Jansen Multifamily Team Blog

The volatility of today’s real estate market makes understanding your lender’s “contractual call protection” features of paramount importance.  These features are contained in most multifamily loans and typically take one of four forms: lockout, step down premiums, yield maintenance and defeasance.  Failure to understand the impact of these loan provisions on your ability to buy, sell or refinance a property can result in eleventh hour chaos and greatly decreases your chances for a successful transaction.

I am director of The Jansen Multifamily Team at Coast|Sperry Van Ness and experienced a real-world example of the call protection feature earlier this year when closing an off-market +/- $5 million apartment transaction in the Puget Sound Region.

I  was aware that the underlying debt on the property was a securitized loan and, as such, advised the seller that the loan would likely have to go through a defeasance in order to deliver title “free and clear of all encumbrances” to the buyer.

To confirm this assumption, I requested a copy of the Seller’s note (a request that was met with resistance).  “The underlying note is irrelevant because the buyer is not assuming the financing,” the seller assured us.  “And I am 100% positive that pre-payment penalty is yield maintenance” he added.

As an abundance of caution, my team provided the seller with a net proceeds estimates that assumed both defeasance and yield maintenance costs.

Two days before the scheduled closing of the property, I received a call from the seller: “Josh, we have a problem!  I read the note and the loan requires a defeasance.”  Why, you might ask, did this matter?  Answer: Timing.  Defeasance is a 30-day process by which the collateral for the loan (the property) is substituted for a pool of securities (treasuries), i.e. the loan can’t be paid off because it is part of a pool that was sold to investors who expect a specific yield for the entire term of the loan.  A virtual deal killer. . . .

In an attempt to prevent a failed closing, the our team immediately contacted a company that specializes in working through defeasance issues.  They were able to coordinate the defeasance process with the master servicer, legal counsel, buyer and seller, pool securities and close the transaction within seven days of my first call to them.  The end result of this transaction may have been a successful closing.  However, the eleventh hour chaos and uncertainty experienced by all parties could have been avoided if the Seller understood the terms of his loan or heeded the counsel of his Advisors.

The below listed synopses of the other three typical call provisions should help you get to know your loan:

• Lockout: specified period of time during which a prepayment of the loan is prohibited; if your loan has a lock-out provision, your only option to complete a sale would be the buyer’s assumption of the underlying debt (assuming assumption is permitted)
• Step Down Premiums: calculated as a fixed percentage of the principal balance being prepaid; as the loan gets closer to maturity, the percentage of the prepayment penalty decreases, i.e. 4% years 1-3, 3% year 4, 2% year 5, 1% years 6-10.
• Yield Maintenance: according to www.freddiemac.com, a yield maintenance provision is “…designed to eliminate the borrower’s ability to capitalize on a decline in market interest rates by refinancing.  In addition to the principal balance prepaid and any accrued interest, the borrower must make a cash payment equal to the present value of the difference between the foregone mortgage interest rate and a specified “reference rate.”  The reference rate typically equals the current yield on the Treasury with a term comparable to that remaining on the loan.

Websites such as www.defeasewithease.com and www.loopnet.com are outstanding informational resources that also offer calculators to assist you with estimating your prepayment  and defeasance premiums.  Although these tools can be helpful, it is important to seek the counsel of experienced commercial real estate professionals.  A skilled Advisor will help you understand the call provisions of your loan and the financial impact of said provisions, thereby maximizing your returns and increasing your chances for success.