Understanding yield maintenance
SummaryBoth yield maintenance and defeasance allow borrowers to unencumber the underlying real estate asset. From a legal and economic perspective, the two processes are fundamentally different.
What is yield maintenance and how does it differ from defeasance?
Both yield maintenance and defeasance allow borrowers to unencumber the underlying real estate asset. However, from a legal and economic perspective, the two processes are fundamentally different. Yield maintenance is the actual prepayment of the loan. Defeasance, on the other hand, entails a substitution of collateral and assumption of the loan by the successor borrower.
A yield maintenance prepayment usually consists of two portions:
- The loan’s unpaid principal balance
- A prepayment penalty – this is typically determined by calculating the present value of the remaining loan payments, with a discount factor equal to the current yield on the U.S. Treasury that matures closest to the loan’s maturity date
The only transaction fee associated with yield maintenance is a small processing fee to the loan servicer. In contrast, the cost of defeasance is determined by the price of a portfolio of bonds that are sufficient to provide for the remaining loan payments, plus transaction fees to several third parties. For borrowers, yield maintenance is generally simpler and less time-consuming than defeasance.
Chatham’s online Prepayment Calculator is designed to give an estimated prepayment penalty for the specified loan. It is designed for use with fixed-rate, U.S.-denominated debt based on the general assumption that the prepayment premium equals the greater of the minimum penalty, or the present value of all scheduled future debt payments (after the prepayment date) discounted at a treasury yield, less the principal repaid.
The Prepayment Calculation is only an estimate – specific debt prepayment provisions are not considered in the calculation. The results should not be used as a precise indication of the Yield Maintenance Costs but rather as a guide to help inform a decision as to whether prepayment is a viable strategy for a borrower.
Chatham Financial has executed over $167 billion total principal defeased, and returned over $200 million in residual value to borrowers. Defeasance consultants are a part of Chatham's global real estate financial risk management practice, solving common but complex capital markets challenges for commercial and multifamily real estate investors.
Need help with defeasance?
Contact a Chatham advisor about defeasance or yield maintenance.
Our featured insights
Financing Priorities 2024: Capital Markets for Corporates, Private Equity, and Real Property Investors
Join us as we examine the latest priorities and trends for navigating real estate and corporate financing. Our expert panel will explore the dynamic capital markets landscape, revealing how it may impact priorities in 2024. Through an interactive Q&A format that encourages a variety of...
Tim Mitchell "pays it forward" in GlobeSt.com with career advice for young professionals
Tim Mitchell, Managing Partner and leader of Chatham's Global Real Estate sector, offers advice to those just starting their career in commercial real estate. His Q&A in GlobeSt.com details Tim's unique career path and the best advice he's received along the way.
Negative defeasance penalties return for the first time since 2006
Chatham Financial has executed several defeasance transactions with negative penalties this fall. Negative defeasance penalties occur when replacement Treasury yields exceed the loan’s coupon. This scenario allows commercial real estate (CRE) owners to exit their CMBS (Commercial Mortgage Backed...
When deciding to prepay your fixed-rate CMBS debt, whether through yield maintenance or defeasance, most borrowers have questions. Chatham routinely supports the majority of principal balance, including the largest individual loans, defeased in a given year. View Chatham's list of yield...
Capital markets and accounting considerations in real estate M&A
Mergers and acquisitions involve a multitude of complexities and risks. Speed and accuracy at every stage of an acquisition is critical to not only winning the deal but also giving the transaction the best chance of financial and strategic success. Financial risk associated with the valuation of...
Defeasance best practices for borrowers, brokers, counsel
Successor borrower rights are a material defeasance consideration, not just at the time of defeasance but at loan origination as well. This provision is often negotiable at loan origination and can play out in a variety of ways at execution. Chatham routinely supports the majority of principal...
Defeasance pitfalls: What borrowers need to know
The intent of this piece is to bring awareness to some defeasance pitfalls, and return leverage to the hands of borrowers.