Appraisals for SBA 504 real estate projects are a very important part of the underwriting process as the SBA needs to make sure that the value of the property is such that even in a subordinate position to the bank the SBA loan is considered secured. Today’s blog takes a look at the requirements of appraisals in 504 real estate deals.
The SBA requires a real estate appraisal if the estimated value of the Project Property is greater than $250,000 or $250,000 or less, if such appraisal is necessary for appropriate evaluation of creditworthiness. The appraisal must also have been done within one year of the date of application to the SBA. In addition, the appraiser must include two of the three methods of valuation. Since the majority of the time the lead bank orders the appraisal, the SBA can also use the same appraisal as long as the CDC and the SBA are listed as intended users of the appraisal in addition to the bank. This avoids the borrower having to pay for a second appraisal for the SBA loan. The cost of an appraisal can usually be included as part of the overall SBA 504 project.
Once the CDC receives a copy of the appraisal, they must review it for the following items:
- Correct address of collateral property
- Date of the appraisal
- Proper Intended Users are listed
- Meets Uniform Standards of Professional Appraisal Practice (USPAP) standards
- Is self-contained utilizing the Cost, Income, and Sales approach to value; If an approach is not utilized, reason is provided
- Interest in property appraised
- Values real estate and land
- Values given for “As is” and “As complete”, as applicable
- Goodwill or going concern value is broken out separately
- Machinery and equipment is broken out separately
- Zoning for collateral property
- Highest and best use of collateral property
- Any noted deficiencies or concerns
- Licensed or state certified appraiser, as applicable
For real estate acquisition projects, the appraised value must be equal to or greater than the purchase price as the SBA, like most lenders, looks at the lesser of purchase price or appraised value to determine eligible costs. For real estate construction projects or those that involve renovations to a property, the SBA can have some flexibility when determining if the value meets their requirements. Knowing that for construction/renovation costs there is not always a 1:1 realization of value versus cost, the SBA can look at a value of no less than 90% of the cost of construction/renovation to determine that the 504 loan is sufficiently collateralized. For example, if a project calls for the construction of a building for $1 million, the SBA could accept an “as-completed” appraisal of at least $900,000. Of course, these decisions are made on a case-by-case basis.
One benefit of SBA 504 financing is that the SBA will recognize the full value of an appraisal in determining loan-to-value. This differs from banks who first discount the appraisal before determining how much they can lend against. So for an appraisal of $1 million on a commercial building and the bank investing 50% of the financing and the SBA 504 investing 40% of the financing, the SBA considers their loan-to-value to be 90%.
Regarding the “as-completed” value, in some cases it is also necessary to get an “as-is” value of the property, especially if the borrower already owns the land (for at least two years) and wishes to use the equity in the land as part of their equity injection into the project. Another value designation in appraisals, typically for hotel projects, is an “as-stabilized” value. This is common for start-up hotels. Unfortunately, the SBA will not accept an “as-stabilized” value in determining sufficient collateral coverage. The SBA will also not accept a restricted appraisal.
After construction is completed, the CDC must obtain a statement from the appraiser, general contractor, project architect, or construction management firm that the building was built with only minor deviations (if any) from the plans and specifications upon which the original estimate of value was based. If the CDC cannot obtain such a statement, then the CDC cannot close the loan without SBA’s prior written permission.
If the project is for the acquisition of an existing business or if the appraisal engagement letter asks the appraiser for a business enterprise or going concern value, the appraiser must allocate separate values to the individual components of the transaction including land, building, equipment and business (including intangible assets) in order to determine eligible project costs.
In most cases, an appraisal does not need to be submitted to the SBA at the same time as the loan request. In those cases, however, the Debenture Authorization would be contingent upon the SBA reviewing and accepting the appraisal in order to close on the loan. There are three cases in which the appraisal must be submitted along with the application - equity in land owned for two years or more that is being contributed as part of the Borrower’s contribution; the real estate is an OREO of the lead bank; or the project is not an arms-length transaction (e.g., transaction between family members).
For other property taken by the SBA, the SBA has no specific appraisal requirements for non-commercial real estate (such as a residence) or real estate (commercial or non-commercial) taken as collateral to secure a personal guaranty. Those cases are handled on a case-by-case basis as part of the overall underwriting of the loan request.