Real Estate Purchases Gobble Up SBA Loans in the Southland : Small business: Those seeking money for working capital or start-up are being squeezed out. But lenders say it’s simply a matter of demand.
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-Tek Inc.
But thanks to a $720,000 loan backed by the SBA, the 28-year-old entrepreneur was able to buy his own two-story building in Anaheim, with more than triple the manufacturing space and a conference room to boot. 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,” Zettler said.
Joseph Meshi, 40, tells a different story. For two years, Meshi says, he sought a $250,000 SBA loan for working capital for Genovation Inc., his computer peripherals business in Tustin. Meshi says he found that lenders didn’t want to help him because they were primarily interested in making loans for real estate.
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,’ ” Meshi said, offering a folder with numerous letters from top SBA officials and congressmen who wrote in response to his complaints. “It’s heart-burning,” he said, his voice still filled with resentment.
Small businesses in Southern California have flocked to the SBA in recent years as traditional bank financing all but dried up during the recession. While bankers have been unwilling to extend credit on their own, many of them have aggressively sought to make low-interest loans through the SBA, which guarantees 70% to 90% of the amount.
But as Meshi and others have learned, there is a catch: In Southern California, where more than $700 million in SBA loans were approved last year, records and interviews show that the bulk of them are being used for real estate purchases.
By contrast, most SBA loans elsewhere in the nation are used for working capital, equipment, inventory, start-up or other non-real estate purposes. But in the Southland, after the region’s economy soured in 1990 and the bottom fell out of the real estate market, small businesses increasingly turned to the SBA to make property acquisitions--deals pushed and facilitated by real estate brokers and smaller banks that found in the federal agency’s program a profitable and generally safe niche.
As a result, small-business owners in the area complain that they are finding it increasingly hard to get SBA loans for non-real estate purposes. Moreover, because real estate loans usually involve more money, especially in Southern California with its pricey property market, these deals cut the SBA’s loan pie into thicker slices, meaning fewer businesses are being served.
“The problem is it cuts out access to SBA funds” for uses other than real estate, said Bob Coleman, a former small-business banker who publishes a newsletter in Pasadena for SBA lenders. And the problem 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, says what’s happening in Southern California runs against the spirit of the federal program, which is supposed to be a lender of last resort and a boost to the economy.
“It’s actually very unfortunate,” White said. “There are so many businesses that don’t need to buy a building but would love to buy some equipment.”
Many of the SBA’s top lenders in Southern California--including the local offices of New Jersey-based Money Store, American Pacific State Bank in Sherman Oaks and 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 drives 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.
The SBA, which approved $8.2 billion in regular business loans in its most recent fiscal year, says it does not know what percentage of those were for real estate acquisitions, either nationally or locally, because it does not categorize its data by how the loans are used. But other SBA statistics reflect the shift toward real estate.
The average amount of an SBA loan in Southern California has increased more sharply than in the rest of the nation, as more of the this region’s loans have gone for real estate. In Orange County, for example, the average size of an SBA loan approved in the fiscal year ended Sept. 30 was $453,000--about double the average loan amount in 1988.
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, acknowledged the tilt toward real estate in Southern California. But he added: “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, starting 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 most everywhere else, the news evoked an outcry in Southern California, followed by a flurry of activity as lenders and consultants raced to submit as many loan applications as possible before year’s end.
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. 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 the agency did have Southern California in mind when it set the $500,000 ceiling. Because real estate prices here 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 the SBA program has been crucial during the credit crunch of the past 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 getting snubbed by two banks. “I heard through my realtor about the SBA,” Schwarz said.
And Zettler, owner of Zet-Tek, 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, an SBA-backed loan requires 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.
While SBA-backed real estate loans have clearly helped small businesses, analysts wonder whether there would be more jobs created and greater economic impact if these loans were used for working capital and equipment purchases.
The proliferation of real estate deals with SBA help has also raised questions about whether some businesses may be 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 acquired. 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’s inspector general’s office, an independent 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.
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 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 did 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 those deals also included equipment purchases.
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 that can make greater profits by doing larger loans.
Bank of Yorba Linda, which has assets of less than $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, Vice President David Scherer said. Of that, 52 were for real estate purchases.
Scherer said Bank of Yorba 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. Also, banking regulators 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,” he said.
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 and are reluctant to hire people to develop such lending. 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,” White said, “it hurts the community.”
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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
