Defeasance Agreement

A defeasance agreement is a specialized closing document that allows a borrower to replace the real estate collateral securing a loan with a portfolio of government or agency securities that replicate the loan’s remaining cash flows. Common in securitized loans such as CMBS, defeasance transfers the income stream substitute to an escrow so bondholders continue receiving scheduled payments while the borrower regains free-and-clear control of the property. The process involves strict security selection, an escrow agent, legal opinions, and precise timing to satisfy bond indentures and servicing requirements.

Sponsors use defeasance when they need to sell or refinance a property but the loan’s prepayment terms make a traditional payoff expensive or contractually restricted. The borrower, broker, and servicer coordinate to purchase appropriate Treasury or agency strips, execute the defeasance agreement, and record release documents that remove the mortgage lien. Underwriters and counsel must confirm that the replacement securities exactly match cash-flow timing and that all parties comply with pooling and servicing agreements if the loan is securitized.

Defeasance is important because it offers an alternative to paying a prepayment premium or negotiating a waiver, enabling borrowers to monetize or re-finance assets locked behind securitized debt. It preserves scheduled payments for investors while allowing property transfer, but it is resource-intensive and carries transaction costs, timing constraints, and documentation complexity. Understanding defeasance mechanics is essential for planning exits on CMBS-encumbered assets and for accurately projecting deal proceeds and closing timelines.