Real Estate Strategies for Small Business Owners as Rates Rise

By Mark Abell

Source: Entrepreneur

In a rising interest rate environment, the cost of capital is edging higher for all small businesses, but especially those who need to purchase property. As a result, U.S. entrepreneurs are returning to banks in large numbers seeking to finance real estate projects.

In many respects the current business climate is perfect for an uptick in small business lending. Business optimism has reached its highest since July 2007, according to the Wells Fargo/Gallup Small Business Index, with a reading of 100 in February, up from 80 in November and 33 points higher than a year ago. Business owners are taking advantage of a better financial situation, enjoying increasing revenue, stronger cash flow and improving access to credit. Since the 2008 financial crisis, small business owners have relied heavily on loans with adjustable interest rates. After all, interest rates were near zero for almost a decade. Now that’s changing. The U.S. Federal Reserve in March increased interest rates for the third time since the financial crisis. While the Fed’s benchmark rate remains at a very low level, below 1 percent, the average interest rate on a 30-year mortgage has risen a half a percentage point higher over the last year, as has the U.S. Prime Rate, the benchmark rate for many small business loans.

Small business owners seeking to finance real estatemortgage loans, ranging from as little as $150,000 to as much as $20 million, have three basic choices.

Conventional commercial mortgages

The cheapest financing option available to small businesses are conventional mortgages. Banks will consider a conventional mortgage for a well-established firm with a predictable revenue stream. Business owners will need a down payment of at least 20 percent for a general use building, such as an office or warehouse building. For specialized-use building, such as a bowling alley or a hotel facility, banks prefer deposits of 30 percent. Startups without profits and firms less than two years old will generally not qualify for conventional loans.

These loans typically have terms of three to 10 years with payments based on a 20- or 25-year amortization and carry interest rates (today these are generally in the mid-4 to mid-5 percent range for most borrowers) that are fixed on the shorter term loans, but adjust after five years on the longer term loans. At the end of their term, these loans typically need to be refinanced into a new loan, which means you have the added costs of new appraisals, environmental reports and loan fees each time they refinance.

The 7(a) loan program

The Small Business Administration’s most popular loan has dominated lending while interest rates have been near zero. These flexible loans typically have an interest rate of up to Wall Street Journal Prime Rate plus 2.75 percent. Today that’s equal to 6.75 percent.

Borrowers can prepay the loans up to 25 percent each year for the first three years without penalty; and after that they can prepay as fast as they want without penalty. The interest rates on these loans often adjust quarterly, so rates will rise with each Fed move. On the other hand, monthly payments are kept lower because these loans have a term of up to 25-years. Businesses can put down a deposit of as little as 10 percent, although loans that exceed 85 percent of the property’s value may require additional collateral.

These loans are especially helpful for younger companies and rapidly growing companies that have cash constraints, but they have the added advantage of never needing to be refinanced and provide low-cost prepayment options for firms that want the option to repay early.

Read Full Article Here