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SBA’s Recent Changes to Standards of Operating Procedures

In today’s market, most financing for complex going-concern valuations of gas station and car wash properties are performed by SBA lenders.  The purpose of this article is to address two important issues as they pertain to gas station and car wash going-concern appraisals, 1) new appraiser requirements (qualified source) and 2) 25-year remaining economic life threshold.  Let’s begin with SBA’s current appraisal requirements as taken from their most recent SOP (Standard Operation Procedures). These documents can be accessed at www.sba.gov.

APPRAISAL REQUIREMENTS

The regulations governing appraisal requirements are set forth at 13 CFR §120.160(b).

Commercial Real Estate

  • SBA requires a real estate appraisal if the estimated value of the Project Property is:
    • Greater than $250,000; or
    • $250,000 or less, if such appraisal is necessary for appropriate evaluation of creditworthiness.
  • The appraiser must be:
    • Independent and have no appearance of a conflict of interest (such as a direct or indirect financial or other interest in the property or transaction); and
    • Either State-licensed or State-certified with the following exception: when the Project Property’s estimated value is over $1,000,000, the appraiser must be State-certified.
  • The appraisal report must be prepared in compliance with Uniform Standards of Professional Appraisal Practice (USPAP) and use one of the following options:
    • A self–contained appraisal report; or
    • A summary appraisal report.
    • Note: USPAP now requires “Appraisal Report” and Restricted Appraisal Report” options (SBA will not accept restricted reports).
  • In order for the appraiser to identify the scope of work appropriately, the appraisal must identify SBA as the client or an intended user of the appraisal, as those terms are defined in the Uniform Standards of Professional Appraisal Practice SOP 50 10 5(F) Subpart C (USPAP). The CDC may also be identified as the client or an intended user. It is acceptable to SBA if the appraisal identifies the Third Party Lender as the client and SBA as an intended user. The CDC may not use an appraisal prepared for the applicant. The cost may be passed on to the borrower.
  • If the loan will be used to finance new construction or the substantial renovation of an existing building, the appraisal must estimate what the market value will be at completion of construction. (“Substantial” means rehabilitation expenses of more than one-third of the purchase price or fair market value at the time of the application.) After construction is completed, CDC must obtain a statement from the appraiser that the building was built with only minor deviations (if any) from the plans and specifications upon which the original estimate of value was based. If the appraiser cannot provide such a statement, then the CDC cannot close the loan without the SLPC’s prior written permission.
  • If the loan will be used to acquire an existing building that does not require construction, the appraiser should estimate market value on an as-is basis. If the appraiser estimates the value other than on an as-is basis, the narrative must include an explanation of why the as-is basis was not used.
  • If the appraisal engagement letter asks the appraiser for a business enterprise or going concern value, the appraiser must allocate separate values to the individual components of the transaction including land, building, equipment and business (including intangible assets). When the collateral is a special purpose property, the appraiser must be experienced in the particular industry.
  • An appraisal must be submitted and approved by the SLPC (except on PCLP loans) prior to closing. If the appraisal comes in:
    • at 90% or more of the estimated value, the CDC may close the loan but must include a written explanation in the loan file if the appraisal is less than the estimated value; or
    • at less than 90% of estimated value, the debenture must be reduced or, if available, the CDC must secure additional collateral or additional investment from the borrower and/or guarantors that will be added to the required Borrower’s Contribution and will be sufficient to address the gap in value. If additional collateral or additional investment is not available, but the applicant demonstrates strong, consistent cash flow sufficient to support the debt, then the SLPC can approve the appraisal and the CDC may close the loan.
  • An appraisal must be submitted to the SLPC with the application under the following circumstances:
    • Equity in land owned for 2 years or more is being contributed as part of Borrower’s contribution;
    • The real estate is Third Party Lender’s OREO; or
    • The Project is not an arms-length transaction (e.g., family members).

Section 5.0 of the SOP 50 10 5(H) effective May 4, 2015 denotes the following change:

Updated Business Appraisal Requirements for 7(a) Loans

Also in Chapter 4, SBA is updating the requirements for a business appraisal in the 7(a) loan program.  First, SBA changed its terminology from “business valuation” to “business appraisal” to align with the terminology used in the lending industry.  Second, SBA is adding a new accreditation to the list of qualified sources to perform a business appraisal: Accredited Business Certified Appraiser (ABCA) accredited through the International Society of Business Analysts.  Third, SBA is updating the business appraisal requirements for change of ownership transactions involving a Special Purpose Property.  If an applicant business operates from a Special Purpose Property (for example, car washes, hotels, gas stations with or without a convenience store, golf courses, medical facilities or bowling alleys), the going concern appraisal must be completed by a Certified General Real Property Appraiser with experience appraising the specific business/property type.  Such appraisals must allocate separate values to the individual components of the transaction including land, building, equipment and intangible assets. Finally, the Certified General Appraiser must have completed no less than four going concern appraisals of equivalent special use property as the property being appraised, within the last 36 months, as identified in the qualifications portion of the Appraisal Report.

