Yield maintenance on a net lease loan: why it can cost more than the rate ever saves.

A single-tenant building leased to a national brand on a long lease is exactly what a life insurance company wants to own a loan on. The income is steady, the tenant pays the expenses, and the loan matches the long-term liabilities life companies need to cover. So life companies compete hard for net lease loans, often with the lowest fixed rates available, on 10 year terms and longer.

The catch is that a life company is counting on collecting that interest for the full term. Yield maintenance is how it protects that. If you pay the loan off early, you pay the lender the income it loses.

Securitized loans (CMBS) do the same thing with defeasance: instead of paying off the loan, you buy a portfolio of Treasury securities that makes the remaining payments for you, plus legal and servicing costs. The economics land in about the same place.

Most owners assume yield maintenance only hurts if rates fall. That's not how most formulas work.

Yield maintenance usually compares your loan's rate to the Treasury yield for the remaining term, and charges you the difference for every remaining year. But your rate was never the Treasury rate. It was the Treasury rate plus the lender's spread. So even if Treasury yields are exactly where they were the day you closed, you still owe the spread on the full balance for every year left on the loan.

That's why the penalty is so large. You're not just covering a rate drop. You're paying the lender's profit for the rest of the term, up front.

Here's a quick service restaurant bought for about $5.2 million with a $3.4 million life company loan:

• Rate: 6.25%, fixed for 10 years
• Amortization: 30 years
• Prepayment: yield maintenance, discounted at the Treasury yield for the remaining term

Three years in, the tenant extends its lease, cap rates have tightened, and a 1031 buyer offers a price you'd take. The balance is about $3.27 million, with seven years left on the loan.

• If the 7 year Treasury is 4.25% (roughly where rates sat when the loan closed): yield maintenance is about $374,000, or about 11% of the balance.
• If the Treasury has dropped to 3.5%: about $528,000, or about 16%.
• Even if the Treasury has risen to 4.75%: still about $276,000.

Now compare a 5-4-3-2-1 step-down on the same loan. Selling in year three costs 3%, about $100,000. And a loan with no prepayment penalty costs nothing.

The rate savings rarely close that gap. Say the life company loan was half a point cheaper than the alternative. On $3.4 million, that's about $17,000 a year, or about $51,000 over three years. Against a $374,000 penalty, the cheaper loan cost you more than $320,000.

Wait it out. Yield maintenance shrinks as the loan gets closer to maturity, and many loans open up with no penalty in the last three to six months. If you can time a sale or refinance to that window, the penalty goes away. But that can be years from now.

Let the buyer assume the loan. Many life company and CMBS loans can be assumed, for a fee, by a buyer the lender approves. That avoids the penalty, but it narrows your buyer pool to people who want your rate, your balance, and your remaining term. On a property that's gone up in value, the buyer also has to bring more cash to cover the gap.

Pay it. Sometimes the sale price or the new loan is good enough that the penalty still pencils. Run it before you list, not after you're under contract.

1. 1.Ask for the prepayment terms first. Step-down, yield maintenance, defeasance, or none, and for how many years. Get the exact formula in writing, including what Treasury yield it uses and whether there's a minimum.
2. 2.Run the penalty at the earliest year you'd realistically sell. Not the year you plan to sell. Net lease owners sell early more often than they expect.
3. 3.Add the penalty to the interest cost. Compare total cost over that holding period, not just the rate.
4. 4.Check the assumption terms. Know the fee and the approval process before you need them.
5. 5.Match the loan term to the lease. A shorter fixed term gives you a natural point to sell or refinance with no penalty.

On qualifying net lease properties leased to national and regional brands, there are loans with no prepayment penalty at all. On our net lease loans, that comes with a 5 year fixed rate on a 30 year amortization, up to 75% of value, at roughly 1.80% to 2.20% over the 5 year Treasury. You can sell to the next 1031 buyer or refinance after a lease extension whenever the timing is right, and pay off only the balance.

Those loans fit best on properties leased to brands with a corporate guaranty or a large franchise operator: quick service restaurants, dialysis clinics, essential retail, auto service, and childcare. If the tenant is local or the rent doesn't cover 1.35x, our commercial DSCR loans also go up to 75%, usually with a step-down prepayment instead of yield maintenance.