Determinants in Commercial Real Estate Credit Spread Models—A Review

Abstract

This article presents a systematic literature review of the determinants of commercial real estate loan credit spreads from 1989 to 2019. The motivation for this analysis is twofold. First, credit spread models receive little attention in commercial real estate, since research mainly focuses on the drivers of housing credit spreads. Second, data availability in the commercial real estate loan sector is still scarce and the data often mixed with other asset or loan types, such as commercial mortgage-backed securities and their related determinants. We synthesize the literature into four dimensions: property and loan characteristics, macroeconomic aspects, and counterparty characteristics. Using an open coding process, the literature is thoroughly analyzed in 10 subcategories. The results disclose that the main determinants are property and loan characteristics, which impact the reliability and riskiness of cash flow and interest and debt service. Since researchers focus primarily on credit risk determinants, counterparty characteristics have lately gained more attention as credit spread determinants, which deserves additional empirical research. Furthermore, we observe that endogeneity issues have become more prevalent, despite difficulties in finding the best treatment and different impacts.

Keywords:

• Commercial real estate loans
• credit spreads
• determinants
• literature review

Disclosure Statement

The author reports there are no competing interests to declare.

Notes

1 The main studies on real estate default determinants are those of Ambrose and Sanders (2003), Archer et al. (2002), Cho et al. (2013), Ciochetti et al. (2003), Grovenstein et al. (2005), and Vandell et al. (1993).

2 Heck (2022) provides an extensive literature review on corporate bond yields and returns.

3 The remaining 137 articles were first scanned whether these contained either determin*, caus*, or expla*. This screening method did not yield exact results, since only 22 studies were eligible for inclusion, potentially excluding relevant studies.

4 Our review focuses on studies that measure individual and actual credit spreads. However, we also considered studies using aggregated or averaged credit spreads assigned by lenders such as insurance companies. We excluded studies that measure coupon rates or that are too closely related to the bond market because of a different research setting, except for the study of An et al. (2009). An et al. (2009) define the credit spread as the coupon rate at origination minus the maturity Treasury rate, stating that this is the individual commercial mortgage-Treasury rate spread.

5 The ARES (American Real Estate Society) journal list of 2021 specifies the top real estate journals, distinguishing in three discipline areas: real estate finance, real estate, and urban economics, and the built environment. Each discipline area includes more than 20 real estate journals.

6 The journal quality list published in 2019 by the ABDC is an internationally accepted ranking based on externally validated journal ranking lists, journal citation metrics, and expert peer review. The list classifies journals into three categories (A–C) plus a distinction category (A*). The comparable Association of Business Schools journal guide includes only two real estate journals; we, therefore, decided to use the ABDC ranking.

7 The study of An and Pivo (2020) about CMBS loans for green buildings support the findings of Eichholtz et al. (2019). Loans for certified green office buildings have reduced default risk, reflecting greater value appreciation than for non-green buildings. These green loans also have slightly lower credit spreads. Due to our predefined research period, the study of An and Pivo (2020) is not included further in our review.

8 An and Pivo (2020) provide a recent study on the effects of environmental certifications on default risk and loan terms for CMBS loans.

9 Some of the major studies on default rates are, for example, those of Ambrose and Sanders (2003), Archer et al. (2002), Cho et al. (2013), and Ciochetti et al. (2003).

10 Duqi et al. (2018) provide an extensive literature review on relationship lending and its advantages and disadvantages for lenders and borrowers in corporate finance.