Defeasance Explained
Defeasance is the prepayment mechanism standard on CMBS (commercial mortgage-backed securities) loans. Instead of paying off the loan with cash, the borrower replaces the collateral with a portfolio of Treasury securities sufficient to make all remaining loan payments. It is one of the most complex prepayment structures in commercial real estate.
How It Works
The borrower buys a portfolio of U.S. Treasury securities whose cash flows exactly match the remaining principal and interest payments on the loan. The Treasuries are pledged as substitute collateral, and the original real estate collateral is released. The loan technically remains outstanding until maturity.
Why CMBS Uses It
CMBS loans are sold to bond investors who expect a defined stream of payments. Defeasance lets the borrower exit while protecting the bond investors' yield. The structure preserves the original cash flows from the bondholders' perspective.
Cost
Defeasance costs include the price of the Treasury portfolio (which can be substantial when rates have fallen), plus defeasance consultant fees, attorney fees, accountant fees, and rating agency fees. Total costs commonly run several hundred thousand dollars on mid-size loans.
Timing and Lockout
Most CMBS loans have a lockout period — typically 24–36 months from origination — during which prepayment is not permitted at all. After the lockout, defeasance becomes available. Some loans also have an open period near maturity when prepayment is permitted without defeasance.
Educational content only — not advice. KQT Advisors, LLC is a commercial loan broker; we are not a lender, attorney, accountant, financial advisor, or fiduciary. We do not originate loans or make lending decisions. The information in this article is provided strictly for general informational and educational purposes and reflects our understanding at the time of writing. It is not — and must not be construed as — financial, tax, legal, accounting, investment, or any other professional advice, and creates no advisor-client relationship. Loan programs, rates, terms, eligibility requirements, fees, and approval criteria are set by individual lenders, the SBA, and other parties and are subject to change at any time without notice. Examples are illustrative only and not guarantees of outcome. Nothing here is a commitment to lend, an offer of credit, or a representation that any specific structure will be available to or appropriate for any borrower. Always consult your own qualified financial, tax, and legal advisors before acting on any information in this article. To the maximum extent permitted by law, KQT Advisors, LLC and its principals, employees, agents, and affiliates disclaim all liability for any direct, indirect, consequential, or incidental loss or damage arising out of any use of, reliance on, or inability to use the information in this article.