SBA Loans Fuel Real Estate Deals : Capital: Critics complain that other kinds of borrowing are being squeezed out. The agency recently set $500,000 limit on such financing.
To Daniel Zettler, the Small Business Administration was a godsend.
Crammed into 5,500 square feet of space near Anaheim Stadium, Zettler’s medical-components company was losing business because it could not expand. He stacked one machine on top of another, but his 15 employees still bumped into each other. “It was live or die for us,” said Zettler, president of Zet-Tec Inc.
But thanks to a $720,000 loan backed by the SBA, Zettler was able to buy his own two-story building in Anaheim with more than triple the manufacturing space and a conference room. He moved about a year ago and has since added 10 workers. “Without the SBA, it would have been very difficult for us to grow,” he said.
Joseph Meshi tells a different story. For nearly two years, Meshi says he sought a $250,000 SBA loan for working capital for Genovation Inc., his computer peripherals business in Tustin. What Meshi found was that lenders didn’t want to help him, he says, because they were interested principally in making SBA loans for real estate purchases.
Meshi said he and his partners offered $1.7 million in personal assets as collateral, including Meshi’s house in Newport Beach. But more than two dozen lenders turned him away.
“One of them told me, ‘Joe, you’re not going to get a loan unless there’s real estate wrapped around it,’ ” said Meshi, showing a folder with numerous letters from top SBA officials and congressmen who wrote in response to the entrepreneur’s complaints. “It’s heart-burning,” he says, his voice still resentful.
In recent years, the agency’s fast-growing loan-guarantee program has been an invaluable source of small business financing, especially in Southern California, where conventional credit during the recession has been very tight.
But the bulk of this region’s SBA loans--unlike elsewhere in the country--has been used for property acquisitions, records and interviews show. And that has left out some people like Meshi. Critics say that SBA lending in this region is focused too much on real estate, making it hard for small businesses to get government loans for other purposes, such as working capital, equipment and inventory.
“The problem is it cuts out access to SBA funds” for other than real estate use, said Bob Coleman, a former small business banker who publishes a newsletter in Pasadena for SBA lenders. And it becomes all the more acute, he said, when the agency’s funding is tight, as it is now. “I think it has been a major concern to the SBA.”
Dale White, a vice president at Truckee River Bank in Northern California, one of the state’s top SBA lenders, said: “It’s actually very unfortunate. There are so many businesses that don’t need to buy a building but would love to buy some equipment.”
Many of SBA’s top lenders in Southern California--including the local offices of New Jersey-based the Money Store, American Pacific State Bank in Sherman Oaks and the Bank of Yorba Linda--readily acknowledge that most of their small business loans are for real estate purchases. But they say it is demand that is driving this business. Even so, some of these lenders say their strategy is to concentrate on property loans, which they view as safer and more profitable because they tend to involve larger transactions.
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The SBA, which approved $8.2 billion in regular business loans in its most recent fiscal year, says it does not know what percent of those were for real estate acquisitions, either nationally or locally, because the agency does not categorize its data by use of loans. But other SBA statistics reflect the shift toward real estate loans.
The average amount of an SBA loan in the Southland has increased more sharply than for the nation, as more of this region’s loans have gone for real estate. In Orange County, the average size of an SBA loan approved in the year ended Sept. 30 was $453,000--about double the average loan amount in 1988.
And nationwide, the share of SBA loans due in 21 or more years has nearly tripled in the last five years to 14%, largely because of the greater volume of real estate loans made in Southern California. Real estate loans are invariably stretched out over 25 years, whereas SBA loans for working capital, equipment and inventory usually run no more than 10 years.
John Cox, SBA’s associate administrator in Washington, agreed that federal loan guarantees in Southern California are being used more heavily for real estate transactions than anywhere else in the country. But he said, “I don’t see it as a problem. As long as we feel they’re sound loans, there’s no magic to it, because we’re filling the need of that area.”
Nonetheless, just two weeks before the new year, the agency announced a $500,000 ceiling on loans, which started Jan. 1. Previously, there was no limit on loan size, though the guaranteed portion of each loan could not exceed $750,000. Taken in stride elsewhere, the news evoked an outcry in the Southland, followed by a flurry of activity as lenders and consultants raced to get in as many loan applications as possible before year’s end.
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Cox said the new limit was not aimed at discouraging SBA loans for real estate use; rather, the step was taken so the agency would not run out of funds, he said. For this fiscal year, $7.8 billion has been allocated for the so-called 7(a) program.
But some analysts and SBA lenders in the region think that the agency did have Southern California in mind when setting the $500,000 ceiling. Because Southern California real estate prices are higher than in most areas of the country, the limit has the effect of slowing the pace of SBA loans used to buy buildings, they said.
“It’s a huge, huge impact for the small business side,” said Peter Gessert, manager of loan underwriting at CB Commercial in Los Angeles, which has closed numerous deals for clients with SBA loans. “They’re going to have to find alternative sources, which will be more expensive.”
Gessert and other real estate brokers say that the SBA program has been crucial during the credit crunch of the last several years because it has enabled owners to buy property, get out of high rents and expand their businesses.
Edward Schwarz, owner of St. Clair Plastics, a plastic injection molding manufacturer, bought an 11,000-square-foot building in Santa Fe Springs with a $500,000 SBA-backed loan after two banks turned him down.
And Zettler, the owner of Zet-Tec, said the best offer he got from a conventional lender to finance his building required a down payment of 40%, or $320,000, which he did not have. By comparison, SBA-backed loans require a 10% down payment, and its terms for real estate acquisitions are generally more attractive than conventional loans. The maximum interest rate on SBA loans is 2.75% above the prime rate.
