CMBS defeasance is the process of releasing a commercial property from a securitized mortgage by substituting a portfolio of government securities for the real estate as collateral. The loan itself stays on the books, the bondholders in the CMBS trust keep receiving their scheduled payments from the new securities, and the borrower walks away with an unencumbered property that can be sold or refinanced. It is expensive and paperwork-heavy, but for a borrower locked out of early payoff, it is usually the only way out before the loan matures.
Why You Can’t Just Pay the Loan Off Early
When a commercial mortgage is pooled into a CMBS trust, the bondholders who buy into that pool are counting on a predictable interest stream for a set number of years. To protect that income, the loan agreement includes a lockout provision barring early payoff for nearly the entire term. The lockout typically lifts only during a short open prepayment window in the final 60 to 90 days before maturity.
Defeasance is the workaround built into the loan documents. Instead of paying off the principal, you replace the collateral. The trust keeps a performing loan, the bondholders keep their cash flow, and your building is freed from the lien. The mortgage is still legally in force; it is simply secured by bonds now instead of real estate.
What the Replacement Collateral Has to Do
The securities you buy have to produce cash flows that match every remaining monthly principal and interest payment, plus any balloon at maturity, dollar for dollar. Loan documents almost always require non-callable U.S. Treasury obligations, usually strips or fixed-rate coupon bonds. Non-callable matters because the government cannot redeem the bond early, which guarantees the payment stream survives through the full remaining loan term.
Some pooling and servicing agreements also allow agency securities issued by Fannie Mae, Freddie Mac, or the Federal Home Loan Banks. Agency bonds sometimes carry slightly higher yields than Treasuries, so where permitted they can shave meaningful dollars off the portfolio cost. A financial analyst assembles the cheapest combination of bonds whose cash flows still cover every future payment. Overpaying for the portfolio by even a small margin comes directly out of your pocket, so the optimization matters. Once the portfolio is approved, the securities sit in a pledged account, and their payments are routed exclusively to servicing the debt.
The Two-Year REMIC Wait
CMBS trusts are organized as Real Estate Mortgage Investment Conduits under the Internal Revenue Code, and the tax rules impose a restriction that catches many borrowers off guard. Under Section 860G(a)(9), a REMIC has a “startup day” fixed on the date the trust issues all of its regular and residual interests. Loan documents routinely bar defeasance until at least two years after that startup day.
A typical loan allows defeasance at the later of a fixed period after origination (commonly two or three years) or two years after the REMIC startup day. The startup day can lag the origination date by weeks or months, so if you recently bought a property with an existing CMBS loan on it, confirm the exact startup day with the master servicer rather than counting forward from your closing. You may be waiting longer than you think.
Defeasance vs. Yield Maintenance
Not every CMBS loan uses defeasance. Some require yield maintenance instead, which is a lump-sum penalty equal to the present value of the remaining interest payments, discounted by the gap between your loan rate and the current Treasury yield for a matching term. You write a check and the loan is gone. Defeasance, by contrast, means actually purchasing a bond portfolio, transferring the loan to a successor entity, and running weeks of legal coordination.
Which costs less depends almost entirely on where rates sit when you need to exit. When Treasury yields have risen above your loan rate, both options get cheaper: each dollar of bond generates more income, so you need fewer bonds, and the yield maintenance spread shrinks or disappears. When rates have fallen, the math flips painfully. You need more bonds to produce the same cash flow at lower yields, and the yield maintenance penalty widens. Borrowers holding older, lower-rate loans during a period of declining rates sometimes find that the defeasance cost rivals or even exceeds the remaining loan balance.
One structural quirk favors defeasance: because you are buying real securities on the open market, you can sometimes use permitted agency bonds that yield slightly more than Treasuries, trimming the cost. Yield maintenance formulas are locked to the Treasury curve and whatever spread the loan documents specify. Neither option is categorically cheaper. The rate environment on the day you need to exit decides the winner.
How the Process Actually Runs
Before you file anything, you need the original promissory note, the recorded mortgage or deed of trust, and a current amortization schedule showing every remaining payment. Those documents fix the obligations the replacement securities have to cover. Most borrowers hire a defeasance consultant to coordinate the moving pieces: legal counsel, the master servicer, an accounting firm, a securities broker, and the entity that will serve as the successor borrower. Running this without a specialist is technically possible but practically a bad idea given the number of parties and the tight sequencing.
The consultant also sets up the successor borrower, a bankruptcy-remote special purpose entity (usually a Delaware LLC) whose only job is to hold the securities and service the loan after your property is released. Using a separate entity keeps your future business risks away from the collateral securing the bonds.
