Outgrowing a rented space, or wanting to own the one you have, is a turning point for a growing business. The SBA 504 loan program was built for that kind of major fixed-asset purchase. Here is how a 504 loan works for buying a commercial building, what the rules require and how to get ready.
Flex Fuel does not promise funding, approvals or rates. This article is general education, not legal, tax or financial advice. Program rules change, so confirm current details with the SBA and a Certified Development Company before you make decisions.
What an SBA 504 loan is
According to the U.S. Small Business Administration's 504 loan page, the program provides long-term, fixed-rate financing for major fixed assets that promote business growth and job creation. 504 loans are made through Certified Development Companies (CDCs), which the SBA describes as community-based nonprofit partners that are certified and regulated by the SBA. CDCs work alongside a senior lender, usually a bank, to structure the project.
The SBA lists a maximum 504 loan amount of $5.5 million, with 10-, 20- and 25-year maturity terms available.
What a 504 loan can and cannot pay for
Per the SBA, eligible uses include:
- Buying, building or renovating existing buildings or land
- Long-term machinery and equipment with a useful remaining life of at least 10 years
- Certain debt consolidation and refinancing that meets the "qualified debt" rules in 13 CFR 120.882
A 504 loan cannot be used for working capital or inventory, for debt that does not meet those rules, or for speculation or investment in rental real estate. If you are looking at an investment property rather than a home for your own business, a 504 loan is not the tool; our guide to a first rental property covers that path. If you already have expensive debt on a building, our guide on how to refinance business debt explains the 504 refinancing rules.
How a 504 deal is structured
A 504 project usually has three pieces: a loan from a third-party lender, the 504 loan through the CDC and SBA, and your own contribution.
Your contribution (the down payment)
Under 13 CFR 120.910, the borrower must contribute cash, acceptable property bought with cash, or land that is part of the project, equal to a percentage of the project cost (excluding administrative costs):
- At least 10% in most cases
- At least 15% if the business has operated for two years or less
- At least 15% if the project involves a limited or single-purpose building
- At least 20% if both of those conditions apply
The lender's share
Under 13 CFR 120.920, the third-party loans must total at least as much as the 504 loan. If the business has operated two years or less, or the project is a limited or single-purpose asset, third-party loans must total at least 50% of the project cost. The 504 loan is usually secured by a second lien on the project property.
Under 13 CFR 120.921, the third-party loan must run at least 7 years alongside a 10-year 504 loan, and 10 years alongside a 20-year 504 loan.
A hypothetical example
This example is hypothetical, with made-up numbers, and is not a quote or a promise of terms. Say an established business that has operated for five years wants to buy an ordinary office-warehouse building for a total project cost of $1,000,000. One structure that fits the rules above:
- Bank loan: $500,000 (50%)
- 504 loan through a CDC: $400,000 (40%)
- Business owner's contribution: $100,000 (10%)
If the same business were only 18 months old, its minimum contribution would rise to 15%, or $150,000, and the bank's share would need to be at least 50% of the project.
Rates and costs
The SBA says 504 interest rates are pegged to an increment above the current market rate for 10-year U.S. Treasury issues, and its page lists costs of approximately 3% of the debt, which may be financed with the loan. Ask for a written breakdown and compare the full cost, not just the rate. Our guide on how to compare business loan offers shows what to line up.
The occupancy rule: you have to use the building
A 504 loan is for a business buying space it will use. Under 13 CFR 120.131:
- Existing building: your business must permanently occupy and use at least 51% of the rentable property. You may permanently lease up to 49% to tenants.
- New construction: your business must permanently occupy and use at least 60%. You may permanently lease up to 20%, and you must plan to occupy some of the remaining space within three years and all of it within ten years.
Who is eligible
The SBA says that to be eligible your business must be an operating business, operate for profit, be located in the U.S., be small under SBA size requirements and not be an ineligible type of business. The SBA also lists qualified management expertise, a feasible business plan, good character and the ability to repay. Loans cannot be made to businesses engaged in nonprofit, passive or speculative activities.
How to prepare before you talk to a CDC
Get organized early:
- Clean financials. Have business tax returns, year-to-date profit and loss and a balance sheet ready. Our guide to business bank statements explains what lenders read.
- Cash flow that covers the payment. Lenders want to see the business can carry the new debt. Our guide to the debt service coverage ratio walks through the math.
- A clear plan. Show how owning the building supports growth; see our guide to a business plan for a loan.
- Your down payment, documented. Know where your contribution comes from and keep a paper trail.
- Personal credit in order. Owners are often asked to sign a personal guarantee, so lenders may review your personal credit too.
Review your personal credit first
Because owners often guarantee business real estate loans, check your own credit before you apply. Flex Fuel clients use SmartCredit to see their credit reports and scores in one place, so there are no surprises when a lender looks. For the business side, see our guide to business credit vs. personal credit.
Thinking about buying a building for your business with an SBA 504 loan? Book a time to review your credit, down payment and documents with us.
How Flex Fuel helps
Flex Fuel works with business owners nationwide (we are based in Atlanta) on funding readiness: reviewing personal and business credit, organizing documents and building a plan before you apply. We only take actions you authorize. Explore our services and see how our guarantee works.
Ready to stop renting and own your space? Book a complimentary strategy session. We will review your credit and funding readiness with you and map out your next steps.
Book a Consultation ›Frequently asked questions
How much down payment does an SBA 504 loan require?
Under 13 CFR 120.910, at least 10% of the project cost in most cases, 15% for businesses operating two years or less or for limited or single-purpose buildings, and 20% if both apply.
Can I use a 504 loan to buy a building and rent all of it out?
No. For an existing building, your business must occupy at least 51% of the rentable space, and the SBA says 504 loans cannot be used for speculation or investment in rental real estate.
Who makes SBA 504 loans?
Certified Development Companies, working with a third-party lender such as a bank. The SBA website lists CDCs.
Can a 504 loan cover working capital?
No. The SBA says 504 loans cannot be used for working capital or inventory.
