Navigating Commercial Mortgage Defeasance Costs: What You Need to Know

Commercial mortgage defeasance costs can be a complex and often misunderstood aspect of commercial real estate financing. For those unfamiliar with the term, defeasance is the process of substituting collateral for a commercial mortgage-backed security (CMBS) loan. This typically occurs when a borrower wishes to sell a property before the loan matures.

Defeasance costs can vary significantly depending on various factors such as the size of the loan, interest rates, and the remaining term of the loan. It is crucial for borrowers to understand these costs and factor them into their financial planning. In this blog post, we will discuss the key points you need to know about navigating commercial mortgage defeasance costs.

What is Defeasance?

Defeasance is a process that allows borrowers to release the collateral securing their CMBS loan. Instead of selling the property and using the proceeds to pay off the loan, the borrower substitutes the collateral with a portfolio of U.S. government securities. This ensures that the bondholders continue to receive the promised cash flows from the loan.

Understanding Defeasance Costs

Defeasance costs primarily consist of two components: the yield maintenance premium and the transaction expenses. The yield maintenance premium compensates the bondholders for the lost interest income due to the early prepayment of the loan. Transaction expenses include legal fees, administrative costs, and third-party fees associated with the defeasance process.

Yield Maintenance Premium

The yield maintenance premium is calculated based on the difference between the interest rate on the loan and the current U.S. Treasury rate. The higher the difference, the larger the yield maintenance premium. This premium is typically paid upfront and can be a significant expense for borrowers.

Transaction Expenses

Transaction expenses can vary depending on the complexity of the defeasance process and the specific requirements of the loan documents. These expenses may include legal fees for drafting and reviewing documents, administrative fees for managing the process, and fees for third-party services such as custodians and rating agencies.

Factors Affecting Defeasance Costs

Several factors can impact the overall cost of defeasance. These include:

• The size of the loan: Larger loans typically have higher defeasance costs due to the larger principal balance and potential lost interest income.
• Interest rates: Higher interest rates can result in larger yield maintenance premiums.
• Remaining term of the loan: The longer the remaining term, the higher the yield maintenance premium.

Navigating Defeasance Costs

When considering commercial mortgage defeasance, it is essential to work closely with experienced professionals who specialize in this area. They can provide valuable guidance and help you navigate the complexities of the process.

Additionally, it is crucial to carefully review the loan documents and understand the specific requirements and costs associated with defeasance. This will help you accurately estimate the potential costs and plan accordingly.

Conclusion

Navigating commercial mortgage defeasance costs can be a challenging task. Understanding the components of defeasance costs, such as the yield maintenance premium and transaction expenses, is crucial for borrowers. By considering the factors that affect these costs and seeking guidance from professionals, borrowers can effectively manage and plan for defeasance expenses.