SBA Owner-Occupancy Rule: What It Means for a Mixed-Use Building
SBA will finance an existing building only if your business occupies at least 51 percent of its rentable space, and you can lease the remaining 49 percent to outside tenants. For new construction the bar is higher, because your business has to occupy 60 percent from the start, you can lease 20 percent permanently, and another 20 percent can be leased only temporarily while you grow into it. These rules apply for the life of the loan, so a building that qualifies at closing has to keep qualifying until the debt is paid off.
The temporary 20 percent on new construction comes with a schedule, since SBA expects you to begin using some of that space within three years and all of it within ten. Lenders will ask for a written plan showing how your business will absorb it, and a projection that depends on a tenant staying for fifteen years undercuts the plan.
Occupancy is measured against what SBA calls rentable property, meaning the square footage used for business operations, including common areas but excluding stairways, elevators and mechanical rooms. Parking does not count, although exterior space used in the business, such as a storage yard, can. Bring a floor plan with measured square footage to your first lender meeting, because the percentage on a broker's flyer is rarely calculated the same way.
Picture a three-story building in Ohio with 3,000 square feet on each floor, your business on the ground floor and apartments on the two floors above. Your business occupies 3,000 of 9,000 square feet, about 33 percent, and the building does not qualify no matter how strong your financials are. Move part of the operation onto the second floor and lease only the third, and you reach about 67 percent, which clears the 51 percent test with room to spare.
The rules also restrict how loan proceeds can be spent on any portion of the building you lease out to others. You cannot use SBA money to improve or renovate space that will be subleased to a third party, so a plan to renovate the apartments with loan proceeds has to be funded some other way. Lenders review the sources and uses with that rule in mind, and a budget that mixes the two gets sent back.
Many buyers hold the real estate in a separate company and lease it to their operating business, which SBA allows through an eligible passive company. In that structure, the real estate company has to lease all of the rentable property to the operating company, and the operating company then has to meet the same 51 or 60 percent occupancy test as if it owned the building itself.
Care businesses usually clear the test easily, because an assisted living facility occupies its entire building, with residents living in rooms that are part of the operation rather than leased space. The test gets harder when a care business sits inside a larger building with retail, offices or independent apartments that belong to someone else.
Before you make an offer on any building you plan to finance through SBA, get measured floor plans and calculate the occupancy percentage using SBA's definition of rentable property. If you fall short of 51 percent, look at moving more of the operation into the building or leasing less of it out before you assume the deal is dead. Then ask the lender to confirm the calculation in writing before you spend money on an appraisal or environmental report.
Once the occupancy test is settled, the rest of the deal still has to work, including the rent from outside tenants, the business's cash flow and the payment on the building. I help business buyers and owner-operators model SBA real estate purchases and build the projections and business plan a lender will review alongside the occupancy calculation. If you are looking at a building you plan to share with tenants, send the deal to amer@awadcapitaladvisors.com, and I can help you see whether it works before you spend money on reports.