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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   August 2008

Another Reverse Option

The real estate option program can allow clients to benefit from their equity

Changes in the commercial real estate market are highlighting new programs that help qualified commercial property-owners receive cash from properties and use the proceeds for personal or business use. Most notable are two programs targeted to borrowers who meet minimum age requirements.

Reverse mortgages -- which typically allow residential homeowners to borrow against current or future equity in their homes -- have arrived in the commercial arena. In addition to more-traditional commercial reverses, the real estate option program is available for borrowers who are at least 65 years old and own a property. Residential and commercial property types are eligible -- including land -- though mobile homes are excluded.

How they work

Unlike traditional commercial reverses, which require the subject property to be sold or refinanced, the option program does not require a property to be paid off, and it is not limited by terms. It does, however, only apply to owners who are in reasonable health.

Another difference is debt vs. equity. When they qualify for a traditional reverse, commercial property-owners retain the full future appreciation of a property. The disadvantage is that the owner encumbers the property through debt.

One advantage of the option program is that it is not a loan and does not add debt to the property. There is no interest paid and no loan payments. It is an equity play for the bank.

The disadvantage is that the bank receives a percentage of future appreciation on the property, assuming it does, in fact, appreciate.

Owners can receive funds through the option reverse mortgage as a lump sum, and they must pay nothing back until they die or sell the property. Owners receive roughly 10 percent of the appraised value of the property. For example, if they owned a $10 million property, they could gain an additional $1 million. In exchange, the bank receives a share in the future appreciation of the property.

For clients who qualify, this program can provide numerous benefits. Owners can use the proceeds as a downpayment on another property or for repairs on the current one. They do stand to give up 50 percent of the current property’s future appreciation. But cash-flow increases from the improvements can be worth more than the future appreciation relinquished.

Others use the proceeds to improve personal cash flow. Borrowers who are 65 years old or older typically are more risk-averse than younger owners. Paying off their loans or debt, and receiving a surplus for personal use, can be attractive to them. They use the program as a hedge against negative or sideways market movement.

Owners also can use it to mitigate looming estate-planning burdens. The premiums received from the transaction can be used to purchase insurance to shield heirs from liquidity and tax liabilities when owners die. In most cases, analysis shows that a property’s value must approximately triple within the property-owner’s remaining lifespan for the owner and heirs to be indifferent. If not, they enjoy a net benefit.

Commercial agents are using this type of transaction as an effective way to develop strong relationships with heirs and to position themselves in favorable standing when owners die.

How to answer questions

Commercial property-owners often have questions about reverse mortgages. Here’s how to answer their common queries about the option program.

  • Does it apply to me? The program is available in Arizona, California, Connecticut, Florida, Massachusetts, New Jersey and New York. By year’s end, it should be available for residential and commercial properties in several other states. As with a reverse, settlement is typically upon the owner’s death. The option program does allow an owner to sell or transfer the agreement to another property, however. Heirs also can pay off the bank at the time the estate is settled. There are contractual impositions on these options if an owner sells during the first 10 years.
  • What if the property depreciates in value? The owner still keeps the money if the property depreciates and the agreement is settled. There are no payments and no interest. The bank assumes the risk of loss if the property value does not increase.
  • What if the property appreciates in value? The owner and bank share the appreciation of the property. The real estate option resembles that of a silent equity partner.
  • What kind of properties is this good for? The real estate option favors commercial and larger estates. Commercial properties in excess of $3 million often work best.
  • What loan-to-value (LTV) ratios are needed? Unlike reverses, which limit high LTVs, the real estate option often accepts LTVs of as much as 80 percent. Because the option does not add debt, the LTVs are not changed or altered when an owner transacts an option program.
  • Would I keep the cash flow? Is the bank involved in day-to-day decisions? Owners keep the cash flow and maintain their rights and obligations as property-owner as long as they actually own the property. The bank’s interest under the real estate option program is its share of the future appreciation above the initial appraisal value.
  • What else am I responsible for? Your clients should read program agreements for all reverse programs and consult appropriate professionals. Under the real estate option program, obligations include maintaining an appropriate amount of property insurance on the property; repairing the property if it suffers significant damage; not allowing liens to be placed on the property, other than those that the bank approves or upon the refinancing; and avoiding default.  


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