How does Defeasance in Commercial Mortgage affect property value?

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Defeasance in Commercial Mortgage is a loan prepayment process where a borrower replaces the income stream of a commercial mortgage with a portfolio of government securities that generate equivalent cash flows, allowing the property to be released from the loan without triggering prepayment penalties. It is commonly used in CMBS loan structures.

How Defeasance Works in Practice

• Borrower purchases a portfolio of US Treasury or agency securities matching the loan's remaining payment schedule
• The securities portfolio is substituted as collateral, releasing the property from the mortgage lien
• A successor borrower entity is created to hold the securities and service the loan to maturity
• The original borrower's property is freed from encumbrance and can be sold or refinanced

How Defeasance Affects Property Value

• Enables property sale or refinancing without triggering CMBS prepayment restrictions
• The cost of purchasing the securities portfolio is the primary financial consideration
• In low-interest rate environments, defeasance costs can be significant as Treasury yields are lower
• Successfully completed defeasance results in a clean title transfer, which supports full market value realization

When Defeasance Is Most Commonly Used

• When a borrower needs to sell a property before the CMBS loan matures
• During portfolio refinancing where one asset needs to be released from a cross-collateralized structure
• When market conditions create a compelling case for early asset disposition
• As part of a capital recycling strategy to free up equity for reinvestment

Defeasance is a sophisticated but important mechanism in commercial mortgage finance that allows property owners to exit CMBS-encumbered assets efficiently. Borrowers must carefully model the cost of defeasance against the financial benefits of early disposition to determine whether the strategy is financially justified.

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