SOP 50 10 8.1 with Technical Policy Updates, Appendix 15, includes specific rules and nuances for change of ownership transactions involving “Special Purpose Properties” affecting loan maturity, business valuation, and underwriting requirements.
To begin, it is important to understand the definition of a “Special Purpose Property”. SOP 50 10 8.1, Appendix 3, defines Limited or Special Purpose Property as a limited-market property with a unique physical design, special construction materials, or a layout that restricts its utility to the use for which it was built. That definition is also stated in Appendix 15 for purposes of change of ownership transactions.
While Appendix 15 states that 7(a) loans that facilitate a change of ownership must not have an amortization that exceeds 10 years, an exemption applies to Special Purpose Properties. For transactions involving the acquisition of an owner-occupied Special Purpose Property which includes the business operating from that property, lenders may structure a single loan with a maturity of up to 25 years if 85% or more of the use of the total project costs are for real estate. This provision only applies when the acquisition of the Special Purpose Property cannot be separated from, and is integral to, the acquisition and continued operation of the business.
There are specific requirements that must be met for business valuations of Special Purpose Properties:
- If the Business Purchase Price is $350,000 or less the lender may perform its own valuation of the business being sold, unless there is a close relationship between the buyer and seller.
- The business valuation must allocate separate values to the individual components of the transaction including land, building, equipment, and intangible assets.
- The Certified General Real Property Appraiser must have completed no less than four going concern appraisals of equivalent special use property as the property being appraised, within the last 36 months, as identified in the qualifications portion of the Appraisal Report.
- Each business valuation assignment under this section must be undertaken with a specific instruction for the Certified General Real Property Appraiser to conduct the appraisal in compliance with current USPAP guidelines.
The lender’s credit memorandum and analysis must address the Applicant’s financial ability to repay the loan. For a transaction involving the acquisition of an owner-occupied Special Purpose Property, the lender must obtain this historical information to the extent it is available. If the purchase price is fully supported by the appraised value of the Special Purpose Property, the lender may base its analysis of repayment on projections as follows:
- For a change of ownership transaction involving the acquisition of an owner-occupied Special Purpose Property that is currently in operation, the lender must calculate and analyze both the historical DSC of the business being acquired and the projected DSC. In situations where the appraised value fully collateralizes the loan, the lender may rely on projections to satisfy the DSC requirement. When utilizing projections in this manner, the DSC requirement must be satisfied within two years from loan funding. This provision only applies when the acquisition of the Special Purpose Property cannot be separated from, and is integral to, the acquisition and continued operation of the business.
The lender must obtain from the Applicant and analyze two years of detailed projections, including the supporting assumptions and justification for relying on projections instead of historical performance. The projections must reflect a debt service coverage equal to or greater than the required DSC per the applicable type of change of ownership transaction within two years from loan funding or, for construction projects, within two years from the end of construction. The lender must also calculate the historical DSC of the business being acquired in accordance with Appendix 15 and include it in the credit memorandum, together with an analysis of the variance between the historical results of the business and the projected results. The historical DSC is not required to meet the applicable ratio when the lender relies on the projected DSC under this provision.
- For the cash flow projections, the lender must calculate the debt service coverage (which may not include anticipated cash flow from rental income from the property) and provide the assumptions supporting the projected cash flow coverage, including, as applicable:
- Justification for revenue growth, i.e., new product lines, sales channels, and new production facilities;
- Justification for any reduction in expenses; and
- A comparison to current industry trends.
- A Business Valuation meeting the requirements of Appendix 15 is required. A Quality of Earnings report is not required for a transaction involving the acquisition of an owner-occupied Special Purpose Property, regardless of the Business Purchase Price.
- The lender must document in its credit memorandum the basis for its determination that the property meets the definition of a Special Purpose Property, that acquisition of the property is integral to the acquisition and continued operation of the business, and why reliance on projections rather than on the historical performance of the business being acquired is appropriate.
- The lender is required to input both the historical DSC and the projected DSC into the SBA Loan System.
Change of ownership transactions can be tricky. Add a Special Purpose Property such as storage units or hotels, and the transaction can become exponentially more complex. Understanding, and properly applying, the Special Purpose Property rules will help to ensure that the SBA loan is underwritten, structured and closed in compliance with SOP 50 10 8.1, Appendix 15.