The Performance of Commercial Mortgages

By Ciochetti, Brian A.; Vandell, Kerry D. | Real Estate Economics, Spring 1999 | Go to article overview

The Performance of Commercial Mortgages


Ciochetti, Brian A., Vandell, Kerry D., Real Estate Economics


Introduction

As of July 1997, commercial mortgage debt outstanding reached approximately $1 trillion. By way of comparison, outstanding municipal and corporate debt stood at approximately $800 million and $1.3 trillion, respectively.(1) Yet, despite the size of this asset class, very little is known about the investment characteristics of commercial mortgages. Whole loans, once originated, are typically held to maturity within the originator's portfolio. Since most commercial mortgage debt is unsecuritized and sells infrequently, transaction data are unavailable from which to estimate returns. Moreover, the proprietary nature of these data limits the breadth and depth of analysis which may be conducted.

The need for a better understanding of the performance of these assets is self-evident. As the performance of commercial mortgages hit historical lows in the early 1990s, the impact of credit-related activity severely affected the operating capacity of life insurance companies, commercial banks and thrifts. However, as the markets for these assets improve, investment interest in both whole loans and their securitized counterparts necessitates a methodology for benchmarking the performance of the asset class and a more detailed analysis of its underlying performance characteristics.

The analysis of the performance of commercial mortgages has received little attention in the academic literature. Most commercial-mortgage research to date has been directed toward furthering our understanding of either the frequency of mortgage default (Snyderman 1991, 1994), probabilities associated with mortgage default (Vandell 1992; Vandell et al. 1993), losses associated with commercial mortgage foreclosure (Curry, Blalock and Cole 1991, Ciochetti 1997, Ciochetti and Riddiough 1997), or the pricing of these mortgages in a contingent-claim framework (Titman and Torous 1989, Kau et al. 1987, 1990, Riddiough and Thompson 1993, Childs, Ott and Riddiough 1996). Only two empirical efforts (Snyderman 1990, Giliberto 1996) have attempted to assess the longitudinal performance of commercial mortgages as an asset class.(2)

Snyderman (1990) uses American Council of Life Insurance (ACLI) mortgage commitment data over the period 1979 through 1988 to create a default-free, synthetic commercial mortgage return index. By assuming a monthly buy-sell strategy, the index captures both term structure and maturity effects. Results suggest that both government and corporate bonds outperformed commercial mortgages over the study period; yet, when matched by maturity, mortgage returns are found to exceed slightly those of other fixed-income instruments. However, the study ignores the effect of mortgage default, which results in an upward bias of returns relative to other fixed-income assets.

Giliberto (1996) also employs ACLI commitment data to construct a quarterly commercial mortgage performance index. Commencing in 1972, hypothetical mortgages are created, represented by term-to-maturity and property-type categories as reported by ACLI. Commitment terms are used to create contractual payments, and each mortgage is tracked from origination to completion as represented by maturity or foreclosure. Credit losses are estimated through a distribution of contemporaneous market loan-to-value ratios, and matched to delinquency and foreclosure rates as reported by ACLI. Results suggest that commercial mortgages have performed similarly to other forms of fixed-income debt.

Both of these studies provide insights into the historical performance of commercial mortgages. Yet, lacking mortgage-specific information with respect to financing terms, cash-flow histories, location or property type, the heterogeneity of individual mortgage returns may not be fully captured.

This study analyzes the performance of commercial mortgages by employing disaggregate data from a sample of commercial mortgages collected from a large insurance company on mortgages originated between 1974 and 1990. …

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