Mr. Hurn

Finance & Investment

SBA 504 Loan Program Levels Playing Field for Small Hoteliers

By Christopher G. Hurn, President & CEO, Mercantile Commercial Capital LLC

In the hyper-competitive hotel business, keeping pace with the major flags and industry giants can be a daunting task for small hoteliers and franchise operators. Banks and other lenders take very close and careful assessments of the small hoteliers' track record and personal credit history when considering financing. Access to capital, which is essential for the small hotel owner/operator to maintain and enhance their property and amenities, is extremely difficult, and ultimately this prevents many of these smaller businesses and properties from reaching their fullest potential.

One of the best solutions for the small owner/operator is the Small Business Administration's 504 loan program, which enabled 753 hoteliers to borrow $802 million during the 2006 federal fiscal year. This total number of borrowers was significantly greater than any other type of business, and it amounted to approximately 14 percent of all of the 504 loans in the country.

These borrowers and hundreds of others in previous years took advantage of the very best possible option for financing for the acquisition or development of their properties. With an SBA 504 loan, first-time owners receive up to 85 percent loan-to-cost financing with the highest cash-on-cash return available in the marketplace. This leaves more of their hard-earned capital to redeploy elsewhere at a higher ROI.

Nearly half of the total loan amount with a 504 loan is the least expensive financing available in the commercial mortgage industry for small and mid-size businesses (averaging about 150 basis points less than market pricing for fixed 20-year terms).

In all 504 loans for hotels, a certified Community Development Corporation (CDC) provides up to 35 percent of the financing for a project under the SBA 504 loan program. A commercial lender provides up to 50 percent, yet they enjoy the low risk of a first-security position.

The borrower's capital contribution is at least 15 percent, and it goes up to 20 percent for companies with an operating history of less than 24 months. The additional equity requirement from the borrower reduces the amount of financing under the SBA portion, so for start-up hotels the financing would be 50 percent from the private sector, 30 percent from the SBA and 20 percent from the borrower.

For construction projects, the private-sector lender covers the entire 80 to 85 percent of the loan for the construction phase after receiving a commitment for 30 to 35 percent of that amount from a CDC under the 504 program. Upon completion of the project, the CDC sells a debenture for its 30 to 35 percent stake and assumes that portion of the debt by reimbursing the commercial lender. The debentures are typically for 20 years and fully amortized, so the borrower then has a 20-year loan. The private-sector lender's portion of this loan may be tied to a variety of indexes, including U.S. Treasuries, FHLB, LIBOR swaps, and the Wall Street Journal Prime rate plus a spread.

The loan fees for the first-mortgage portion are typically 1.5 percent of that amount, and borrowers are able to build these fees into the financing. The total interest rate on the SBA portion of the loan based on recent debenture sales and including fees has been approximately 6.5 percent. SBA 504 loans do not finance franchise fees, working capital or inventory, and they cannot be used to refinance entire projects. However, the loans are ideal for expanding existing projects or launching new construction.

Conventional commercial financing and the SBA 7(a) program simply do not measure up to the 504 loan for the small hotelier to acquire and develop their own facilities. The loans are ideal for both new construction as well as expansions of existing properties. Most 504 borrowers save substantial up-front cash that is then used to fund the operating expenses of their business. Moreover, the interest cost saved by utilizing a 504 loan vs. other alternatives is also significant.

The ability to procure capital for the small hotelier is even further enhanced with the 504 because it enables the borrower to include renovation, closing and other soft costs along with furniture, fixtures and equipment (FF&E) into the financing package. For many of these small businesses, the ability to include FF&E into this long-term financing package is critical to cash flow management and enables them to increase profitability.

The 504 loans are granted to almost any type of for-profit U.S. small to mid-sized business owner with the exception of financial service providers, passive real estate investors, companies having a tangible business net worth greater than $7 million, or companies with net profits after taxes that averaged more than $2.5 million during the past two years. As a community lending program, the 504 program requires applicants to demonstrate job formation, export potential or other economic development goals. The loan must be used for capital expenses including land, buildings, new construction, renovations and equipment. Owner occupancy requirements are 51 percent for existing buildings and 60 percent for new construction.

SBA 504 loans feature very competitive fixed interest rates when compared with conventional financing - 6.5 percent (fixed for 20 years) as recently as June 2007. The resulting blended overall rate is often well below conventional loans. In addition, borrowing from the SBA 504 program does not preclude hotel owners from also applying for funding from the SBA 7(a) program for working capital, inventory and other needs.

SBA 504 loans require the same amount of documentation and due diligence as ordinary commercial loans. Approval processes, too, are comparable to conventional loan processing when borrowers work with experienced commercial lenders.

A significant portion of all SBA 504 loans go to start-up businesses, and the program is inarguably one of the best tools for new companies to enter the hospitality arena. There is limited capital available for new hoteliers who hope to finance the acquisition of their first or second property. Access to financing is even more limited for new construction for these young businesses. The traditional sources for capital for these businesses have been investors, relatives and former operating partners, e.g., property managers who purchase the facility that they are currently operating from the owners.

Many savvy business owners purchasing their first, second or even third hotel/motel property do so with the help of the 504 loan program. Once they outgrow their 504 eligibility and are operating several successful properties, they turn to conventional bank financing, which is readily available for larger operators, for their subsequent projects.

As with all hotel financing, securing a 504 loan for an existing property requires a profitable operating and occupancy history, and factors such as the strength of the flag, management and location are also important.

Essentially, the 504 loan program levels the playing field for small hoteliers with the large companies by enabling them to obtain higher loan-to-value ratios at below market fixed interest rates for up to 20-year terms. There are many examples of companies such as Moon Dye and AHKH who have used it to enable them to maintain a competitive edge, and the increasing costs of commercial real estate and construction are going to drive even more small hoteliers to the loan program in the future.

Christopher G. Hurn is the President and CEO of Mercantile Commercial Capital LLC, one of the nation's leading providers of SBA 504 loans for small business owners wishing to acquire or develop their own facilities. Previously, he worked as a senior management consultant, financier and executive with companies such as GE Capital, Heller Financial and NAI Realvest. Mr. Hurn attended the Georgetown's Law Center and holds a Master's from the UPenn's Fels Center (formerly at the Wharton School of Business). He earned two Magna Cum Laude Bachelor degrees (B.A. and B.S.) from Loyol. Mr. Hurn can be contacted at 407-786-5040 or churn@mercantilecc.com Extended Bio...

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