SBA Loan Changes Make Financing Your Next Storage Project Easier

by Katherine D’Agostino

In November 2023, the Small Business Administration (SBA) made significant changes to its loan refinancing programs, primarily the 504 Debt Refinancing Program. This initiative aimed to provide relief and support to small businesses struggling with existing debt burdens and to make access to capital easier.

Here are some key changes that were made that can help you get your deal to the finish line – whether you are buying or developing self-storage, boat and RV storage, flex warehouse or contractor yards – and beyond (think refinancing and paying out partners):

Expansion of Eligibility –  

The SBA broadened the eligibility criteria for storage businesses looking to refinance their existing debt through the 504 Debt Refinancing Program. The requirement for “substantially all” of the qualified debt to be used toward an Eligible Fixed Asset (land, buildings, machinery, and equipment) was lowered to 75% instead of 85%. This expansion allowed more small businesses to qualify for refinancing, potentially providing them with better loan terms and reduced financial strain.

The SBA 504 and 7a are the two primary loan programs in the self-storage industry. The 7a loan caps out at $5 million and the 504 loan at $14 million. Ben Smith, Vice President of Celtic Bank, said both programs work well.

“With the 7a, your rates are generally a little higher. Your fees are a little higher and the prepayment penalties are less severe,” Smith said. “Under the 504 program, your down payment’s a little lower: 10-15%. The rates and fees are lower. The process is a little more intense and the prepayment penalties are steeper, but it’s also a good program.”

Seller Debt Now Qualifies as Equity –

Seller debt can be used as equity toward a down payment for 7a loans. Prior to these changes, seller debt was not an acceptable way to come up with the 10% down needed for a 7a loan and could only count for 5% of the required equity injection. It can now count as the full 10%.

Borrowers can now also pay on their seller debt while they are paying their 7a loan after they have paid on their 7a loan for two years (it used to be on full stand-by until the bank loan was paid). There cannot be a balloon payment in the seller debt and it must be fully amortized.

If a borrower’s seller debt is not counting toward equity, of course, the seller debt can have any terms that the borrower and seller agree to. It is important for borrowers using seller debt as equity to review the language in their seller financing agreement with their bank lender prior to finalizing it to make sure it is compliant with SBA requirements.

Smith explained the bank is simply making sure the seller financing terms make sense. “Is it a reasonable interest rate? Is it a reasonable amortization or payback period? 25% due in six months doesn't make sense. But 7% interest on standby for the first two years, followed by three, five, or seven-year repayment; that's a good deal.”

Cody Baker, CEO of Baker Capital Partners, said that the SBA doesn’t typically like the seller to carry notes, but as long as the debt is covered below the threshold of leverage, it should work.

“The stipulation that we had on a recent deal was similar to what Ben describes,” Baker added. “The seller wanted to do a five-year note, but because the bank's portion was a 10-year note and there was a 25-year note from the SBA, the bank wanted the seller note to match the 10 years.”

HELOCs and Cash Out Refinances are Now Allowed –

The new terms made it easier to use borrowed funds when sourcing equity for the down payment. Soft costs and land that has been paid for and are included in the project budget have always counted towards the equity of the self-storage project. Gift letters have commonly been part of the SBA 7a program, explained Nick Collins, Vice President of Bank Five Nine.

HELOCs on a home or other real estate and cash out refinances of real property are now allowed as part of borrower equity. “Keep in mind, a bank would still need to include the HELOC or cash out refinance debt terms into the cash flow analysis and combine that debt along with any bank debt being used for the self-storage facility,” Collins said. “Being gifted the down payment has always been a straight-forward process as long as a gift letter is drafted from the money source and there are no repayment terms expected.”

“The first-time buyer being able to utilize residential real estate is huge,” Baker said. “I believe you can also use unrealized equity in the home, even if you have debt on the home. If you have a hundred grand worth of equity in the project and the property, you can put that up as a collateral piece and utilize that hundred grand as equity.”

