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Modeling of commercial real estate credit risks

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  • Yong Kim

Abstract

Modeling the probability of default for commercial real estate mortgages is more complicated than that for non-commercial real estate loans. This is because borrowers will default only if both the net operating income and the property value fall below the threshold levels. To make modeling more complicated, the property value at the time of default will determine the loss-given default. In this paper, I derive closed-form solutions for the probability of default and the expected loss of commercial real estate mortgages in a Merton framework. The model is in its essence still a single risk factor model, although there is a sector risk factor that influences both the net operating income and the property value. I obtain analytically the economic capital for the corporate-wide commercial real estate portfolio, with granularity adjustments for name concentration and sector concentration.

Suggested Citation

  • Yong Kim, 2013. "Modeling of commercial real estate credit risks," Quantitative Finance, Taylor & Francis Journals, vol. 13(12), pages 1977-1989, December.
    • Handle: RePEc:taf:quantf:v:13:y:2013:i:12:p:1977-1989
    DOI: 10.1080/14697688.2011.592854
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    References listed on IDEAS

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    1. Lütkebohmert, Eva & Gordy, Michael B., 2007. "Granularity adjustment for Basel II," Discussion Paper Series 2: Banking and Financial Studies 2007,01, Deutsche Bundesbank.
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    Cited by:

    1. Rongda Chen & Jingjing Yu & Chenglu Jin & Xinyang Chen & Liu Yang & Shuonan Zhang, 2024. "Political connection and credit risk of real estate enterprises: evidence from stock market," Palgrave Communications, Palgrave Macmillan, vol. 11(1), pages 1-12, December.
    2. Beate Monika Philipps, 2021. "Commercial Real Estate Loans - Categorization of an Investment Segment," European Journal of Business Science and Technology, Mendel University in Brno, Faculty of Business and Economics, vol. 7(1), pages 5-26.
    3. Jia-wen Zhang & Long-hui Chen & Xiang-yun Liu & Fen Ding, 2014. "Measurement of Credit Risk of Small and Medium-sized S&T Enterprises in China," International Journal of Business Administration, International Journal of Business Administration, Sciedu Press, vol. 5(4), pages 21-31, July.
    4. Murphy, Austin & Headley, Adrian, 2022. "An empirical evaluation of alternative fundamental models of credit spreads," International Review of Financial Analysis, Elsevier, vol. 81(C).

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