Capital structure, the adjusted present value, and mortgage choice

Abstract

Choosing the right combination of mortgage interest rate and discount points is important for real estate investors to minimize their cost of capital. This paper subscribes to Myers’ (1974) Adjusted Present Value (APV) method to study the effect of capital structure on the mortgage choice. An important implication and advantage of subscribing to the APV method is that an investor’s risk aversion does not affect the investor’s mortgage choice. Our framework relies on the daily observable, and objectively and market-determined interest rates and, by avoiding the need to estimate a risk-adjusted discount rate, offers a simpler and cleaner platform for empirical tests on the mortgage choice questions than those proposed in the extant literature.