A pricing model has been developed over time for shopping center mortgages.
This pricing model has significance for shopping center investors and buyers looking to determine the correct level of the loan to value ratio as a buydown on the interest rate to be charged. It is relevant for the shopping center lender for the equilibrium interest to be linear in the riskless rate, production costs, and the price of the default and reinsurance options. Once thesee options have been priced, the lender will then determine the interest rate. By pricing separately the components of the mortgage, they can be restructured into tranched securities, which introduces the possibility of securitization and increased liquidity.
The adjusted-for-risk rate of interest is dependent on short term riskless rates, with the movements in returns to shopping center investments, LTV ratios, and capital requirements at the lender. An option structure exists inside a shopping center mortgage. This structure includes an income security and two put options, one sold by the lender with a relatively high strike price for the borrower to default and the other bought by the lender with a relatively low strike price at which the lender may reinsure.
This structure has been applied to shopping center markets and their representative financing programs. It can be expanded to cover other forms of loans and to determine optimal reinsurance premiums. In reality, lenders and private investors are not often able to reinsure directly, except in the form of the ultimate put to deposit insurance.
Shopping centers involve relatively large loan sizes, and the conclusion that relatively high production cost lenders must charge disproportionately high interest rates may place pressure on their borrowers. Given relationship lending, it is difficult for borrowers to switch lenders after an unanticipated rise in production costs. Rather than carry a large risk on one borrower, the lender requires low loan-to-value ratios that appear onerous, but are consistent with optimal behavior.
The lower put price is for the reinsurance against lender default. If there were complete coverage of all default risk by a third party, such as the federal government, as is the case with residential mortgages underwritten and reinsured by Ginnie Mae, then the mortgage rate would only include prepayment risk above a riskless rate. Observed mortgage rates must includea a premium for the default risk that cannot be laid off with a reinsurer. Hence commercial mortgage rates, including those on shopping centers, include pricing for default risk.
Our experience with the complex nature of shopping center finance allows us to provide customized shopping center loan solutions for all kinds of investors nationwide. Call us today at 1-888-729-8881 so we can help you structure the loan that meets your exact needs.
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