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The Pricing of Construction Loans

Author

Listed:
  • Su Han Chan

    (Johns Hopkins University)

  • Ko Wang

    (Johns Hopkins University)

  • Jing Yang

    (California State University - Fullerton)

Abstract

In this study, we use a simple 2-period game theoretic model to determine a mutually acceptable interest rate for a construction loan. This mutually acceptable interest rate is the rate that makes a developer indifferent between using 100% equity financing and a construction loan. It is also the highest interest rate that a developer is willing to pay and a bank is willing to lend. The three risk factors identified in the model are the loss, leverage and first-phase loan ratios. Our analytical and numerical analyses indicate that the derived mutually acceptable interest rate has desirable properties as the rate increases with an increase in the three identified risk factors.

Suggested Citation

  • Su Han Chan & Ko Wang & Jing Yang, 2016. "The Pricing of Construction Loans," International Real Estate Review, Global Social Science Institute, vol. 19(4), pages 411-434.
    • Handle: RePEc:ire:issued:v:19:n:04:2016:p:411-434
    as

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    References listed on IDEAS

    as
    1. Jyh-Bang Jou, 2011. "Optimal Capital Structure in Real Estate Investment: A Real Options Approach," International Real Estate Review, Global Social Science Institute, vol. 14(1), pages 1-26.
    2. Rose Neng Lai & Ko Wang & Yuqing Zhou, 2004. "Sale before Completion of Development: Pricing and Strategy," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 32(2), pages 329-357, June.
    3. Chan, Thomas Sai-fan, 1999. "Residential Construction and Credit Market Imperfection," The Journal of Real Estate Finance and Economics, Springer, vol. 18(1), pages 125-139, January.
    4. Mahalia Jackman, 2010. "Investigating the Relationship between Residential Construction and Economic Growth in a Small Developing Country: The Case of Barbados," International Real Estate Review, Global Social Science Institute, vol. 13(1), pages 109-116.
    5. Su Han Chan & Fang Fang & Jing Yang, 2014. "Presales, Leverage Decisions and Risk Shifting," Journal of Real Estate Research, American Real Estate Society, vol. 36(4), pages 475-510.
    6. Kenneth M. Lusht & Bruce E. Leidenberger, 1979. "A Research Note on Factors Associated with Troubled Residential Construction Loans," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 7(2), pages 243-252, June.
    7. Shan Min Charmaine Cheok & Tien Foo Sing & I-Chun Tsai, 2011. "Diversification as a Value-Adding Strategy for Asian REITs: A Myth or Reality?," International Real Estate Review, Global Social Science Institute, vol. 14(2), pages 184-207.
    8. Su Chan & Ko Wang & Jing Yang, 2012. "Presale Contract and its Embedded Default and Abandonment Options," The Journal of Real Estate Finance and Economics, Springer, vol. 44(1), pages 116-152, January.
    9. Sanjay Sehgal & Mridul Upreti & Piyush Pandey & Aakriti Bhatia, 2015. "Real Estate Investment Selection and Empirical Analysis of Property Prices: Study of Select Residential Projects in Gurgaon, India," International Real Estate Review, Global Social Science Institute, vol. 18(4), pages 523-566.
    10. Andrew J. Collins & David M. Harrison & Michael J. Seiler, 2015. "Mortgage Modification and the Decision to Strategically Default: A Game Theoretic Approach s," Journal of Real Estate Research, American Real Estate Society, vol. 37(3), pages 439-470.
    11. Brent W. Ambrose & Joe Peek, 2008. "Credit Availability and the Structure of the Homebuilding Industry," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 36(4), pages 659-692, December.
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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Construction Loan; Real Option; Risk Shifting; Interest Rate;
    All these keywords.

    JEL classification:

    • L85 - Industrial Organization - - Industry Studies: Services - - - Real Estate Services

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