Owner-occupancy: how much of the building you have to use yourself

The rule exists to keep the programs out of landlord finance. An operating business buying premises it works from is exactly what 7(a) and 504 real estate lending is for. A borrower buying a building for the rent roll is a passive business, and passive businesses are ineligible.

What occupancy actually means

The percentages and the time period are fixed by SBA rule, and they are precisely the kind of figure that shifts between SOP revisions. Get the current numbers from the lender or from sba.gov rather than from a listing agent.

Rentable square footage is the measure, and it is measured, not estimated. Common areas, mechanical space and unusable areas are handled by definition. On a marginal building, have the lender confirm the calculation before you commit — a deal that occupies just under the line is not a deal.

Illustrative only — the denominator decides the deal

Occupancy is a fraction, and most people argue about the numerator when the denominator is what moves.

Occupy 10,400 square feet and you are at 52.0% of gross and 57.1% of rentable. Comfortable either way.

Occupy 9,600 square feet and you are at 48.0% of gross and 52.7% of rentable. On one measure the deal fails and on the other it passes, and the difference is a definition in a rule rather than anything about the building.

That is why a marginal building has to be measured, with the calculation confirmed by the lender in writing, before you sign a purchase contract. Get the measurement from the source everyone will rely on — the appraisal or a professional measurement — rather than from a listing sheet, since brochure square footage is frequently gross and frequently approximate.

The second thing the example shows is where the margin should be. A deal that clears the line by two points has no room for a tenant who will not leave, a build-out that shrinks your footprint, or a re-measurement that finds a mechanical room somebody had counted.

The holding company structure

Most owner-occupied SBA real estate is not bought by the operating business. It is bought by a separate entity that owns the property and leases it to the operating company, which is a permitted structure under the eligible passive company rules at 13 CFR 120.111.

The conditions matter and they are checked:

• Both entities are parties to the loan, as borrower and co-borrower or guarantor.
• The lease from the holding company to the operating company runs at least as long as the loan term, including renewal options.
• Rent is constrained so the structure cannot be used to pull cash out ahead of the loan.
• The operating company itself has to be eligible and has to meet the occupancy test.

Have the lease drafted with the lender's SBA department in the loop. A lease that does not meet the conditions gets redrafted at closing, which is the worst possible time.

Leasing out the rest

Permitted, within the occupancy limits, and the rental income is usually credited in the cash flow analysis with an appropriate vacancy assumption. Existing tenant leases will be reviewed, and subordination or estoppel documents may be required from tenants.

What is not permitted is drifting out of compliance later. The occupancy requirement is a term of the loan, not a condition that expires at closing. If your business shrinks and you fill the space with tenants, you have a covenant problem. Raise it with the lender rather than waiting for the annual review.

Before you make an offer

1. Get the rentable square footage and your intended occupancy in writing.
2. Confirm the current occupancy percentage with the lender for your program and property type.
3. Ask whether the deal requires a holding company, and who is drafting the lease.
4. Ask what happens to existing tenants and their leases.
5. Confirm the environmental and appraisal requirements, since both sit on your critical path.

A building you will genuinely operate from is financeable. A building you mostly want to rent out is not, and no amount of structuring changes that.

What compliance looks like after closing

The occupancy requirement is a term of the loan for its whole life, not a condition that expires at funding, and the two situations that breach it are both ordinary business events.

Neither is a crisis if it is raised early. Lenders deal with both; what they deal with badly is finding out at an annual review, from a rent roll, that the borrower has been non-compliant for a year. Raise it in the month you decide, and ask what the options are — a waiver, a partial paydown, a refinance out of the programme, or a plan to reoccupy.

The tenants, the lease, and two things to refuse

Alongside the checks above, do three things with the lease and the tenants.

Get the existing rent roll with each tenant's lease term, renewal options and holdover terms. A tenant with four years to run in space you need is a problem you cannot solve with money.

Ask which tenant leases the lender will require to be subordinated, and whether estoppel certificates will be needed. Those take signatures from third parties with no stake in your closing date.

Have the holding company lease drafted with the lender's SBA department involved from the start. A lease redrafted at closing is the most avoidable delay in this whole product.

Then refuse two things. Refuse to sign a purchase contract without a financing contingency that specifically covers the occupancy calculation, not just the appraisal. And refuse to plan a deal around occupying the minimum — the rule sets a floor, and a building you barely qualify to buy is a building you will have to explain every year.