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Call Options and Liquidation in Commercial Mortgage Financing

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  • David T. Brown

Abstract

This paper models a commercial real estate project where a wealth‐constrained manager uses outside debt financing to purchase a project who’s return depends on future economic conditions and the manager’s investment in the project. It is shown that it is inefficient to finance the project with callable debt. This prediction is consistent with observed real estate financing practice. I also model the outcome of financial distress allowing for (1) debt forgiveness, (2) equity in exchange for debt forgiveness, and (3) foreclosure. The model motivates (1) why commercial real estate loans are often foreclosed, and (2) why lenders foreclose assets at fire‐sale prices.

Suggested Citation

  • David T. Brown, 2002. "Call Options and Liquidation in Commercial Mortgage Financing," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 30(1), pages 115-136.
    • Handle: RePEc:bla:reesec:v:30:y:2002:i:1:p:115-136
    DOI: 10.1111/1540-6229.00032
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    Cited by:

    1. Giovanni Marseguerra & Flavia Cortelezzi, 2009. "Debt financing and real estate investment timing decisions," Journal of Property Research, Taylor & Francis Journals, vol. 26(3), pages 193-212, June.

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