The Performance of Commercial Mortgages

This study examines the return characteristics of a large, well-diversified commercial mortgage portfolio. Mortgage-specific cash-flow histories are constructed for 2,480 loans originated over the period 1974 through 1990, and a contingent-claims approach to pricing risky debt is used to estimate inter-temporal market values. Quarterly holding-period returns are compared across selected mortgage groups and to alternate asset classes. Our findings suggest that both mortgage returns and volatility of return are comparable to those of other forms of fixed-income assets over the study period. Implied property price volatility is found to average 17%, a result significantly higher than reported in earlier studies. While mortgage returns are found to vary by property type and region of origin, cross correlation of returns is found to be high, illustrating the systematic effect of interest rates on the performance of commercial mortgages over the period 1974 through 1990. However, an increase in credit risk in the latter years of the study suggests that diversification may be a worthwhile objective for holders of these assets. We do not find evidence to suggest that abnormal returns were earned on commercial mortgage portfolios over the study period.