The main difference between defeasance and yield maintenance is that defeasance involves replacing the collateral of a loan with securities (generally fixed-rate government bonds) that will offer a lender an equivalent return, while yield maintenance involves the borrower paying a penalty to the lender in order to prepay the loan.

Whether defeasance is best for an individual borrower depends on their individual situation; however, defeasance is almost universally a good idea for lenders. This is because bonds present a significantly lower prepayment risk than do commercial or multifamily mortgages.

Defeasance can help you refinance your loan by allowing you to pay off your existing loan without incurring any additional costs or penalties. This can be beneficial if you are looking to take advantage of lower interest rates or if you are looking to sell your property.

Defeasance is a common type of prepayment penalty for CMBS loans and even certain types of Fannie Mae and Freddie Mac multifamily financing. The defeasance process replaces the collateral of a loan with securities which provide the lender with an equivalent return. Usually, defeasance involves fixed-rate government bonds.

Source: https://www.commercialrealestate.loans/commercial-real-estate-glossary/the-strategy-of-defeasance

Defeasance in commercial real estate is a process that allows a borrower to pay off a loan without incurring a prepayment penalty. The process involves replacing the loan with a portfolio of government or corporate bonds that generate the same cash flow as the loan. The borrower must purchase the bonds, secure them in a custodial account, and record and file them for tax purposes. A defeasance consultant is typically hired to conduct the entire process, as it can be complex and require negotiation and communication with the lender. Source 1 and Source 2.

Defeasance in commercial real estate can provide several benefits for both the lender and the borrower. For the lender, defeasance removes any risk of repayment and replaces it with returns guaranteed by U.S. Treasury bonds (or, in some cases, bonds issued by Fannie Mae, Freddie Mac, or Ginnie Mae).

From the borrower's perspective, defeasance can be particularly advantageous if interest rates are expected to rise, as it replaces the loan's collateral with bonds and the borrower doesn't need to be concerned with rising rates. Defeasance can also have accounting benefits, as it removes the debt from the company's balance sheet, making it less complex when it comes to logging debt service transactions.

The main risks associated with defeasance in commercial real estate come down to cost. The process is generally so complex that a team of experienced accountants and legal experts are required to execute everything successfully. As these aren’t single-day transactions — and can take months, depending on the situation — this time factor can make the process itself prohibitively expensive. Additionally, beyond the staff requirements, defeasance’s costs are also increased by the intensive capital investment into the replacement collateral — the bonds — used to offset the yields.

For the borrower, there are also some risks to defeasance, but they broadly depend on a borrower’s specific situation and wider economic conditions and trends. If interest rates are expected to rise, defeasance can be particularly disadvantageous for loans with a variable rate. By replacing the loan’s collateral with bonds, a borrower may not be able to take advantage of the lower rates.

The steps involved in a defeasance transaction typically include:

• Hiring a defeasance consultant to conduct the entire process
• Purchasing the exact amount of bonds
• Securing the bonds in a custodial account
• Recording and filing the bonds for tax purposes
• Negotiating and communicating with the lender
• Retaining a defeasance consulting company to help minimize costs
• Working with an experienced broker-dealer to tailor a pool of securities
• Securing a securities intermediary to hold the bonds in a separate account
• Making monthly debt payments to the lender with the cash proceeds from the securities
• Optimizing the portfolio of securities to match the value of the remaining debt service payments
• Adhering to legal and industry standards

For more information, please see What is Defeasance and How Does it Work? and Defeasance for CMBS Loans.

The main disadvantages of defeasance come down to cost. The truth is that defeasance can be extremely expensive. First, the process is generally so complex that a team of experienced accountants and legal experts are required to execute everything successfully. As these aren’t single-day transactions — and can take months, depending on the situation — this time factor can make the process itself prohibitively expensive. Second, beyond the staff requirements, defeasance’s costs are also increased by the intensive capital investment into the replacement collateral — the bonds — used to offset the yields.

In addition, a certain amount of negotiation and communication with the lender will typically be required throughout the entire process. For instance, while defeasance is tax-deductible, a borrower (or their original accountant) may not be used to filing the type of paperwork and documentation required for a borrower to take the deduction.