Can You Lease Out Space in an SBA 504 Building?

Many Alabama business owners find a building that is bigger than they need today. That raises a fair question: can you lease out space in an SBA 504 building and let the rent help carry the payment? Alabama Small Business Capital (ASBC) hears this often, and the short answer is yes, within limits.

This guide explains how much of an SBA 504 loan property you must use yourself, how much you can lease to tenants, and what to plan for before you buy.

Quick Summary

• An SBA 504 loan is meant for owner-occupied property, so your business must be the main user of the building.
• For an existing building, your business generally must occupy at least 51 percent of the rentable space.
• For new construction, your business generally must occupy at least 60 percent, with limits on how much can be leased to others.
• You can usually lease the rest to tenants, but buying a building mainly as a rental investment does not qualify.
• The 504 loan is typically split about 50 percent bank or credit union, up to 40 percent CDC, and at least 10 percent borrower.
• Rental income is not a substitute for your own ability to repay, so lenders look at your business first.
• SBA rules change, so confirm the current numbers with ASBC before you sign a contract.

Can You Lease Space in a Building Bought With an SBA 504 Loan?

Yes. An SBA 504 loan can finance a building where your business uses most of the space and leases the rest to other tenants. The key word is most. The program exists to help small businesses own the place where they operate, not to fund landlords.

SBA regulations set the minimum share your business must occupy. Those minimums are what decide how much space you can offer to tenants.

How Much of the Building Must You Occupy?

The required share depends on whether the building already exists or is being built new. The figures below come from SBA's regulation on owner occupancy (13 CFR 120.131).

Project typeYour minimum use of the rentable spaceSpace generally available for tenantsExisting buildingAt least 51%Up to about 49%New constructionAt least 60%Limited, with the rest planned for your own growth over time

New construction has more moving parts. Your business generally needs a plan to grow into additional space over a set period, and the details are specific. Ask your CDC to walk through them for your exact project.

What Does "Rentable Space" Mean?

Rentable space is the part of the building that could be used or leased, measured in square feet. Lobbies, hallways, and storage that serve your own operation are usually part of the math too. Your lender and the CDC will confirm how they count it, so do not rely on a rough guess.

A Hypothetical Example: Buying a Building and Leasing the Extra Space

Here is a simple example. Say a dental practice buys an existing 12,000 square foot office building for $2,000,000. The practice plans to use 7,000 square feet and lease 5,000 square feet to a tenant.

The practice would occupy about 58 percent of the building (7,000 divided by 12,000). That is above the 51 percent minimum for an existing building. A typical 504 structure for the $2,000,000 purchase price might look like this:

SourceShareAmountBank or credit union (first-lien loan)50%$1,000,000CDC (SBA 504 debenture)Up to 40%$800,000Borrower down paymentAt least 10%$200,000

This is only an illustration. Real projects include closing costs, fees, and sometimes renovation costs, and the borrower's share can be higher. The first-lien lender is the bank or credit union that holds first claim on the property. The debenture is the CDC's portion of the loan, which is backed by SBA.

How Much Down Payment Does a Building With Tenants Need?

The standard 504 equity injection, which is simply your cash down payment, is generally at least 10 percent. It can rise by 5 percent if your business is a startup and by another 5 percent if the building is a special-purpose property, meaning one that is hard to use for anything else. A startup buying a special-purpose building could be looking at about 20 percent.

For a deeper breakdown, read our guide on the SBA 504 Loan Program or try the 504 loan calculator to estimate your own numbers.

How to Check If Your Building Plan Meets the Occupancy Rules

Use this short sequence before you make an offer on a property.

1. Get the total rentable square footage of the building.
2. Estimate how much space your business needs today, including room you will use right away.
3. Divide your space by the total to find your occupancy percentage.
4. Compare the result to the minimum for your project type, 51 percent for an existing building or 60 percent for new construction.
5. Talk with your CDC about how the remaining space will be leased and any timing rules.
6. Ask your attorney to review lease terms before you sign with a tenant.

What Types of Tenants Make Sense?

Many owners look for tenants whose business fits naturally with theirs. A medical practice might lease to a lab or therapy provider. A professional office might lease a suite to an accounting or insurance office. Leasing to a complementary tenant can also bring steady foot traffic.

Avoid leaning on one tenant for your payment. If that tenant leaves, the loan is still yours.

Will Rental Income Help You Qualify?

Possibly, but lenders usually underwrite your business first. They look at your cash flow, credit, and experience, and they treat rent as a secondary source. Rent from an existing tenant with a signed lease is generally viewed more favorably than projected rent from a space with no tenant yet.

Do not plan on rent being the only way you cover the payment. No one can promise approval, and each deal is reviewed on its own facts.

Common Mistakes When Leasing Out SBA 504 Space

• Buying too much building. If you occupy less than the minimum, the project generally will not qualify.
• Counting on tenants you have not found. Empty space still carries a loan payment.
• Skipping the lease review. A poorly written lease can cause problems later. Have an attorney look at it.
• Ignoring tax questions. Rental income may be treated differently than your business income. Talk with a CPA about how it applies to you.

Where Does the 504 Process Start?

If you are comparing a building with tenants to one you would fully occupy, start by walking through the numbers with a CDC. Our team can show you how the structure works, and our proven process page explains each step from application to closing.

The Bottom Line

You can lease extra space in an SBA 504 building, but your business has to be the primary occupant. For most existing buildings that means using at least 51 percent of the space, and new construction generally needs at least 60 percent. Rent can help, but it should not be the whole plan.

Before you make an offer, run your square footage numbers and confirm them with a CDC. If you are an Alabama business owner thinking about buying a building, our team has over 35 years helping Alabama business owners with the SBA 504 loan. Call ASBC at (334) 209-2600 or contact us online to talk through your project.

Frequently Asked Questions

Can I rent out part of my SBA 504 loan building in Alabama?

Yes, in most cases. Your business generally must occupy at least 51 percent of an existing building, and the remaining space can usually be leased to tenants. New construction has a higher occupancy minimum.

What percentage of an SBA 504 property must I occupy?

SBA's regulation generally calls for at least 51 percent for an existing building and at least 60 percent for new construction. Confirm the current rule with your CDC before you buy.

Can I buy a commercial building only to lease it out with a 504 loan?

No. The 504 program is for owner-occupied property used by an operating small business. A building bought mainly for investment or rental income generally does not qualify.

Does tenant rent count toward qualifying for a 504 loan?

It may be considered, especially if a signed lease is in place. Still, lenders generally focus on your business's own cash flow, so plan to carry the loan without relying on rent alone.

Who should I talk to about a commercial real estate loan with tenants in Alabama?

Start with a Certified Development Company such as ASBC, along with your bank or credit union, your attorney, and your CPA. Each one covers a different part of the deal.