Best Practices: Loan Maturities for Real Estate Construction and Leasehold Improvement Loans

What is the maximum maturity for a real estate loan with construction or renovation? How about a leasehold improvement loan? May a lender amortize an interest only period that is not required to complete significant construction or renovation? This article is intended to address these questions and provide guidance as to the treatment of an interest only period.

The SOP 50 10 5(J) at pages 141-142 in Section III. LOAN MATURITIES (13 CFR § 120.212) states:

• The loan term must be the shortest appropriate term based on the use of proceeds and the borrower’s ability to repay.
• Real estate loans must not exceed 25 years unless a portion of the loan is used for construction or renovation of the real estate. If the use of proceeds on a real estate loan includes construction or renovation, the construction or renovation period may be added to the 25 year maximum maturity if reasonably necessary to complete the improvements.

The SOP explicitly states that the maximum maturity of a real estate loan with construction or renovation may be extended by the number of months reasonably required to complete the construction or renovation.

• For example, if the construction or renovation period required to complete a real estate acquisition and development project is 4 months and the lender has approved these 4 months to be interest only, then the maximum loan term may be 25 years and 4 months. The borrower would pay 4 months of interest only followed by principal and interest payments amortized over the remaining 25 year loan term (300 months).

On the other hand, the language in this section of the SOP is less clear as it relates to the maximum maturity of a leasehold improvement loan. The SOP states the maximum loan term generally may not exceed 10 years unless the improvements are for significant construction/build-out or to renovate a building on leased land. Because the language in the SOP does not define “significant,” lenders may ponder whether a period of time to complete these leasehold improvements may be added to the maximum loan term. Since it is logical to interpret this provision in a similar manner to the earlier provision on real estate loans and lenders have customarily done so for many years, it appears that a reasonable period of time to complete leasehold improvements could be added to the loan term.    Clarification from the SBA would be welcomed by the industry.

• For example, if the construction or renovation period required to complete a significant leasehold improvement project is 4 months and the lender has approved these 4 months to be interest only, then the maximum loan term may be 10 years and 4 months. The borrower would pay 4 months of interest only followed by principal and interest payments amortized over the remaining 10 year loan term (120 months).

If a lender makes a loan which includes significant construction, renovation, or leasehold improvements, but the lender also has approved a permissible interest only period for a non-construction related (but justifiable) reason based upon the nature of the business and documented its credit write-up, then the repayment of the loan must still fall within the permissible maximum loan terms identified above. In other words, the length of any interest only period that is not required to complete the construction, renovation, or leasehold improvements cannot be used to extend the maximum loan term allowed for a real estate loan with construction or renovation or a leasehold improvement loan with significant

construction/build-out.

• For example, if a lender approves a start-up loan with significant leasehold construction/buildout and has approved 6 months of interest only (4 months to complete the renovation and 2 months for business stabilization due to the nature of the business, which the lender has justified and documented in its credit write-up), then the maximum loan term may be 10 years and 4 months. The additional 2 month interest only period must be amortized over the remaining 10 year loan term. The borrower would pay 6 months of interest only followed by principal and interest payments amortized over the remaining 9 years 10 months (118 months).

 

Lenders must always remember the SOP requires the loan term to be the shortest appropriate term based on the use of proceeds and the borrower’s ability to repay. The Small Business 7(a) Lending Oversight Reform Act enacted in June 2018 enhanced the SBA’s lender oversight review process and increased the enforcement options of the Office of Credit Risk Management (“OCRM”), and it is important for lenders to document all decisions and continue to use prudent lending standards as a guide when approving any interest only period for a loan.

For more information regarding compliance with loan maturities for real estate construction and leasehold improvement loans, please contact Kristen at 407.618.0698 or at kdickey@starfieldsmith.com.