What Is Defeasance in Commercial Real Estate? How the Process Works
If you have a commercial mortgage and you want to sell or refinance before the loan matures, you may not be able to simply pay it off. Many loans, particularly securitized ones, require defeasance instead: you swap the property securing the loan for a portfolio of government securities that keeps paying the lender exactly what the loan would have.
The idea is straightforward. The execution involves a dozen parties, a new legal entity, and a bill that moves with interest rates. Here is how it works and what it costs you.
Key Takeaways
- â–ªDefeasance substitutes government securities for the property as collateral. The loan stays in place; the building is released.
- â–ªIt exists because securitized loans promise bondholders a fixed income stream that early repayment would interrupt.
- â–ªYield maintenance does the same job differently, by paying off the loan with a penalty attached.
- â–ªCost moves with interest rates. When rates have risen since origination, defeasance is usually cheaper, and can even produce residual value.
- â–ªThere is normally a lockout period after securitization before defeasance is permitted at all.
- â–ªBudget 30 to 45 days and engage a defeasance consultant early, since the process runs on a fixed sequence.
What Is Defeasance?
Defeasance means substituting one form of collateral for another. In commercial real estate, the borrower buys a portfolio of government securities structured to produce exactly the payments still owed on the loan, transfers that portfolio and the loan obligation to a new entity, and in return the lender releases its lien on the property.
The loan itself is never repaid early. It continues to run to maturity, funded by the securities rather than by rent from the building. That distinction is the whole point.
Why Lenders Require It
Defeasance goes hand in hand with CMBS loans. When a lender securitizes a loan and sells bonds against it, investors are promised a set income over a set period. If the borrower repays early, that income stops and the promise breaks.
Defeasance solves it by keeping the payment stream intact from a different source. Bondholders continue to receive what they were promised, and the borrower gets the freedom to sell or refinance the property. Many commercial loans include a defeasance clause even when they are not initially securitized, so the lender keeps the option to securitize later.
When Borrowers Use Defeasance
Two situations account for most defeasances: selling the property, and refinancing it. In both cases the buyer or the new lender needs clear title, which means the existing lien has to go.
Some constraints apply:
A lockout period. Securitized loans typically cannot be defeased until a set period after securitization has passed, commonly two years.
The clause has to already exist. Defeasance must be provided for in the original loan documents. It cannot be added later.
Only certain collateral qualifies. Substitute collateral is generally restricted to noncallable government securities.
Defeasance or Yield Maintenance?
Both compensate the lender for losing the income stream. They work differently, and one is usually meaningfully cheaper depending on where rates sit.
| Defeasance | Yield maintenance | |
|---|---|---|
| What happens to the loan | Stays in place, funded by securities | Paid off early |
| What the borrower provides | A portfolio of government securities | The balance plus a prepayment penalty |
| Complexity | High: multiple parties, new entity, 30 to 45 days | Lower: a calculation and a payment |
| Cheaper when | Rates have risen since origination | Rates have fallen since origination |
| Upside for the borrower | Possible residual value if securities overperform | None; the penalty is a cost |
The reason rates matter: defeasance requires buying securities that generate the loan’s remaining payments. When Treasury yields are high, fewer securities are needed, so the portfolio costs less. When yields are low, it costs more. Yield maintenance behaves in the opposite direction.
If your loan permits both, model each before choosing. Where only defeasance is allowed, that is worth raising when the loan is negotiated rather than discovering later.
How the Defeasance Process Works
The process usually runs 30 to 45 days and follows a set sequence.
- Engage a defeasance consultant. They confirm defeasance is permitted, review the loan documents and balance, and model the cost against yield maintenance.
- Give notice of intent to defease. The servicer usually requires written notice and a good faith deposit toward the lender’s costs.
- Assemble the parties. The consultant coordinates the servicer, securities custodian, accountant, rating agencies, title company, and attorneys.
- Draft the defeasance agreement. The lender prepares the documents and may request further information from the borrower.
- Form the successor borrower. A special purpose entity is created to take on the loan and hold the substitute collateral.
- Structure and verify the collateral. A securities portfolio is built to match the remaining payments, and an accountant confirms it covers everything due to maturity.
- Obtain rating agency approval where required. Smaller loans, or loans representing a small share of the pool, often do not need it.
- Close. The borrower buys the collateral, assigns the loan and collateral to the successor borrower, and the lender releases its lien so the property can be sold or refinanced.
- Settle any residual value. If the portfolio produces more than the loan requires, the surplus is negotiated in advance and returned to the borrower.
What Defeasance Costs
There are two parts to the bill. The larger is the securities portfolio itself, which depends entirely on the remaining balance, the time to maturity, and prevailing Treasury yields. The smaller is transaction costs: the consultant, accountant, attorneys, rating agencies where involved, and the successor borrower entity.
Because the portfolio cost moves daily with the bond market, quotes are time-sensitive. Timing the transaction thoughtfully can make a real difference on a large loan.
One point worth negotiating up front: ask whether the lender will accept agency securities alongside Treasuries. Higher-yielding agency paper can mean buying fewer securities to produce the same payments, which lowers the cost.
What This Means If You Are Selling or Refinancing
Build the defeasance timeline and cost into the deal from the start. A buyer expecting to close in three weeks will not appreciate discovering a 45-day defeasance sitting in the way, and the cost can be large enough to change whether a sale or refinancing makes sense at all.
Get a defeasance quote early, treat it as a live number rather than a fixed one, and give the process the time it needs.
This article is for general information and is not legal, tax, or financial advice. Loan terms and defeasance provisions vary. Consult your loan documents and qualified advisers before proceeding.
Frequently Asked Questions
What is defeasance in commercial real estate?
Substituting government securities for the property as loan collateral. The securities produce the payments still owed, the loan continues to maturity, and the lender releases its lien so the property can be sold or refinanced.
How much does defeasance cost?
Mostly the cost of the securities portfolio, which depends on the remaining balance, time to maturity, and current Treasury yields, plus transaction fees for the consultant, accountant, and attorneys. The figure moves with the bond market, so quotes are time-sensitive.
What is the difference between defeasance and yield maintenance?
Defeasance replaces the collateral and leaves the loan running. Yield maintenance pays the loan off early with a penalty covering the lender’s lost interest. Defeasance is usually cheaper when rates have risen since origination; yield maintenance when they have fallen.
How long does defeasance take?
Typically 30 to 45 days from notice to closing, because of the number of parties involved and the need to form a successor borrower and verify the collateral. Start early if a sale or refinancing depends on it.
Can any commercial loan be defeased?
No. The loan documents must provide for it, and securitized loans normally have a lockout period after securitization before defeasance is permitted. Some loans allow yield maintenance instead, and a few allow either.
Matthew Preston
Content Writer, CRE News & Market Analysis
Matthew has covered commercial real estate for CommercialCafe since 2022. He focuses on the office and industrial sectors, reporting on leasing, development, and investment across national markets and individual submarkets. His work draws on data and original research. He also writes about demographic shifts and urban innovation in U.S. cities. The New York Times, The Real Deal, Bisnow, The Business Journals, and Yahoo Finance have cited his reporting.
