Negotiating Defeasance Provisions at Origination Can Materially Impact the Bottom Line

Real Estate Issues, Spring 2007 by Henner, Cheryl Pavic

Rules governing the structuring of the defeasance collateral stipulate that the earned interest cannot be applied toward scheduled loan payments. However, all accrued interest can be realized when the loan matures. If successor borrowers offer a sharing arrangement, borrowers can receive a portion of this residual value (see Figure 4). For this reason, it is important for borrowers to be able to designate successor borrowers. As previously mentioned, this tactic also enables borrowers to benefit if the right to prepay the loan survives the defeasance. An example of language that secures this right is: "Borrower shall, in its sole discretion, establish or designate a successor entity which is acceptable to the Rating Agencies."

THINKING ABOUT DEFEASANCE AT ORIGINATION

Defeasance provisions represent just one element of a loan-an element that does not necessarily influence upfront costs or monthly debt service payments. Thus, defeasance provisions are easy to overlook when negotiating the term sheet of a new loan. However, defeasance is typically the only way borrowers can release property for sale or refinance purposes. Because regulations preclude modifications to defeasance provisions after a loan is securitized, the best time to shape the destiny of a defeasance is at origination. Understanding the various defeasance provisions and requesting preferential language when negotiating the term sheet of a new loan will minimize future defeasance costs for borrowers.

About the Author

Cheryl Pavic Henner is a defeasance consultant for Chatham Financial, a Kennett Square, Pa.-based advisory firm that serves the capital markets. Chatham Financial was a participant in the largest real estate defeasance transaction-more than $1 billion-on record. Pavic Henner holds a bachelor's decfree in architectural engineering from the Milwaukee School of Engineering and an MBA with a concentration in urban land development from California State University-Sacramento.

CHERYL PAVlC HENNER is a defeasance consultant for Chatham Financial, an advisory firm that serves the capital markets.