IDEAS home Printed from https://ideas.repec.org/a/kap/jrefec/v60y2020i3d10.1007_s11146-018-09695-4.html
   My bibliography  Save this article

Underwriting Limits and Optimal Leverage in Commercial Real Estate

Author

Listed:
  • Leo Cremer

    (RheinMain University of Applied Sciences)

Abstract

Risk-averse commercial mortgage lenders follow an underwriting policy with strict limits based on the property’s value and cash flow. A borrower then chooses the initial loan amount and amortization that fit into these requirements and maximizes the investment’s net present value. For an underwriting policy based on typical mortgage ratios, this optimization problem has a closed-form solution. Applying the formula to loan business data from life insurance companies, fluctuations in market parameters and cash flow-based policy limits can explain the major part of the observed variability in initial leverage. This analysis gives further support to observations that initial leverage is endogenous to the underwriting process, while cash flow-based and forward-looking measures are of primary importance in commercial loan risk management.

Suggested Citation

  • Leo Cremer, 2020. "Underwriting Limits and Optimal Leverage in Commercial Real Estate," The Journal of Real Estate Finance and Economics, Springer, vol. 60(3), pages 375-395, April.
    • Handle: RePEc:kap:jrefec:v:60:y:2020:i:3:d:10.1007_s11146-018-09695-4
    DOI: 10.1007/s11146-018-09695-4
    as

