A simple prepayment model of commercial mortgages

Prepayment behavior of single family mortgages has been intensively researched over the past 10 years. This knowledge is essential for valuing the uncertain cash flows of publicly traded mortgage-based securities. A similar need in the much smaller commercial mortgage market remains unfilled. Commercial data to support empirical research are generally unavailable, while results from the single family market are not readily transferable since commercial contracts are different, often including a lockout or yield maintenance provision, and commercial borrowers are believed to behave more ''ruthlessly'' than single family borrowers. This paper reports prepayment data and presents the results from a simple prepayment model, using a sample of 7,800 multifamily mortgages owned by Freddie Mac and originated over the period 1984 to 1990. The empirically estimated model follows the current literature in relying primarily on the spread between the book value and the market value of the mortgage to measure the prepayment incentive. The Wall Street characterization of commercial mortgages being ''fast prepays'' is assessed by comparing these model results with a Foster and Van Order single family specification. (C) 1997 Academic Press.