An interesting case landed on our virtual doorstep a few days ago. Two experienced lenders with a long-time CDC client called with a situation that could take some doing to resolve. And they can’t agree on the solution. I’ll call them Eager Edgar and Cathy Cautious, which should clue you in. Here’s the deal:
EDGAR. Richard, we have an applicant who purchased a property from foreclosure in September 2022 for $6.6 million. The property had been a hotel but the business ceased operation prior to foreclosure and was now vacant. The acquisition was financed by a mortgage company with a $5.5 million, 24-month note, interest payable monthly. At the time of purchase the property had fallen into disrepair, so the buyer made $1.1 million in capital improvements using personal cash.
Now, the balloon is coming due and the owner wants a 504 loan for $5.9 million to pay off the mortgage company. Is this a refi without expansion or a plain old ordinary acquisition loan?
ME. Well, the project clears the first hurdle in considering refinance: The targeted note, i.e., the one being refinanced, was short-term in nature. And more than 85% of the proceeds of the original debt was incurred in acquiring a 504-eligible fixed asset (SOP 50 10 7.1, page 299).1 You are paying off a balloon, so the financing will provide a substantial benefit to the borrower: He has been current on all payments due on the existing debt for not less than a year; no proceeds will go to an associate, and so on.
EDGAR. Great. We can check the boxes for these and all other requirements for a refi with expansion. Stick a fork in it. It’s done! Next loan?
CATHY. Not so fast! This is really an acquisition loan, no different from our usual loan. The property was distressed and the business was closed when the loan was made. So there was no business, and we’re financing a startup. And a hotel of course is single purpose.
So we have a startup and a special purpose, requiring a 20% borrower contribution. The total project cost is $7.7million ($6.6 million for acquisition plus $1.1 million for improvements). The buyer has contributed $1.8 million so far, about 23% of eligible project costs. So, yeah! We can stick a fork in it ‘cause it’s done, but not for the reasons Edgar thinks.
ME. OK, Dear Readers, Who do you think is right, Edgar or Cathy? Can a project be considered either a 504 debt refi without expansion or a purchase with eligible bridge financing? And how would you structure the loan?
If you’ve been reading our eBulletins for some time, you know we address issues concerning the CDC/504 industry on Wednesdays, mostly every two weeks. And I believe this eBulletin is a JRB First: A Two-Parter. I’ll have an analysis and solution for you in our next eBulletin two weeks from today. Stay tuned.
See you in a fortnight!
In a refi without expansion the threshold is now 75%. However in SOP 50 10 7. 1 the threshold for refi with expansion is unchanged at 85%.