Thomas Welch, John Poole | July/August 2016
During the last cycle, commercial mortgage backed securities lending gained in popularity, culminating in a frantic pace of origination between 2005 and 2008. During that period, many borrowers went through loan defeasance. But for a fairly long stretch of time following the CMBS market implosion, the economics of defeasance rarely made sense. However, with rates still near historic lows and commercial real estate prices favorable to sellers, many more loans will enter into defeasance over the next several years. This article discusses what borrowers should know if they are considering defeasance, and why they should ask for defeasance prepayment provisions in a new loan.
What Is Defeasance?
Defeasance is the standard CMBS industry alternative to traditional prepayment penalties such as the yield maintenance penalty common to life insurance company loans and fixed percentage penalties common to local bank loans. Rather than being a true prepayment, defeasance is the substitution of securities collateral for real estate collateral. This allows a release of the property lien, freeing the asset for refinancing or sale. A borrower’s property is released when a portfolio of U.S. government securities is structured to replace the cash flow covering the debt service. A special purpose entity, known as the successor borrower, assumes the role of the borrower and makes payments on the loan using the portfolio of securities. The complexity and upfront costs of loan defeasance can be intimidating, and the intricate process has often led to an uneven playing field.
Larry Dietz, an associate broker with Saurage Rotenberg Commercial Real Estate, has over 30 years of Sales, Marketing and Public Relations experience. He is a Designee member of the Certified Commercial Investment Member Institute (CCIM) and CCIM Louisiana Chapter; a member of the Commercial Investment Division of the Greater Baton Rouge Board of REALTORS® (CID); as well as an affiliate member of the National Association of REALTORS® (NAR). He is a licensed real estate broker in Louisiana and Mississippi.
Saurage Rotenberg Commercial Real Estate is a member of the Baton Rouge Area Chamber of Commerce (BRAC); the West Baton Rouge Chamber of Commerce; the Baton Rouge Better Business Bureau; the Louisiana Commercial Data Base (LACDB); and the International Council of Shopping Centers (ICSC). Several agents, on an individual basis, are members of the Society of Industrial and Office Realtors® (SIOR), the Certified Commercial Investment Member Institute (CCIM); the National Association of REALTORS® (NAR); and the Greater Baton Rouge Association of REALTORS® Commercial Investment Division (CID).