Are you interested in selling or refinancing your commercial property in Colorado? If your mortgage or loan doesn’t allow prepayment, defeasance may be your only option to complete a deal. Often, commercial mortgages do not allow prepayment. However, a defeasance may be available instead. Defeasance is a process of substituting collateral, usually Treasury bonds or Agency securities, for the property that secures the loan through a Deed of Trust.

What is a defeasance?

Defeasance essentially replaces the property secured by a real estate mortgage or loan with certain assets other than cash, usually Treasury bonds or Agency securities. Through defeasance, a borrower can substitute another cash-flowing asset - Treasury bonds or Agency securities - for the original collateral on the loan – the commercial property subject to the Deed of Trust. The substituted assets - Treasury bonds or Agency securities – are selected to generate the same cash flow as the underlying commercial loan would provide. The substituted collateral permits the lender to release the encumbered commercial property, as there is new collateral that ensures the same future cash flow as the underlying promissory note requires. Defeasance also offers borrowers flexibility and potential financial gains when interest rates are rising.

The defeasance process allows the Deed of Trust on the commercial property to be released. This release allows for the sale or transfer of the property while providing the note holder with the same the monthly principal and interest payments due under the loan. Oftentimes, commercial loans are securitized, or bundled into a debt tranche and sold to investors as commercial mortgage-backed security (CMBS). As such, the note holder needs to ensure that the payments under the loan continue. By maintaining the note holder’s security interest through the defeasance process, you will be free to sell or refinance the property.

Defeasance may be the only way you can complete a deal.

If you need to sell or refinance commercial property but the loan terms don’t allow you to prepay the loan, chances are that you will need to seek a defeasance to complete a deal. If you are in this predicament, you should ensure that your lender allows for defeasance of the loan. The defeasance process is complex and time consuming, so it is crucial to consult with a professional experienced in the defeasance process, such as a real estate lawyer, to help you through the defeasance process.

Who does the defeasance process benefit?

In short, the defeasance process can be mutually beneficial for lenders and borrowers.

Defeasance can be highly beneficial to note holders, because the process generally substitutes riskier investments, CMBS, with the same yield provided by what is generally regarded as safer assets - Treasury bonds or Agency securities.

Defeasance can also be helpful to borrowers as well, as it allows them to get out of their loan early and provides the freedom to transfer or refinance the commercial property. An additional benefit for borrowers is that defeasance is tax deductible.

How long does it take for a defeasance?

A typical defeasance takes 30 days to complete but can often be expedited with additional fees. Because the process is so time consuming, it is imperative to seek representation and get the process started before closing a deal on the commercial property. Beginning the defeasance process at the last minute could delay or even derail a sale or refinance opportunity.

How do I start the defeasance process?

An experienced real estate lawyer can examine the specific terms and conditions of your loan and advise you through the process. Since the defeasance process is complex and time consuming, it is important to consult with a lawyer experienced in real estate transactions. Representation is necessary, because negotiation and communication with the lender or note holder are typically ongoing throughout the lengthy defeasance process. If you are selling or refinancing commercial property, it is very important to enlist the help of professional representation to ensure that this process is completed correctly and to your maximum benefit.

If you’re thinking about selling or refinancing your property and would like to discuss the defeasance of your mortgage, Geraghty Law Office can help. Please fill out an intake form if you are interested in scheduling a consultation with GLO.