Defeasance is a clause, usually in a commercial mortgage agreement, that gives the mortgagor the right to redeem the property upon full payment of the mortgage.

This is usually done so that the mortgagor can pay off the mortgage earlier than scheduled to save on interest costs, without incurring a penalty from the issuing financial institution for early termination of the mortgage.

In low interest rate environments, REITs may take on additional gearing in order to seize available growth opportunities.

However as interest rates climb, the REIT manager may decide that it will be prudent to save on interest costs by paying off remaining debt outstanding.

If a defeasance clause exists, this can be done without the REIT incurring a form of financial penalty.

REITs investors in climates with highly sporadic spikes of interest rates may wish to enquire on the existence of defeasance clauses in your REITs debt obligations.

This entry is part of REITsWeek's glossary of REITs and real estate investment terms.

By Ridzwan Rahmat

Ridzwan has been analysing REITs and business trusts since 2008, and personally manages a portfolio comprising mainly of SGX-listed REITs. He founded REITsWeek in 2013.