Wednesday, February 14, 2007
Yield maintenance and Defeasance
Most very attractive commercial financing over the last few years has been saddled with the burdens of yield maintenance or defeasance clauses. Essentially this is a prepayment penalty that does not go away, can be huge and can hinder the effective marketing of an investment property. Yield maintenance is simple - a formala is used to calculate what the prepayment penalty is based on the current market interest rates and the remaining term of the loan. This can be a large amount, but a seller can sell if he sees economic benefit. Defeasance is another difficulty all together - the loan cannot be retired, period. Companies such as Capital Defeasance Group provide the solution. The loan is removed from the property, the seller can sell unencumbered, the loan is then replaced to the lender by a portfolio of fixed rate income products (treasury notes and bills) which continue to pay down the loan according to schedule. Simple right? Actually yes, just difficult to explain without a powerpoint presentation. There definitely are significant costs involved. The upside is a property that CAN be sold.