How Commercial Property Owners Can Save on Defeasance Costs
One of the several terms in commercial real estate that the industry could use a refresher on includes defeasance. According to Eitan Weinstock, a senior analyst at AST Defeasance, a CMBS loan defeasance consulting firm, “In commercial real estate, defeasance is the process of releasing a commercial property from the lien of a mortgage and replacing it with a portfolio of government securities.”
Commercial real estate owners are increasingly confronting defeasance clauses in commercial mortgage-backed securities (CMBS) or conduit loans that require strict prepayment penalties in order to refinance or sell a property prior to maturity. While many of the parameters in a CMBS loan agreement are difficult to negotiate, seasoned property owners can negotiate a few specific clauses to minimize future costs should they decide to make their loans null and void.
Per the recommendations of Eitan Weinstock, the following practices can be employed at the beginning of the loan process to save money in the long-run.
- Negotiate the Length of the Open Window — The loan’s open window is the timeframe in which you can prepay your loan without penalty or interest. Generally, CMBS loans allow open windows of two to three months. Requesting that this timeframe be stated in months rather than days will maximize any potential refunds from the defeasance account.
- Defease to the Open Window — The ability to defease to the loan’s open window will allow CRE owners to purchase securities through the open date rather than the maturity date. For example, owners can save three months of interest and custodial fees if one possesses a three-month open window.
- Appoint the Successor Borrower — A successor borrower entity is created to assume responsibility for the newly created defeasance account, and will be entitled to any proceeds from the defeasance account. If the original borrower retains the ability to choose the successor borrower, the original borrower will be able to share in any proceeds from the defeasance account.
- Prepayment Rights — Loan documents include prepayment provisions, which allow the borrower to pay off the loan in full prior to the maturity date without penalty. Borrowers should ensure that the contract does not contain a clause negating the right to prepay the loan following a defeasance. This will enable the creation of significant proceeds from the defeasance account.
- Agency Securities — Permissible defeasance collateral consists of government securities, with loan documents often specifying the use of U.S. Treasury obligations. Borrowers should seek the ability to purchase agency securities as defeasance collateral to ensure that the portfolio of purchased bonds is as inexpensive as possible.
- Purchasing Rights — Borrowers should retain the ability to purchase the securities for defeasance, rather than giving the lender the right to purchase securities. Having the right to choose the broker-dealer can mean the elimination of broker’s fees as well as the ability to go to multiple broker-dealers to accomplish the lowest possible securities pricing.
Graphic courtesy of AST Defeasance