Commercial Loan Underwriting and Option Valuation

Abstract

This article seeks to answer why over a nineteen-year period the debt-coverage ratio for commercial noninsured properties averages 1.29. The article applies the corporate liabilities extension of the Black-Scholes option pricing model to the equity valuation of a real estate project. The regression results of the modified model robustly sustain its usefulness in explaining the derivation of the debt-coverage ratio. The results confirm that commercial mortgage loan underwriters operate with a five-year horizon in creating the equity cushion needed to protect themselves against interest-rate risk.