Review of the SBA 7(a) Hotel Loan Program
Structure – The SBA 7(a) is a single 25 year fully amortized loan. The SBA offers a 75% guarantee for the lender, which reduces the risk of exposure for the lender by financing their riskier assets, such as hotels that have higher Loan to Values.
Purpose – A 7(a) loan is able to be used for any hotel financial needs. This includes acquisition, refinance, partner buyout, Property Improvement Plans, renovation, as well as loan consolidations, construction, and permanent financial costs.
Rate – The cost spread is calculated depending on factors including the hotel quality, sponsorship, the current market, and how much lender competition there is in that specific market. Starting in 2013, a number of lenders are going to be offering 3 and 5 year fixed rate loans on hotels that are exceptionally strong. When the PRIME rate changes, an SBA (7a) loan will be adjusted.
Maximum Loan – While the maximum amount for a loan is 5 million, it is possible to get a commercial loan to exceed that limit.
Loan to Value – If a business is hoping to expand in the same market, the maximum loan to value is 90%. However, for a start-up hotel the maximum loan to value is capped at 80%.
Debt Service Coverage Ratio – This is when you are dividing your Net Operating income, before any depreciation or interest costs, by your annual debt service. This ratio should be either 1.25 or above. Something to note is that this type of loan does not require you to have any FF&E reserves, therefore the lender is not required to escrow taxes or insurance on it.
Initial Deposit – The initial deposit is usually used in order to cover report costs, including the required appraisal and Phase I report. The deposit usually comes to between $8K and $10K. It’s important to note that all 7(a loans are fully amortized and are usually due 25 years into the loan.
Repayment – The penalty of prepayment declines slowly. In the first year of the loan, the prepayment penalty declines by 3%. The second year it declines by 2%. The first year it declines by 1%. After the third year, there are no prepayment penalty.
SBA – SBA is able to guarantee up to $150,000 on 85% of loans and over $150,000 on 75% of loans. The maximum amount that SBA is able to expose is £3,750,000. Therefore, if a business is hoping for a $5,000,000 loan, the most that a loan lender will be able to guarantee then is either 75% or $3,750,000.
Costs – A few costs to note are that the appraisal is about $5K, the Phase I report costs around $2K, and the Lender processing costs total to about $3.5K. Additional costs total to around $10.5K. Additional costs consist of other legal fees and other attorney costs.
Personal Guarantee and Assumption – The SBA is very strict when it comes to getting a guarantee from any partners in a business that owns at least 20% of the company shares. If one of these partners are not willing to cooperate and offer full guarantee, they must reduce their shares to below the 20% threshold. While all SBA 7(a) loans are completely assumable, the lender must qualify whomever is assuming the loan. The credit grade of the loan simply can’t be lowered by unqualified sponsors assume the loan.
The Benefits of Having a 7(a) Loan for a Hotel
There are many benefits to 7(a) loans, the first being the closing period. Loans are stressful, so getting them over fast is a bonus. The closing of a 7(a) loan is typically between 45 and 50 days, and on top of that the prepayment of either 3 years or 5 years is considered to be the perfect bridge loan, offering a short exit strategy while at the same time not maturing for 25 years.
Another benefit is the high Loan to Value that it has to offer. Not only do SBA loans allow a high loan to value, but they offer ways to increase the LTV such as the seller carrying a portion of the down payment. Again, remember that these loans are assumable therefore borrowers are able to have the hotel buyer assume the loans in order to avoid receiving a huge prepayment penalty.
While the majority of lenders tend to only finance the real estate part of the hotel industry, the SBA tends to include the both FF&E and PIP/renovation costs. On top of that, SBA guarantees that our lenders will be able to supply the necessary funding for hotels of all markets, and in every state. This means that there is no longer a reason for hotel owners to be stuck with their local community banks, they can decide to go with a nationwide bank.
While SBA 7(a) loans have their limits, they can be used to finance existing loans including 7(a) loans, SBA 504 Loans, and USDA B&I loans, along with many other loan types. Remember, SBA 7(a) loans are regulated therefore it’s important for lenders costs to be conformed to the SBA guidelines. With that in mind, hoteliers will not see unreasonably high charges on their statements.
The Downsides of an SBA 7(a) Loans
Proceeds from an SBA loan can be used only when a business is being borrowed. The borrows are not able to cash-out from the equity of the hotel in cases including:
- Injection of equity into other investments
- Pulling cash out and holding
- Paying off debts that weren’t caused by the hotel itself
- Paying off personal debts that weren’t caused by the hotel itself. This may include HELOCs or personal credit cards, but only if they were used for business costs specific to the hotel, provided that there is proof to go along with it.
Although, the hotel may be financed once again in order to include Property Improvement Plans, renovation costs, remodelling costs, and paying off loans (including credit card costs), as well as many other financial aspects. In order for a loan to be refinanced, it must remain in good standing and must have been current for at least 12 months. Even though it is required that the hotelier to provide bank statements which show payments for the period of the loan, lenders may require a statement of up to 24 months.
In order to avoid weighing down the 75% guarantee to lenders, the SBA requires a large guarantee fee which they then use in order to compensate their lenders. On top of that, SBA loans can only be used to finance the business needs of the owner running the hotel, not investors.
Policies and Regulations of SBA 7(a) Loans
SBA loans are government issued, therefore have their fair share of disadvantages such as being surrounded by endless policies and regulations. Even though there’s a lot of these policies and regulations, there are still many questions that have been left unanswered to both the SBA and lenders.
Citizenship & Additional Collateral
When it comes to taking out the loan itself, at least 51% of the hotel’s ownership must be with someone, or multiple people, that is a US citizen. It is also possible for the citizen a Legal Permanent Resident.
Even though SBA 7(a) allow for high loan to value of up to 85%, for those loans that are over 75%, if the equity and assets are available, then the lender will most likely require additional collateral. If the needed equity or assets are unavailable then there is a chance that the lender may still fund your needed loan without them.