Defeasance

Defeasance: What the Market Actually Requires

Defeasance is unique among prepayment structures because the loan never actually pays off. A defeasance consultant and counsel assemble a portfolio of government securities whose coupons and maturities produce cash on or before every remaining payment date, the securities are pledged through a successor borrower entity, and the real estate is released. The note keeps paying, the trust never notices, and the borrower is out. This is exactly why CMBS requires it: a securitized loan lives inside a REMIC trust whose bondholders were sold a fixed cash-flow schedule and whose tax status depends on leaving the mortgage assets undisturbed. A cash prepayment would break the schedule; substituting Treasury collateral preserves it payment for payment.

The cost has two parts. The securities premium is the market-driven piece: when Treasury yields are below the note rate, replicating a high-coupon payment stream costs more than the loan balance, and the premium behaves much like yield maintenance. Transaction costs are the fixed piece, typically $60,000 to $100,000 across the defeasance consultant, securities broker, lender's counsel, servicer, accountants, and rating agencies, plus a 30 to 45 day process. Two nuances save real money: the securities usually only need to run to the loan's open prepayment window rather than to final maturity, which shortens the portfolio and cuts its cost, and the successor borrower structure can generate residual value that a well-advised borrower negotiates to share in.

Against yield maintenance, defeasance is cheaper when Treasury yields sit above the note rate: the replacement portfolio then costs less than par, driving the effective premium toward zero or negative, while a yield maintenance clause would still collect its 1% floor. Yield maintenance is cheaper on smaller balances and short remaining terms, where defeasance's fixed transaction costs overwhelm any securities-side advantage, and whenever speed matters, since yield maintenance is a same-week check rather than a month-long structured closing.

Why It Matters for Your Loan

For any sponsor with CMBS debt, defeasance is the toll booth between the property and a sale or refinance, and its cost swings with the Treasury market. Timing a payoff a quarter earlier or later can change the premium by hundreds of thousands of dollars on a $15,000,000 loan. Commercial Lending Solutions runs defeasance estimates alongside assumption scenarios whenever a CMBS-encumbered asset heads to market, because sometimes the smarter trade is letting the buyer assume the loan instead.