CMBS loans and SBA 504 loans are two incredibly popular forms of commercial real estate financing, but they have several important differences. CMBS loans, also known as conduit loans, are issued by lenders, pooled with other similar loans, and then sold on the secondary market. In comparison, SBA 504 loans, which are guaranteed by the Small Business Administration (SBA), are 50% financed by a lender, and 40% financed by a Certified Development Company (CDC), a local non-profit group intended to increase economic development in a specific area. The remaining 10% consists of a borrower down payment.

In general, CMBS loans have partially amortizing loan terms of 5, 7, or 10 years, with amortizations of between 25 and 30 years. SBA 504 loans, however, have fully amortizing loan terms of 25 years. Generally, SBA 504 and CMBS interest rates are quite similar, with both rates sitting around 5% for most loans. It should also be mentioned that since SBA 504 loans are intended for small businesses, they can also finance the purchase of heavy equipment, which will be used to collateralize the loan. In comparison, CMBS loans can only be used to purchase commercial real estate.

The biggest difference between CMBS and SBA 504 loans is the fact that CMBS loans typically do not allow for owner-occupied commercial real estate, while SBA 504 loans require that the property in question be owner occupied. So why would a borrower ever have to choose between the two? Well, there are exceptions to the rules, and that’s where things get more complex.

In certain cases, highly-qualified CMBS borrowers can occupy as much as 60% a building, as long as they rent the remaining 40% out to a similarly qualified tenant with a long-term lease. And, just like CMBS borrowers, well-qualified SBA 504 borrowers may also be able to occupy as little as 60% of a building, leasing around 40% of the property to one or more eligible tenants. So, for borrowers who want to occupy some, but not all, of a commercial structure, both CMBS and SBA 504 loans could be a smart option.

CMBS loans offer commercial real estate investors a number of advantages, including:

• Flexible underwriting guidelines
• Fixed-rate financing
• Fully assumable
• Lenders and bondholders can potentially achieve a higher yield on investments
• Investors can choose which tranche to purchase, allowing them to work within their own risk profiles

For more information, please see this article and this article.

Given that there are several different types of Small Business Administration loans available, not to mention conventional financing options out there, it makes sense to wonder exactly what benefits a small business could see from a 504 loan. Actually, there are quite a few that make this a very good option for almost any business.

• Almost all small businesses in the U.S. will qualify: While the 504 loan program does have a wide range of requirements, almost all small businesses in the US will qualify for the program. However, realize that in order to qualify, your business must be beyond the beginning planning stages. That is, you must be ready to purchase property, invest in a building, or start construction of a new building, for example.
• 90% financing: The 504 loan program offers small business owners access to up to 90% financing for their project. This is more than most other options on the market. Even 7(a) loans from the SBA are only able to fund 85 – 90% of the project. Conventional loans fall below that mark (60 – 75% funding).
• Longer amortization periods: SBA 504 loans offer longer amortization periods (10, 20, or 25-year terms depending on what is being financed), allowing you to spread your payments over a longer amount of time to reduce the amount paid per payment.
• No balloon payments: 504 loans are not balloon loans. That is, you will pay on your loan without having to worry about making a very large payment at the end of the term. In this way, it more closely resembles a fixed-rate home mortgage.
• Fixed-rate interest rates: While the interest rate on the loan will vary depending on the market at the time the loan is made, it will be made at a fixed-rate interest rate, below the current market, and will be fixed for the duration of the loan’s term (10, 20, or 25 years).
• Cash savings: Conventional loans require that you pay around 1% of the loan’s value out of your own pocket in fees. Even 7(a) loans require that you pay between 2% and 3.75% of the loan amount out of pocket. The 504 loan requires that you pay a maximum of 2.65% of the loan’s value in fees, but those costs are included in the loan amount, meaning that you have only the down payment when it comes to out of pocket costs.
• Low down payment: Speaking of down payments, the SBA 504 loan usually only requires 10% of the loan value down. A 7(a) loan will require between 10 and 15% down, and a conventional loan will require between 25 and 40% down. This makes the 504 loan the most affordable option available to most business owners. However, note that your down payment may be higher depending on the project.

The major downside of CMBS loans is the difficulty of getting out the loan early. Most, if not all CMBS loans have prepayment penalties, and while some permit yield maintenance (paying a percentage based fee to exit the loan), other CMBS loans require defeasance, which involves a borrower purchasing bonds in order to both repay their loan and provide the lender/investors with a suitable source of income to replace it. Defeasance can get expensive, especially if the lender/investors require that the borrower replace their loan with U.S. Treasury bonds, instead of less expensive agency bonds, like those from Fannie Mae or Freddie Mac.

In addition, CMBS loans typically do not permit secondary/supplemental financing, as this is seen to increase the risk for CMBS investors. Finally, it should be noted that most CMBS loans require borrowers to have reserves, including replacement reserves, and money set aside for insurance, taxes, and other essential purposes. However, this is not necessarily a con, since many other commercial real estate loans require similar impounds/escrows.

The eligibility requirements for SBA 504 loans are pretty simple. Your business must be a for-profit organization, must meet current SBA size standards, have a net worth of less than $15 million, not earn more than 1/3 of its income from packaging SBA loans, and have an average net income of $5 million or less after taxes for the preceding two years. Additionally, your business cannot be engaged in any sort of passive or speculative activities. You can find a full list of eligibility requirements and other important information with the SBA here. Note that additional requirements may be placed by CDCs or conventional lenders.