Commercial real estate owners are increasingly confronting defeasance clauses in conduit or CMBS loans. These clauses require strict prepayment penalties in order to refinance or sell a property prior to maturity.
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 that are placed in a collateral account and pledged to the lender.
This structure allows the borrower to sell or refinance the collateral property prior to loan maturity. Unlike a prepayment on the loan, however, the defeasance structure keeps the loan payment stream in place for the lender.
While many of the parameters in a CMBS loan agreement are difficult to negotiate, well-versed property owners can negotiate a few specific clauses to minimize future costs should they decide to defease their loans.
What follows are seven ways to save money later with proper planning at the beginning of the loan process.
- 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. However, there are many loans with larger open windows. Additionally, 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 you to purchase securities through the open date rather than the maturity date. For example, you can save three months of interest and custodial fees if you possess 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.
- Cap Servicer Fees — Servicers often charge processing fees of $15,000 to $25,000 per defeasance. Borrowers should cap the servicer processing fees at $5,000. By placing a fee cap in the loan documents, the servicer will be obligated to lower its fees.
— Eitan Weinstock is a senior analyst at AST Defeasance, a CMBS loan defeasance consulting firm, offering a full range of services including helping borrowers negotiate the prepayment section of new CMBS loans.