CAIA Level I: An Introduction to Core Topics in Alternative Investments, 2nd Edition

CHAPTER 9

Real Estate Fixed-Income Investments

A mortgage loan can be simply defined as a loan secured by property. The property serves as collateral against the amount borrowed. If the borrower defaults on the loan, then the lender can take possession of the property. The borrower can usually partially or fully prepay the mortgage before the contractual due date. These partial prepayments may be made by borrowers to save on future interest payments. However, lenders may add prepayment penalties to mortgages to discourage borrowers from refinancing prior to maturity.

A primary distinction between mortgages is residential versus commercial. The residential and commercial mortgages and their markets differ in a number of ways, such as the structure of the actual loans and with regard to the characteristics of the securitized markets. A key difference in terms of the actual loans is the nature of the borrower. Residential mortgage loans are typically taken out by individual households that generate no explicit rental income if the houses are owner-occupied. Therefore, the credit risk of residential mortgages depends on the borrower's income and financial position, in addition to the characteristics of the property. In contrast, commercial mortgage loans are largely taken out by corporations or other legal entities. The risk of mortgages on commercial properties often focuses on the rental income generated by the property that can be used to make the mortgage payments. Another feature ...