Throwing Good Money After Bad? Cash Infusions and Distressed Real Estate
California Institute of Technology
Francis A. Longstaff
University of California, Los Angeles (UCLA) - Finance Area; National Bureau of Economic Research (NBER)
Eduardo S. Schwartz
University of California, Los Angeles (UCLA) - Finance Area; National Bureau of Economic Research (NBER); Centre for International Finance and Regulation (CIFR)
UCLA Working Paper No 4-94
When a leveraged real estate project experiences cash-flow problems, the owner must either inject additional cash or default on the mortgage. We show that it is not optimal for the owner to default as soon as net cash flow becomes negative. Surprisingly, the owner can expropriate some of the mortgage lender's wealth by injecting cash and continuing to pay interest. When the owner has cash constraints, outside investors may be able to extract significant economic rents by financing distressed real estate projects. These results have interesting implications for mortgage lending and the pattern of real estate transaction volume.
JEL Classification: G21working papers series
Date posted: July 18, 1994
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