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The proliferation of real estate loans in this region has raised concerns that some businesses may be unfairly taking advantage of the program. SBA rules do not allow its loans to be used for speculation, and a loan recipient must occupy at least 51% of the property it acquires for its business. Yet bankers say some business owners are looking for bargains now that the real estate market appears to have bottomed out.
“It’s giving us some concern,” said Tim Cross, head of inspections for the SBA inspector general’s office, an autonomous arm of the agency. Cross said his office may conduct an investigation of Southern California loans in the future. “If it’s simply turning over property . . . that may not be the optimal way to use 7(a) loans,” he said.
Steve Waddell, head of SBA’s district office in Santa Ana, estimates that 60% of all the loans approved by his district are for real estate--about double the level of several years ago.
In order to serve the greatest number of small businesses, “SBA officials would prefer that we would be doing more loans for other than real estate,” Waddell said. For the fiscal year ended Sept. 30, 11% of the loan guarantees nationwide were for deals valued at $500,000 or more. But those loans accounted for 38% of the $8.2 billion in loan guarantees.
SBA officials say the agency’s new reduced loan document program, which is designed to make it more attractive for banks to make loans of less than $100,000, will help more businesses acquire working capital and equipment. But what’s happening in Southern California, SBA officials say, is being driven by the banking community. The banks, for their part, say they merely respond to the market.
“In Southern California, we had a lot of real estate that’s dropped in value,” said Philip Inglee, president of Liberty National Bank in Huntington Beach, which handled about $30 million worth of SBA loans last year. Inglee said 70% to 75% of his SBA-backed loans went for real estate, though some of these deals also included equipment purchases--a fact that the Money Store also stressed. “The nature of the market is such that we have made the most of real estate.”
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The majority of SBA loans are made by smaller community banks, which have found a profitable niche in the federal program where there’s no competition from big commercial lenders, which can make greater profits by doing larger loans.
Banks generally sell the guaranteed portion of an SBA loan (usually 75% for real estate) to the secondary market, where brokerages these days pay $110,000 up front for every $100,000 SBA loan. The agency will guarantee up to 90% of its smaller loans.
Bank of Yorba Linda, which has assets below $100 million, opened an SBA production office in Laguna Hills about three years ago. Last year, the bank made 58 small business loans for a total volume of $27 million, said senior vice president David Scherer. Of that, 52 were for real estate purchases.
Scherer said the Bank of Yorba Linda chose to focus on real estate loans because they are less risky. With a real estate loan, if the borrower defaults, the underlying real estate will almost always have value. He said that banking regulators also are more likely to criticize loans for equipment and working capital, because they are more complex, difficult to assess and may not have collateral of the same quality. Even the SBA reviewers, Scherer said, prefer real estate loans because of the collateral. “Most of the guys down there like real estate,” he said.
Bank of Yorba Linda, Scherer said, will consider SBA loans under $100,000 for working capital. “But other than that, the risk would be too great.”
Analysts understand why banks in Southern California are so cautious. Steve Stultz, a longtime SBA loan consultant in Newport Beach, said he believes most viable businesses can arrange SBA loans for working capital and for needs other than real estate. But he said that, with so many SBA lenders concentrating on what is profitable and safe, “it slows down access” of loans to some companies.
Others are more critical.
“It’s a cop-out,” said White, of Truckee River Bank, referring to the regulatory fears expressed by banks. White says some SBA lenders won’t arrange loans for equipment or working capital because they don’t have the expertise. At Truckee, he said, 60% of the SBA loans it approved were for things other than real estate. “If they narrow the program to real estate, it hurts the community,” White said.
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Rick Rey, a management consultant in Los Angeles, is seeking a $500,000 loan to buy a restaurant at Big Bear Lake. Though Rey’s application would include some real estate as collateral, he said bankers were queasy about portions of the loan that weren’t secured by property.
“Most would rather lend for real estate acquisitions,” he said. “Maybe the SBA can start looking at having a separate pool for real state and a pool for non-real estate.”
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Small Business Loans on the Rise
The dollar amount of Small Business Administration loans made in Orange County has more than tripled since 1988. Because more of these loans are being used to buy real estate, the average loan amount has doubled. Data includes development company loans (specialized business loans linked to job creation); years are fiscal periods, ended Sept. 30:
(1994)
Loans: 408
Total volume (in millions): $184.9
Average Size (in thousands): $453
Real Estate Drives Average
The average size of SBA loans made in Southern California is higher than in Northern California and the rest of the nation. The main reason: More of the loans here were used for real estate transactions. Top SBA lending districts in dollar volume, excluding development company loans, fiscal 1994:
Loans Total volume Average size (in millions) (in thousands) Los Angeles 1,024 $368.9 $360 San Francisco 1,200 367.5 306 Atlanta 913 305.1 334 Santa Ana* 677 268.7 397 Dallas 1,430 263.7 184
* Makes loans to Orange, Riverside and San Bernardino counties
Due Dates Delay
Since 1989, the percentage of SBA loans due in 21 or more years has nearly tripled, largely because of the huge volume of real estate loans made in Southern California. These loans are invariably amortized over 25 years, while loans for working capital, equipment and inventory usually run for less than 10 years. When loans are due nationwide:
1989 1994 Years loans loans 1-10 63% 54% 11-20 32 32 21 or more 5 14
Source: Small Business Administration