Streamlined Application Process –

To facilitate the refinancing process for small businesses, the SBA implemented changes to streamline the application and approval process for 7a and 504 loans and for the 504 Debt Refinancing Program. This included reducing paperwork requirements and expediting the review process, enabling businesses to access much-needed funds more quickly.

Minority investors who own less than 19% or less of the self-storage, boat and RV storage, flex warehouse or contractor yard facility no longer have to provide three months of bank statements showing their funds. Each guarantor or investor must typically provide one month of bank statements and sign an investor affidavit.

Under the recent changes to the SBA program, personal equity injections may not come from a business balance sheet without being transferred to a personal account first. Funds may come from a HELOC, or a line of credit as previously discussed, but must be transferred to a personal account.

”There's a limited amount of information required on individuals with 19% ownership or less. However, every lender can ask for as much information as they want,” Smith clarified. “If the 19% owner is providing 80% of the down payment, they may request to see more information from that individual. Every lender is different but there is the possibility a lender could want to see the financial. well-being of that 19% owner. And that might result in a personal financial statement or personal and business tax returns or bank statements.”

Partner Buyouts and Partial Changes of Ownership Got More Difficult –

SBA requires equity when there is a complete change of ownership, a change of ownership between existing owners, and partial changes of ownership. If the remaining partner is borrowing the money to buy a partner out, the borrowed funds cannot exceed a ten-year period which would hurt cash flow.

“In the case of a partial change of ownership, the project must reflect debt to worth ratio no greater than 9:1 on most recent financial year end and current quarter balance sheets,” added Collins. “If it doesn’t meet the above, cash in the amount of 10% of the ownership purchase price is required.”

Acquisitions as Expansions with No Money Down –

Acquisition of other self-storage, boat and RV storage, flex warehouse, or contractor yard facilities can now be considered expansions if the self-storage owner or ownership group is looking to purchase an existing site, expanding a site, or building a new site because it is viewed as expanding the business.

“Depending on the 7a or 504 program, an owner will have to have 12-24 months of ownership history in their current facility,” Collins said. “With the 7a, you can technically obtain a new 7a loan with zero money down for the expansion by using the equity for the first facility you own.”

Acquisitions projects may be considered expansions if ownership in both facilities is the same, if they share the same NAICS code and if they operate in the same geographic area. The geographic area is open to interpretation by the bank. For example, if an operator is opening or acquiring a facility an hour from another facility he/she owns that will be operated under the same management, that could be considered an expansion.

Baker emphasizes the seasoning aspect of how long a borrower has owned that land is crucial. “If you just bought a storage facility three or four months ago, most banks won't allow you to two months later realize a new value even if it is producing more because of the ownership seasoning required. Most banks require 12 to 24 months of ownership seasoning in order to realize a new appraisal value and pull out all equities into the project.”

“The analysis I take clients through all the time when they want to refinance is, what does your ownership seasoning look like? How much cash did you put in? How much are we trying to pull out?” said Baker. “If you put in a million bucks, and we're only trying to pull out half a million bucks and the bank’s requirement is 24 months, but we're at 20 months or 18 months, we can probably make that happen because we're not cashing out all the skin in the game.”

Personal Resources Test is Eliminated –

The SBA is no longer looking at people’s liquid assets to determine eligibility for an SBA loan.

“A general rule of thumb is someone could possibly be considered “too good” for the SBA if their cash on hand equals or exceeds the loan being requested,” said Collins. “Net worth shouldn’t impact an individual since some people have a high net worth but is equity in real estate projects.”

“There have been times where a bank could argue that even though someone has the liquidity level that may be questioned by the SBA they need to keep liquid reserves for business purposes, emergency funds, operating capital, taxes, and other needs. I think there is more flexibility in the “net worth” rule than people may think.”

Baker adds, “Currently, conventional banks are having a hard time with liquidity across the board, therefore, they’re leaning heavily on borrower liquidity as a second source of repayment, along with requesting deposits from that stated liquidity of the sponsor. The SBA lends to start-up businesses and entrepreneurs so this liquidity hurdle seen across the country is much easier through the SBA loan program at this time.”

