An Options-Based Model for Valuing Commercial Mortgage Loans

DRAFT Not to be distributed without permission of the authors. This work is preliminary and subject to modification. Summary This white paper provides a non-technical introduction to the Zealand Commercial Mortgage Loan Pricing Model. The accurate valuation of commercial mortgages is a complex and challenging task. The roots of this difficulty are the complex set of interacting options embedded in the structure of these loans. As a result, sophisticated models must be used to correctly price commercial mortgages. The Zealand Commercial Mortgage Loan Pricing Model is a comprehensive and leading edge analytical took that uses the options approach, supported by econometric modeling of underlying property and credit market fundamentals and the extensive use of real estate capital markets data. The model recognizes the fundamental uncertainties inherent in commercial mortgage loans – default, prepayment, and balloon risks – and uses advanced mathematical and statistical techniques to provide rapid and accurate valuations. The Zealand model fully reflects both the range of loan characteristics – tenant and collateral quality, supply and demand trends for the surrounding property markets, call protection, etc. – along with the broader economic and capital market factors that influence the relative pricing of commercial real estate debt.