    Download full text from publisher

    File URL: http://link.springer.com/10.1007/s11146-018-09695-4
    File Function: Abstract
    Download Restriction: Access to full text is restricted to subscribers.
    File URL: https://libkey.io/10.1007/s11146-018-09695-4?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Sheridan Titman & Stathis Tompaidis & Sergey Tsyplakov, 2005. "Determinants of Credit Spreads in Commercial Mortgages," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 33(4), pages 711-738, December.
    2. Philip A. Seagraves & Jonathan A. Wiley, 2016. "The Cap Rate Spread: A New Metric for Commercial Underwriting," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 44(2), pages 490-520, April.
    3. Grovenstein, Robert A. & Harding, John P. & Sirmans, C.F. & Thebpanya, Sansanee & Turnbull, Geoffrey K., 2005. "Commercial mortgage underwriting: How well do lenders manage the risks?," Journal of Housing Economics, Elsevier, vol. 14(4), pages 355-383, December.
    4. Erasmo Giambona & John P. Harding & C.F. Sirmans, 2008. "Explaining the Variation in REIT Capital Structure: The Role of Asset Liquidation Value," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 36(1), pages 111-137, March.
    5. George W. Gau & Ko Wang, 1990. "Capital Structure Decisions in Real Estate Investment," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 18(4), pages 501-521, December.
    6. Wayne R. Archer & Peter J. Elmer & David M. Harrison & David C. Ling, 2002. "Determinants of Multifamily Mortgage Default," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 30(3), pages 445-473.
    7. Hoon Cho & Brian Ciochetti & James Shilling, 2013. "Are Commercial Mortgage Defaults Affected by Tax Considerations?," The Journal of Real Estate Finance and Economics, Springer, vol. 46(1), pages 1-23, January.
    8. Ambrose, Brent W & Benjamin, John D & Chinloy, Peter, 2003. "Bank and Nonbank Lenders and the Commercial Mortgage Market," The Journal of Real Estate Finance and Economics, Springer, vol. 26(1), pages 81-94, January.
    9. Cannaday, Roger E & Yang, Tyler T, 1996. "Optimal Leverage Strategy: Capital Structure in Real Estate Investments," The Journal of Real Estate Finance and Economics, Springer, vol. 13(3), pages 263-271, November.
    10. Ciochetti, Brian A. & Deng, Yongheng & Lee, Gail & Shilling, James D. & Yao, Rui, 2003. "A Proportional Hazards Model of Commercial Mortgage Default with Originator Bias," The Journal of Real Estate Finance and Economics, Springer, vol. 27(1), pages 5-23, July.
    11. Brent W. Ambrose & John Benjamin & Peter Chinloy, 1996. "Credit Restrictions and the Market for Commercial Real Estate Loans," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 24(1), pages 1-22, March.
    12. Roger E. Cannaday & T. L. Tyler Yang, 1995. "Optimal Interest Rate‐Discount Points Combination: Strategy for Mortgage Contract Terms," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 23(1), pages 65-83, March.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Brent Ambrose & Michael Shafer & Yildiray Yildirim, 2018. "The Impact of Tenant Diversification on Spreads and Default Rates for Mortgages on Retail Properties," The Journal of Real Estate Finance and Economics, Springer, vol. 56(1), pages 1-32, January.
    2. Haffki, Ricarda & Mager, Ferdinand & Hennig, Kerstin, 2023. "Big is beautiful: The impact of bank–borrower relationship and sponsor size on credit spreads and underwriting fees in commercial real estate lending," Global Finance Journal, Elsevier, vol. 58(C).
    3. Geetesh Bhardwaj & Rajdeep Sengupta, 2008. "Where's the smoking gun? a study of underwriting standards for US subprime mortgages," Working Papers 2008-036, Federal Reserve Bank of St. Louis.
    4. Kelly, Robert & O'Toole, Conor, 2016. "Lending Conditions and Loan Default: What Can We Learn From UK Buy-to-Let Loans?," Research Technical Papers 04/RT/16, Central Bank of Ireland.
    5. Xudong An & Yongheng Deng & Joseph Nichols & Anthony Sanders, 2013. "Local Traits and Securitized Commercial Mortgage Default," The Journal of Real Estate Finance and Economics, Springer, vol. 47(4), pages 787-813, November.
    6. Lok Man Michel Tong & Gianluca Marcato, 2018. "Modelling Competitive Mortgage Termination Option Strategies: Default vs Restructuring and Prepayment vs Defeasance," ERES eres2018_300, European Real Estate Society (ERES).
    7. Grovenstein, Robert A. & Harding, John P. & Sirmans, C.F. & Thebpanya, Sansanee & Turnbull, Geoffrey K., 2005. "Commercial mortgage underwriting: How well do lenders manage the risks?," Journal of Housing Economics, Elsevier, vol. 14(4), pages 355-383, December.
    8. An, Xudong & Deng, Yongheng & Gabriel, Stuart A., 2011. "Asymmetric information, adverse selection, and the pricing of CMBS," Journal of Financial Economics, Elsevier, vol. 100(2), pages 304-325, May.
    9. Jun Chen & Yongheng Deng, 2013. "Commercial Mortgage Workout Strategy and Conditional Default Probability: Evidence from Special Serviced CMBS Loans," The Journal of Real Estate Finance and Economics, Springer, vol. 46(4), pages 609-632, May.
    10. Xudong An & Yongheng Deng & Anthony B. Sanders, 2006. "Subordinations Levels in Structured Financing," Working Paper 8566, USC Lusk Center for Real Estate.
    11. David Glancy & John R. Krainer & Robert J. Kurtzman & Joseph B. Nichols, 2022. "Intermediary Segmentation in the Commercial Real Estate Market," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 54(7), pages 2029-2080, October.
    12. Yingjin Hila Gan & Christopher Mayer, 2006. "Agency Conflicts, Asset Substitution, and Securitization," NBER Working Papers 12359, National Bureau of Economic Research, Inc.
    13. Kelly, Robert & O’Toole, Conor, 2018. "Mortgage default, lending conditions and macroprudential policy: Loan-level evidence from UK buy-to-lets," Journal of Financial Stability, Elsevier, vol. 36(C), pages 322-335.
    14. Christopoulos, Andreas D. & Barratt, Joshua G. & Ilut, Daniel C., 2024. "Synthetic cap rate indices (1991-Covid era)," Global Finance Journal, Elsevier, vol. 60(C).
    15. Lamont K. Black & Chenghuan Sean Chu & Andrew M. Cohen & Joseph B. Nichols, 2011. "Differences across originators in CMBS loan underwriting," Finance and Economics Discussion Series 2011-05, Board of Governors of the Federal Reserve System (U.S.).
    16. Andrew Felton & Joseph B Nichols, 2012. "Welcome remarks," BIS Papers chapters, in: Bank for International Settlements (ed.), Commercial real estate loan performance at failed US banks, volume 64, pages 19-24, Bank for International Settlements.
    17. Yildiray Yildirim, 2008. "Estimating Default Probabilities of CMBS Loans with Clustering and Heavy Censoring," The Journal of Real Estate Finance and Economics, Springer, vol. 37(2), pages 93-111, August.
    18. Lamont Black & John Krainer & Joseph Nichols, 2017. "From Origination to Renegotiation: A Comparison of Portfolio and Securitized Commercial Real Estate Loans," The Journal of Real Estate Finance and Economics, Springer, vol. 55(1), pages 1-31, July.
    19. David Glancy & Robert Kurtzman & Lara Loewenstein & Joseph Nichols, 2023. "Recourse as shadow equity: Evidence from commercial real estate loans," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 51(5), pages 1108-1136, September.
    20. Xudong An & Yongheng Deng & Stuart Gabriel, 2009. "Value Creation through Securitization: Evidence from the CMBS Market," The Journal of Real Estate Finance and Economics, Springer, vol. 38(3), pages 302-326, April.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:kap:jrefec:v:60:y:2020:i:3:d:10.1007_s11146-018-09695-4. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Sonal Shukla or Springer Nature Abstracting and Indexing (email available below). General contact details of provider: http://www.springer.com .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.