Defeasance? Ask these questions.
Defeasance is the process through which a borrower is released from the obligations of their debt. This piece helps CRE professionals understand the questions they should ask before defeasing.
While the defeasance process can be summarized in a few lines, in practice it is very complex, involving a large number of parties with competing interests. Having an independent, experienced advisor on the borrower’s side is important to ensuring an on-time, cost-effective, and complication-free close.
Things to look out for when defeasing
- Has the defeasance consultant thoroughly reviewed the loan documents and provided a comprehensive defeasance analysis to the borrower?
- Have all anticipated third-party fees been fully disclosed to the borrower?
- What is the consultant’s fee structure? Is it reasonable?
- Will the consultant ask for a deposit? Chatham does not charge an upfront deposit for consulting services.
- Will residual value be generated as a result of the defeasance? If so, is the defeasance consultant returning a significant majority of this value back to the Borrower?
- Can the defeasance be structured to the early prepayment date, for a complete upfront savings on the last few months of interest?
- Is the loan subject to rating agency review which will entail additional time and cost?
- Will the securities portfolio include higher-yielding, lower-cost agency securities in addition to Treasuries, if applicable?
- How is the defeasance consultant going to purchase securities? Competitive auction or one relationship bank? A competitive auction utilizes the power of the marketplace to drive prices lower through competition.
- Have the changes in defeasance costs over the life of the transaction been reviewed?
- How much will defeasance costs decrease after every monthly loan payment?
- How will movements in Treasury yields affect defeasance costs?
- Is the loan currently eligible for defeasance? All CMBS loans are locked out for a period of two years following securitization. Some CMBS loans are subject to a yield-maintenance penalty instead of defeasance.
Common mistakes made by borrowers when defeasing
- Not budgeting enough time for the defeasance process
- Accepting costs that are higher than market standard
- Failing to negotiate favorable defeasance provisions in new loans (for refinances) or Purchase and Sale Agreements (for sales)
Hiring an independent consultant is not only recommended, it's usually a critical piece to avoiding these mistakes and navigating the defeasance process without delaying loan closing.
Chatham Financial has executed over $100 billion total notional defeased and returned over $169 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.
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When deciding to prepay your fixed-rate CMBS debt, whether through yield maintenance or defeasance, most borrowers have questions. View Chatham's list of yield maintenance and defeasance FAQs.
Both 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.
The intent of this piece is to bring awareness to some defesaance pitfalls, and return leverage to the hands of borrowers.