What Is Yield Maintenance for Commercial Real Estate Investors?

Yield maintenance is a type of prepayment penalty — like defeasance and step-down prepayment — that enables lenders to receive a similar yield from the prepayment of a loan than they would have received through the completion of scheduled payments on the loan. Yield maintenance clauses specifically require that if a borrower is to prepay a loan, they are required to also pay the difference between the interest rate on the loan and the standing market interest rate on the prepaid capital up to the loan’s maturity date as a penalty. In other words, the purpose of yield maintenance is to compensate investors or lenders for the loss of their future interest income that occurs when a borrower pays a loan off early.

Yield Maintenance Calculator

How to Calculate Yield Maintenance

Yield maintenance premium calculations follow this formula:

Yield Maintenance = Present Value of Remaining Payments on the Mortgage x (Interest Rate - Treasury Yield*)

*Treasury Yield = The current treasury interest rate on new debt with the same maturity date as the original loan.**

CRE Lenders and Yield Maintenance

For commercial financing of $1 million or more, a yield maintenance clause is pretty common. After all, yield maintenance is arguably one of the best options for lenders to protect themselves from lost revenue. Lenders also find that yield maintenance helps them to sell commercial loans for securitization — besides being beneficial to the lender, yield maintenance clauses typically also guarantee a set percentage of return to the purchasers of the repackaged debt.

CRE Borrowers and Yield Maintenance

For borrowers, yield maintenance is particularly desirable in an environment where interest rates are expected to rise — particularly when the clause doesn’t stipulate a minimum prepayment fee. This is because yield maintenance in this scenario basically allows a borrower to repay a loan at a present value discount. Additionally, the inclusion of yield maintenance typically denotes that the loan is assumable, which can be a desirable benefit to some investors.

Yield Maintenance vs. Alternative Prepayment Penalties

In commercial real estate, prepayment risk is generally mitigated through one of three mechanisms: yield maintenance, defeasance, or step-down prepayment. All are designed to mitigate lender loss, albeit through different methods.

• Yield maintenance - A straightforward payment of a penalty fee along with the difference between the interest rate on the loan and the standing market rate up to the maturity date of the loan.
• Defeasance - A complex process that involves swapping the collateral of the loan with interest-yielding financial instruments of relative value.
• Graduated or step-down prepayment - A payment schedule that sees the borrower pay a premium that gradually reduces over a fixed period of time.

Besides dictating how lenders are padded against prepayment-induced losses, each prepayment penalty also has unique attributes borrowers should consider if given a choice between them. For example, while yield maintenance and step-down prepayment actually result in the prepayment of the loan, defeasance tackles prepayment risk through the substitution of collateral. And while defeasance and step-down prepayment come with a lockout period — which prevents borrowers from prepaying their loan early for a set period of time — yield maintenance doesn’t.