When Should You Pay a Defeasance?

LOS ANGELES—The owner of the 10-property Pacifica Hotel portfolio has secured a $153 million in first mortgage financing to refinance existing debt. The borrower opted to pay a defeasance fee to refinance the loan early and lock in a lower long-term rate—a move that many borrowers in similar situations are making. Rather than wait out the year to refinance with potentially higher interest rates, more and more borrowers are opting to pay the prepayment penalties to secure a lower rate. In this case, the borrower was able to secure a mid-4% interest rate on its 10-year fixed rate loans.

“The loans are maturing within 12 to 18 months, and they wanted to take advantage of the interest rate environment that we are in right now,” Elliot Eichner, a principal at Sonnenblick-Eichner Co., tells GlobeSt.com. “After doing the analysis, we thought it was better to refinance today where interest rates are and do the prepayment premiums. It made sense to refinance. This is no different than nine out of 10 long term fixed rate loans that we have done in the last 24 months. Everybody is anticipating that rates are going to increase. Lenders love hospitality today, and rates are good. Everything is good right now, and nobody knows where rates are going to be when these loans mature.” Eichner secured the funds on behalf of the borrower.

A CMBS lender provided the financing for the portfolio. Although Eichner says there was significant competition to win the deal, most of the lenders were CMBS. “We were looking for maximum leverage because we were paying the prepayment, so most of the interest was from securitized lenders,” he says. The non-recourse loans were also not cross collateralized. The 10-property Pacific Hotel portfolio totals 739 guestrooms. The oceanfront properties located in Cambria, Pismo Beach, Venice, Marina del Rey and Manhattan Beach, as well as one property in Port St. Lucie, Florida.

Although a lot of borrowers are making the decision to pay penalties before rates go up, Eichner says that you really need to look at each deal on a case-by-case basis, looking at the current rate and the date of maturity to determine if it is the right decision. “A lot of our clients are paying defeasance fees, and it makes sense to pay the defeasance in a lot of cases,” he says. “There is no right or wrong answer because we just don't know where interest rates are going to be. Given how low interest rates are, a lot of people are choosing to pay the defeasance.”

Another option is to go through an early rate lock program to secure a low rate in advance of maturing debt. Sonnenblick-Eichner also secured $41 million in financing with a 3.5% interest rate 100 days before its existing financing reached maturity.