What does all this mean?  Do the SBA changes have a significant effect on special use appraisals such as gas stations and car washes?  Let’s do a quick review.  Previously when lending on intangible assets the SBA SOP required business appraisals (or allocations thereof as part of a going-concern) in excess of $250,000 to be performed by a qualified source as defined as someone with one of the following accreditations:

  • Accredited Senior Appraiser (ASA)
  • Certified Business Appraiser (CBA)
  • Accredited in Business Valuation (ABV)
  • Certified Valuation Analyst (CVA)
  • Accredited Valuation Analyst (AVA)

Qualified Appraiser Source

In a gas station or car wash going-concern appraisal requirement these accreditations were triggered when business or intangible value allocation exceeded $250,000 and the SBA was lending on those intangible assets.  Unfortunately, many appraisers simply avoided the requirement by allocating greater percentage amounts to real property to offset the deficit, reducing business or intangible allocation to less than $250,000.  The good news is that SBA may have realized their error and took a step back with their new requirement that an experienced appraiser be employed, someone who has appraised (4) of the same going-concern type properties within the preceding 36 month period the date of appraisal.  The additional accreditations no longer are necessary.  Perhaps a step in the right direction, though still considered weak.  Someone appraising (4) gas stations over a (3) year period would not be considered a specialist by any means nor would they have enough proprietary data points to render credible valuations.

So we know now that a qualified appraisal source is someone who follows USPAP and SBA requirements having met the new, somewhat loose experience requirements.

25-Year Loan Maturation

Aside from allocations of real estate verses intangibles where there will always be differing points of views, the major concern we see with SBA lenders and special use gas station and car wash properties is that of remaining economic life.  Since loan maturities are tied to economic life, appraiser’s estimated remaining economic life is critical to the success of the loan.  SBA recognizes maximum loan maturities for real estate at 25 years and equipment at 10 years.  This poses special problems for gas station and car washes that have significant amounts of “equipment” included in the assets to underwrite.  If the fueling improvements (USTs, dispensers, canopy, signage, EVR, etc.) or attached car wash conveyor system are considered as “equipment” it would be difficult to quality borrowers given such a significant portion of their loan would be collateralized by short lived assets.  However, because these “equipment” items are permanently attached RPC allocated them as real estate.  However, these items have much shorter lives than buildings alone and when blended together results in economic life as if new at 25 to 30 years.  This leaves little room for age life depreciation as a facility older than 5 years may not have enough remaining economic life to meet the 25 year maturity threshold.  With the abundance of short-lived items comprising a significant portion of the overall value, these properties generally need substantial renovation every 20 years or so not to mention the ever-changing regulatory landscape, which adds another unknown wrinkle to the effective life of the fueling improvements.

Economic Life Vs. Physical Life

Unlike most commercial properties where it is commonplace to put aside replacement reserves, this is not the case with gas station and car wash operators.  The wear and tear and these property types is perhaps greatest of all with expensive government regulations and compliances that often require significant upgrades and capital outlays that are unforeseen.  For these reasons economic lives for car wash buildings, gas stations, and c-stores are accelerated.  This is proven by the appraiser relied upon cost manual published by Marshall and Swift that shows most commercial buildings with 35 to 55 year lives while gas station, car washes, and c-stores have reduced economic lives between 20 and 45 year lives.

Simply stated, economic life is how much longer the improvements will contribute value to the underlying land whereas physical life is how much longer will the improvements last.  In many cases existing gas stations are razed for new development, their existing improvements still had physical age left, but economically the improvements were at the end of their lives.  Physically, a c-store building or UST for that matter could physical remain in place (physical life) well in excess of its economic life, but due to changes in technology, government compliance, and competition these improvements will likely be replaced and or modified long before they physically wore out.  Generally speaking economic life is less than physical life, especially for aged special use properties.

Gas stations and car washes depreciate faster than other commercial property types, though SBA seems to treat them no differently than a restaurant or industrial building.  RPC uses 40 year economic life for a typical c-store building and will report shorter lived fueling improvements and site improvements separately.  When remaining economic life is below SBA thresholds there are options available to the appraiser that adhere to USPAP or SBA guidelines while maintaining appraisal reliability.

Replacement Reserves If gas station operators put aside replacement reserves economic lives of the buildings and equipment would be increased, while in response cash flow would be reduced.  The operator is simply trading cash flow for extended economic life of their real property.  We have provided just such an analyses to assist with insufficient remaining economic life.

Remaining Physical Life We have been asked by some lenders to add narrative stated, when appropriate, that the remaining physical life of the building exceeds the 25 year threshold, though it may not in terms of remaining economic life.  Providing this type of language has allowed SBA some leniency as to remaining economic life.  This may be due to SBA’s interpretation of what they deem to be economic and physical life.  However, we could not find SBA referenced definition of these terms.

Renovation and Upgrades A final option when remaining economic life thresholds cannot be met though timely and costly is renovating or upgrading the facility such that economic life is extended to meet and or exceed loan maturity thresholds.  This is particularly attractive for buyers of older facilities that may not qualify under current SBA guidelines.

In summary we learned that there are new appraiser experience requirements for special use going-concern properties that may reduce the pool of competent appraisers.  We discussed the problems often encountered with the 25 year threshold and remaining economic life but in turn offered several reasonable and proven solutions.  It appears that SBA is making efforts to address these issues.  We are hopeful that SBA will continue to review and modify current policy as to special use going-concerns, and implement additional SOPs that address reserves, renovations, and physical remaining life.

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The creation of these articles supports Retail Petroleum’s mission to provide clients and industry advocates with timely information and insights about our ever-evolving industry. The partners at Retail Petroleum fund the articles. The information was not commissioned by any business or institution.