Debt Refinance is Easier –

Historically, the SBA would not allow an SBA loan to be refinanced with another SBA loan.

“Now that is possible, which allows someone that is currently in a 7A floating rate SBA loan to refinance into a 504 SBA loan with a fixed rate,” explains Baker. “This is beneficial to the borrow because it protects against market fluctuations.”

In addition, banks no longer require written proof that a borrower’s current lender will not refinance their 7a SBA loan. In order to be eligible to refinance, the new monthly payment must be reduced by at least 10%. The borrower’s SBA loan must have been current for twelve months in order to be eligible.

REITs as Third Party Managers –

Previously, the SBA viewed self-storage and boat and RV storage facilities managed by real estate investment trusts (REITs) such as Public Storage, Extra Space, CubeSmart Self Storage or National Storage Affiliates, as passively managed. Therefore, facilities managed by a REIT were not considered for SBA loans (although any other third party management company that was not a REIT was allowed).

This has now changed, and self-storage owners may now have a REIT-managed facility and qualify for an SBA loan. The REITs themselves are not allowed to use the SBA loan program.

“A bank still has to review the third-party management agreement to make sure it complies with the SBA SOP rulebook. I think using a REIT is still a gray area with compliance requirements,” added Collins.

“Management agreements that give the management company sole discretion over the business operations with minimal oversight of the decision-making by the storage facility, while not passive, create affiliation between the management company and the storage facility’s owner,” Collins explained. “The SBA has determined, however, that affiliation is not created between the storage facility’s owner and the management company if the management agreement includes meaningful oversight by the Applicant business over the management company’s activities.”

To clarify, “Meaningful oversight” by the Applicant business means involvement in the decisions made concerning the operation of the business, which include a management agreement that provides for the storage facility’s ownership to do all of the following:

·       Approve the annual operating budget;

·       Approve any capital expenditures or operating expenses over a significant dollar threshold;

·       Have control over the bank accounts; and

·       Have oversight over the employees operating the business (who must be employees of the Applicant business).

SBA 504 Refinancing–

The SBA extended the maximum loan term available under the program, giving borrowers more flexibility in managing their debt obligations. Longer loan terms can result in lower monthly payments, easing the financial burden on small businesses and improving their cash flow. Borrowers can consolidate multiple loans and their equity in the collateral often fulfills the down payment requirement.

Many small business owners are not aware that they can refinance their commercial mortgage with an SBA 504 loan to help free up trapped capital and the low, long-term, fixed interest rate allows lower monthly payments. The refinancing can be used to purchase land or buildings, construct, upgrade, or renovate buildings, or purchase equipment with a service life of ten years or more.

Self-storage, boat and RV storage, flex warehouse or contractor yard projects will likely qualify for the 504 Refinance Program if the original loan is at least 6 months old, the property is at least 51% owner-occupied or long-term equipment, and/or the debt to be refinanced was originally used for the purchase and improvement of fixed assets.

Increased Loan Amounts –

The SBA raised the maximum loan amount that eligible businesses could receive through the 504 Debt Refinancing Program. This increase provided small businesses with access to larger amounts of capital, allowing them to refinance more of their existing debt and potentially obtain better terms for their self-storage, boat and RV storage, flex warehouse, or contractor yard development.

Overall, these changes were designed to make it easier for small businesses to refinance their existing debt and improve their financial health. By providing access to affordable capital and reducing administrative burdens, the SBA aimed to support the growth and sustainability of small businesses across the country.

Contact Sensei Katherine to receive specific guidance on how to do a self-storage feasibility study that results in a self-storage business plan with high occupancy and the highest possible return. She offers a free preliminary report which provides an objective review of any proposed project to determine if the market’s demographics, competition and demand support its development. Schedule a meeting and find more information at https://www.selfstorageninjas.com/self-storage-feasibility-consulting.