I had an interesting experience recently. A client and I had a running back-and-forth about possible situations when a real estate development project would be eligible for an SBA loan – or not. It all boils down to the primary source of revenue. This is a winding road. Hang in with me!

Case #1: The Ineligible Real Estate Developer. The client was working with a real estate developer who wanted to build a building, have his development business occupy most of it, and lease the rest to other companies. He was surprised when I said the developer was ineligible for SBA funding because the venture was speculative: “But Richard! His business will occupy the building. It’s not speculative at all.”

Here’s Why. Businesses primarily engaged in subdividing real property into lots and developing it for resale on its own account are not eligible. And an ineligible passive business cannot obtain an SBA loan for any purpose, including the purchase or construction of a building for its own use. (SOP 50 10 5 (J) Subpart C, Chapter 2, III. A. 3. b) & h) pgs. 277 & 278 for 504 loans; SOP 50 10 5 (J) Subpart B, Chapter 2, III. A. 3.  b) & h) pgs. 99 & 100 for 7(a) loans)

Case #2: The Eligible Home Builder. Okay so then the client told me about a home builder who wanted to buy a building and put his business in it. “So following your logic, Richard, he builds houses and some of them are built with the purpose of re-selling them later. Isn’t that speculative?”  I told the client there was nothing wrong with that at all. “But Richard! You see, the home builder built a model home, exhibiting what type of homes he builds. Surely that is speculative.”

A home builder who doesn’t start building a home until there is a contract to buy it once construction is done is not speculating. The builder is building a home for a specific customer. Nothing wrong with that. Even when the builder sells that model home, or a group of model homes, if the income from that activity is not the primary source of revenue, then the builder is not a developer. And so is eligible.

It All Depends on That Key Word: “Primarily.” If besides buying real estate for the purpose of subdividing it and reselling it, the developer also manages rental properties, the developer might be eligible. The crux: What’s the percentage of income the developer earns from the development work, and what percentage is earned from property management? If most of the income is earned from property management, then yes, the developer is eligible.

Even business owners who occasionally dabble in development work might still be eligible. Just as one bad apple doesn’t necessarily spoil the whole bunch, neither does an occasional foray into development work necessarily spoil eligibility. It all depends on whether the business is primarily involved in development, or whether it occasionally develops property.

What’s the Primary Source of Revenue? Once that’s determined, everything falls into place. All clear? Feel free to contact me with your questions – and your dilemmas!

Richard Jeffrey
Associate CDC-504 Programs