Defeasance is a loan prepayment mechanism commonly found in CMBS and other fixed-rate CRE loans that allows the borrower to release the property from the mortgage lien by substituting a portfolio of U.S. government securities (typically Treasury STRIPS) that replicate the remaining scheduled loan payments. The loan itself is not paid off — it continues to exist and make payments to investors — but the real estate collateral is replaced with risk-free securities. This mechanism exists because securitized loans cannot simply be prepaid without disrupting the cash flows promised to bondholders. The cost of defeasance depends on the difference between the loan’s coupon rate and current Treasury rates: when Treasuries yield less than the loan rate, defeasance is expensive; when they yield more, it can be relatively cheap or even result in a premium to the borrower.
How It Works in Practice
Defeasance is one of the most complex and expensive transactions in CRE debt, typically requiring a team that includes a defeasance consultant, a securities broker, a successor borrower, and rating agency approval. The process takes 30 to 45 days and involves purchasing a precise portfolio of Treasuries whose cash flows exactly match every remaining loan payment through maturity. Timing matters enormously — Treasury rates move daily, so the cost of defeasance changes every day. Borrowers considering a sale, refinance, or recapitalization of a defeased property need to model the defeasance cost well in advance and monitor it regularly. Many borrowers are surprised to learn that their defeasance window doesn’t open until two years after origination, or that certain CMBS deals have unique structural requirements. LoanBoss tracks defeasance eligibility dates, open periods, and estimated costs so borrowers can make informed decisions about when to act.
Related Terms
Part of the LoanBoss CRE Debt Glossary. For hedging-specific terms, see Pensford’s resources.