The formal process starts with a notice of intent to defease, submitted to the master servicer. The notice identifies the loan, names your counsel, and proposes a closing date. Most loan agreements require at least 30 days’ notice. The servicer responds with a checklist, delivery instructions, and the contact for its outside counsel, who will independently review the entire transaction against the loan agreement and the pooling and servicing agreement. That review commonly takes several weeks. Counsel confirms the successor borrower is properly formed, checks that the proposed securities meet collateral requirements, and makes sure the transaction will not jeopardize the trust’s REMIC status. Document pushback at this stage is normal, so build buffer time into the schedule.
Once the package is approved, the parties execute a defeasance assignment and assumption agreement that transfers the loan from you to the successor entity. The securities are purchased on the open market and deposited into the pledged escrow. Treasury prices move daily, so the final cost of the portfolio is not locked in until that purchase actually executes. A rate move in the days before purchase can meaningfully change your bill. After the securities are in place and the transfer is complete, the servicer records a release of the mortgage in the local land records, and the lien is officially gone from your property.
Timeline
From first contact with the servicer to the recorded release, a standard defeasance runs about 30 to 45 days. The biggest variable is servicer review, which depends on their staffing, the complexity of the loan, and how clean your documentation is. Expedited closings under two weeks are possible when every party is responsive, but that leaves no room for error. If you are tying the defeasance to a property sale, give yourself at least 45 days from the notice of intent. A buyer wiring funds will want assurance the lien will be cleared, and a delayed defeasance can kill a deal.
What It Costs
Defeasance has two cost components: the price of the replacement securities and the transaction fees. Transaction fees apart from the securities themselves commonly run between $50,000 and $100,000 or more, depending on loan size and complexity. That total covers the master servicer’s processing fee (roughly $10,000 to $20,000), the servicer’s outside counsel reviewing the documents (often $17,000 to $35,000), the defeasance consultant (around $7,500), a verification accountant producing the report that confirms the securities’ cash flows match the debt payments (around $3,500), the setup and in some cases annual maintenance of the successor borrower entity, your own counsel’s fees, and, on large enough loans, a rating agency review fee. None of these are optional.
The sticker shock is sharper on smaller loans, where fixed costs eat a bigger share of the balance. Spending $75,000 in fees plus a securities premium on a $3 million loan feels very different than it does on a $30 million loan.
The securities themselves are almost always the largest line item, and their cost swings with interest rates. When Treasury yields are higher than your loan rate, each dollar of bond generates more income, so you need fewer bonds and the portfolio can occasionally cost less than the outstanding balance. When yields have dropped well below your loan rate, each bond produces less income, so you need more of them, and the premium above par can be substantial. This is the single most important variable in the whole transaction and the one you have the least control over. If you have flexibility on timing, even a modest rise in Treasury yields can save tens of thousands on the securities purchase.
Are the Costs Deductible?
The IRS has not issued a ruling specifically addressing defeasance costs, but tax practitioners generally treat them like prepayment penalties, which are deductible as interest expense under IRC Section 163. The deciding question is whether you, as the original borrower, are fully released from the loan or retain some residual obligation.
If the successor borrower assumes all obligations and you are completely released, the defeasance costs are likely deductible in the year of the transaction. If you retain any obligation on the note, the costs instead must be amortized over the remaining loan term as original issue discount. Have your tax advisor review the specific release language in the assumption agreement before closing. Getting that language right is not just a legal formality; it decides the timing and character of your deduction.
Partial Defeasance for Multi-Property Loans
If one CMBS loan secures several of your properties and you want to sell just one, you may not need to defease the whole loan. Partial defeasance releases a single property by substituting securities that cover only the portion of debt allocated to that asset. The remaining properties stay in the loan pool, and the balance is reduced accordingly.
The mechanics are the same as a full defeasance, with an added layer: the servicer and its counsel have to determine how much of the balance is allocated to the released property, and the pooling and servicing agreement may impose minimum release prices or loan-to-value tests. Not every CMBS loan permits partial defeasance, so confirm the option in your loan documents before you commit to selling a property.
Check the Open Prepayment Window First
Before you spend a dollar on defeasance, look at how close your loan is to maturity. Most CMBS loans allow penalty-free prepayment during the final 60 to 90 days before maturity. If you are near that window, waiting a few months and paying the loan off at par can save you the entire defeasance cost, easily six figures on a sizable loan. Defeasance portfolios are also typically structured to run only through the start of that open window rather than all the way to maturity, which already reduces the number of bonds you need to buy. If your loan matures within the next year or two, run the numbers on both timing scenarios before you commit.