Updated August 16, 2026
Defeasance is a prepayment mechanism common on CMBS and some agency loans in which you do not actually pay the loan off — you buy a portfolio of government securities that produces the same payment stream the lender was expecting, and substitute it as collateral. The loan continues on paper; the building is released. The cost is driven almost entirely by the rate environment: if Treasury yields are below your loan's coupon, replicating your payment stream is expensive, and the bill can run into six or seven figures. If Treasury yields are above your coupon, defeasance can be surprisingly cheap and occasionally close to neutral. The number is a market calculation, not a fee schedule, and it changes daily.
These three appear in LA multifamily loan documents and behave very differently. Read your loan documents, not a summary, because the difference is often hundreds of thousands of dollars.
Defeasance. Substitute securities for the building as collateral. Costs include the securities portfolio itself plus accountant, attorney, rating agency, and servicer fees, and it takes roughly 30 days with a specialist consultant running it.
Yield maintenance. Pay the lender a lump sum that makes them whole on the interest they expected. Simpler mechanically than defeasance, similar economic driver, and usually with a stated floor such as 1% of the balance.
Step-down or declining prepayment premium. A schedule — 5% in year one, 4% in year two, and so on. The most seller-friendly structure, because the cost is knowable in advance and unaffected by rates.
Open window. Most loans have a period near maturity, often the last 90 days or so, when prepayment is free. If your sale timing is flexible, hitting that window can save the entire prepayment cost.
The mechanism is worth understanding because it determines whether waiting helps or hurts.
The lender's position is a stream of payments at your coupon. To let you go, they need to be put in an equivalent position. When Treasury yields are lower than your coupon, buying that stream costs more than your outstanding balance — the excess is your cost. When Treasury yields are higher than your coupon, the same stream can be bought for less, and the cost approaches zero or a stated floor.
The practical consequence: an owner with a 3.5% loan facing a higher-rate environment may find prepayment far cheaper than they feared, while an owner with a 6% loan in a falling-rate environment faces the opposite. This is the reverse of most people's intuition, and it is worth getting an actual quote rather than assuming.
Get a written prepayment quote from your servicer. Not an estimate from memory. Quotes are dated and move with the market, but a current one tells you the order of magnitude.
Ask what the open window is and when it starts. If it is within a year, that alone may set your sale timing.
Ask whether the loan is assumable instead. A buyer assuming below-market debt avoids the prepayment cost entirely and may pay more for the building. That comparison — assume versus prepay — is the actual decision.
Put the number in your net sheet before you set a price. A prepayment cost is a direct reduction of proceeds, on the same footing as commission and transfer taxes.
On loans with a large defeasance or yield maintenance cost, the calculus sometimes shifts away from selling this year at all — the prepayment penalty can consume more than the price improvement a seller is waiting for. On loans that are assumable at a below-market rate, the strategy shifts the other way: market the debt aggressively, because it is one of the few things that genuinely expands the buyer pool in a tight financing market.
The mistake is treating the loan as an afterthought. On LA multifamily deals in the current cycle, the debt frequently determines both the net proceeds and which buyers can transact at all.
Ask your servicer three questions before you do anything else: what is my prepayment structure, what is the cost today in writing, and is the loan assumable. Those three answers determine whether the sale is a straightforward prepayment, a marketing opportunity built around assumable debt, or a timing question that argues for waiting for the open window. All three are legitimate answers — but you cannot choose between them without the numbers.
How long does defeasance take?
Roughly 30 days with a specialist consultant coordinating the securities purchase, the accountant's verification, and the servicer's approval. It has to be built into the escrow timeline from the start, not added late.
Can the buyer pay the prepayment cost?
Everything in a transaction is negotiable, and buyers do sometimes contribute where the seller's loan is the obstacle to a deal they want. Practically, a buyer asked to absorb a large prepayment cost reduces their price by a similar amount, so the seller usually bears it either way.
Is a prepayment penalty deductible?
Generally treated as interest expense for tax purposes, but the specifics depend on your situation and how the transaction is structured. That is a question for your CPA — and it is worth asking, because on a large penalty the after-tax cost is meaningfully lower than the headline number.
Michael Sterman is Senior Managing Director Investments at Marcus & Millichap.
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