Increase in Defeasance
U.S. defeasance activity hit a post-crash high of $20.9 billion last year, driven largely by refinancings that allowed borrowers to pocket cash or improve their properties. The volume of defeased loans in 2014 was up by $7.7 billion, or 58% from $13.2 billion the previous year, according to an annual Moody’s report. It was the second consecutive year of rapid growth: the 2013 total marked an increase of $7.3 billion from 2012.
Borrowers use defeasance to release properties from securitized commercial mortgages, usually because they want to sell or refinance collateral properties. Amid an ongoing rise in originations by commercial MBS shops and portfolio lenders, Moody’s expects defeasance volume to increase by another 20% this year, to $25 billion.
As happened in 2014, the activity will likely stem predominately from refinancings rather than sales, said Sandra Ruffin, a Moody’s vice president. Given rising real estate values and the availability of relatively cheap debt, even owners without plans to sell have an incentive to replace existing mortgages on their properties.
About $18 billion, or 86% by balance, of the loans defeased last year were originated in 2005-07, at the height of the last market cycle. But Ruffin noted that “the commercial real estate property markets have recovered to such an extent that defeasance is still attractive even if the loan’s maturity is years away.“
One motivation for borrowers to refinance sooner than later is the expectation that the Federal Reserve will finally begin raising interest rates later this year. If it does, higher loan rates could make early refinancing less attractive—but it’s difficult to predict whether that would curtail defeasance, said associate analyst Tarun Bhan. The added cost could be offset by other factors, such as increasing property values, the resulting prospect of higher loan proceeds and prevailing coupons that are still lower than rates on existing mortgages.