Why It Matters
Here's why defeasance matters: if you own commercial property secured by a CMBS loan and you want to sell before the loan matures, you can't just write a check to pay it off. The loan was pooled with others and sold to bond investors who depend on predictable monthly payments. Defeasance lets you swap your property out of that pool and replace it with Treasuries that deliver the same payments — freeing you to sell or refinance while keeping the bond investors whole.
At a Glance
- What it is: A CMBS loan exit mechanism that substitutes property collateral with U.S. Treasury securities
- Who uses it: Commercial borrowers selling or refinancing property before their CMBS loan matures
- Time required: 30–60 days from initiation to close — plan the sale timeline accordingly
- Typical cost: $20,000–$50,000+ in consultant and legal fees, plus the cost of purchasing Treasuries
- Rate sensitivity: Cheap when interest rates have risen; expensive when rates are low
- Alternative: Yield maintenance — a cash penalty that achieves a similar economic result via different mechanics
- Open window: Most CMBS loans have a 3–6 month open prepayment window at the end of the term when defeasance (or any prepayment) is not required
How It Works
Why CMBS loans can't just be paid off. When a lender originates a CMBS loan, the loan gets pooled with others, securitized, and sold to institutional bond investors. Those investors bought bonds tied to a specific cash flow schedule — your monthly payments are part of it. Early repayment disrupts that stream. Defeasance solves this by providing a replacement income source — a portfolio of Treasuries — rather than a lump-sum payoff the securitization structure can't absorb cleanly.
The substitution process, step by step. You hire a defeasance consultant who calculates the required Treasury portfolio, sized to replicate your loan's remaining monthly payments exactly. The consultant coordinates the Treasury purchase, creates a bankruptcy-remote successor LLC to hold the securities, and manages the legal transfer with the loan servicer. Once complete, the lien on your property releases and you can sell or refinance. The full process runs 30–60 days. Consultant fees typically range from $20,000–$50,000; legal fees add another $5,000–$15,000.
How interest rates determine the cost. The bigger cost driver isn't the consultant — it's the price of the Treasuries themselves. When current rates are higher than your loan rate, Treasuries are cheaper to buy (fewer dollars generate the required payment stream). When rates are low relative to your loan rate, you need to spend more on Treasuries to match the cash flow, and defeasance gets expensive fast. A borrower exiting a 4.75% CMBS loan into a 6% rate environment pays far less than one exiting into a 3.5% environment. Run the numbers before assuming defeasance is affordable.
Real-World Example
Brian owns a 32,000-square-foot retail strip center in suburban Atlanta, financed with a $4.3M CMBS loan at 4.75% with a 10-year term originated in 2021. A regional grocery chain approaches him in 2027 with a strong acquisition offer — but the loan doesn't mature until 2031, and the open prepayment window doesn't open until mid-2031.
Brian hires a defeasance consultant. With rates now higher than his loan rate, the Treasury portfolio comes in at $4.43M — a $130,000 premium above his outstanding balance. Consultant fees: $31,000. Legal: $8,600. Total defeasance cost: $169,600 on top of normal closing costs.
He models the alternative: hold until 2031. The grocery offer is strong enough that selling now — even after defeasance costs — nets $147,000 more than the projected hold-and-sell outcome. He proceeds. The lien clears in 44 days, and the sale closes on schedule.
Pros & Cons
- Contractual exit right: Defeasance is built into the loan documents — if you perform the substitution correctly, the lender must release the lien. No negotiation over whether you're allowed to exit.
- Lien releases cleanly: Once the successor LLC assumes the loan, your property is free and clear — you can close the sale without waiting for loan maturity.
- Cheaper when rates rise: In a rising-rate environment, Treasury yields go up, meaning you spend less to match the required cash flow. Defeasance can significantly undercut yield maintenance in those conditions.
- Predictable timeline: Experienced consultants close these in 30–60 days. Commercial buyers understand the process and can plan around it.
- Expensive when rates are low: Low Treasury yields mean a larger, costlier portfolio to match your loan's cash flow. In a low-rate environment, defeasance costs can run well into six figures beyond your loan balance.
- Cannot compress the timeline: Defeasance takes 30–60 days minimum — no exceptions. A buyer who needs a fast close will force you to either delay or walk.
- Lock-out periods block exit entirely: Most CMBS loans prohibit defeasance (and any prepayment) during the first 2–3 years. There's no workaround.
- Requires specialists: You need a defeasance consultant, securities broker, and real estate attorney experienced in CMBS — this is not a standard closing team.
Watch Out
- Read the prepayment clause before acquiring any CMBS-encumbered property. Identify the lock-out period, whether the loan uses defeasance or yield maintenance, and when the open prepayment window begins. Finding out you're locked out after signing a sale contract is an expensive surprise.
- Build defeasance costs into your hold-period underwriting. A 5-year hold on a 10-year CMBS loan almost certainly means defeasance at exit. Stress-test that cost across rate scenarios before you close on the acquisition.
- The successor LLC must be structured correctly. This bankruptcy-remote entity holds the Treasuries and legally assumes the loan. An incorrectly structured LLC — wrong jurisdiction, missing lender consent, defective operating agreement — kills the substitution. Hire specialists who've done this before.
- Open prepayment window ≠ defeasance window. In the open window (typically the last 3–6 months of the loan term), the loan can be repaid at par with no defeasance required. If you can time a sale to that window, you avoid defeasance costs entirely.
The Takeaway
Defeasance is the mechanism CMBS loans use instead of traditional prepayment — it substitutes your property with Treasuries and keeps the bond investors' cash flow intact. The cost ranges from manageable to significant depending on where interest rates are relative to your loan rate. Any time you're buying a property with CMBS debt attached, or originating a CMBS loan, defeasance should be in your exit planning from day one.