lenders view the SBA as an antiquated, slow, cumbersome, fee-ridden lender of last resort. This is simply not true. The agency has made great strides in the past 10 years to become as efficient (if not more efficient) than conventional lending, and the vast majority of SBA borrowers are very bankable business owners. Despite what may have originally caused such pre-conceived notions about the SBA, its programs (the 504 especially) are now the choice of smart and savvy franchisees.
The Foreseeable Future
Until the economy gets back to its old self, which may be quite a while, conventional lending will continue to remain on the sidelines or frozen. In the meantime, SBA lending will continue to prosper and franchisees will be able to obtain the financing they need to purchase or expand their commercial property from lenders who specialize in SBA loans.
The Small Business Jobs and Credit Act of 2010 created the SBA 504 Loan Refinance Program which has given hundreds of business owners access to the embedded equity in their commercial properties. Proceeds from these refinances can be used for qualified business expenses, which is essentially working capital.
This helpful program has the potential to be the catalyst that gets America’s small- business owners firing on all cylinders again, but it’s set to expire on Sept. 27. If this is the first you’re hearing of it, blame it on the slow roll-out that has hindered its reach. All is not lost, though—there’s still a short window of time to apply for a 504 refinance, and there’s a very small chance Congress will extend this refinance program another year. If that happens, it will be easier to see through the murkiness to true economic recovery.
Chris Hurn is CEO and co-founder of Mercantile Capital Corporation, a three-time Inc. 500|5000 company, two-time SBA Financial Services Champion, and one of the largest providers of SBA 504 loans nationwide. He can be reached at 866-622-4504 or email@example.com.