Commercial Magazine

Picking Up the PACE

Clean energy loans help developers save money while curbing their carbon footprint

By Kris Jones

Commercial real estate owners want to be more energy efficient with their properties. Conserving resources and reducing a building’s carbon footprint isn’t just good for the environment — it also saves money.

A fast-growing program that helps landlords achieve these goals is Commercial Property Assessed Clean Energy (C-PACE) financing. Commercial mortgage brokers should work with their clients and help them to understand how to use C-PACE to finance development, renovation and value-add projects that will be well-positioned to profit from these sustainability efforts.

As of mid-2021, 37 states (along with the District of Columbia) have passed C-PACE legislation. With more owners and developers placing an emphasis on environmental, social and governance (ESG) initiatives, C-PACE financing is expected to become a more common component of the capital stack.

Financing basics

For the uninitiated, C-PACE is an alternative financing mechanism for commercial properties. These loans provide low-cost, long-term and nonrecourse fixed-rate funding for building components that improve energy efficiency, utilize renewable energy, conserve water and more.

Depending on the jurisdiction, eligible components can include roofs, windows and insulation. The loan also can cover water conservation systems; heating, ventilating and air conditioning (HVAC) systems; high-efficiency lighting; renewable energy sources such as solar power; automated building controls; seismic retrofits; and resiliency against flood and storm damage.

For clients who want to renovate an existing property and replace old building components with new appliances, devices and materials, commercial mortgage brokers and bankers should explain that an evaluation is needed to determine which improvements are eligible under C-PACE requirements. If brokers have clients who are pursuing a ground-up development project and will be building at or above current code standards, then they should conduct this same analysis. In both scenarios, there are costs that are likely to qualify for C-PACE financing.

Real-world use

C-PACE loans are surprisingly diverse and adaptable. For instance, in the Texas capital of Austin, a borrower secured approximately $1.6 million in C-PACE financing to fund energy-efficiency and water-conservation improvements to help reposition a vacant hotel into multifamily housing. The combined loan-to-cost ratio was about 86%.

In Omaha, Nebraska, another developer for a multifamily project near the downtown core borrowed roughly $2.9 million of C-PACE financing (at a combined loan-to-cost ratio of 91%) to fund wall insulation, lighting and HVAC upgrades. The loan also paid for low-flow fixtures and smart thermostats that are expected to result in nearly $57,000 in utility savings during the first year alone.

In yet another example, a hotel-refurbishment project in Detroit was able to secure a $3.5 million loan to retroactively reimburse the borrower for PACE-eligible work completed in 2020. The eligible expenses included insulation, windows, lighting, HVAC, low-flow fixtures, air filtration reduction and smart thermostats. These improvements were projected to save more than $87,000 in utility costs during the first year.

Unique program

To clarify, a C-PACE loan is not a mortgage. It is nonrecourse financing that is collateralized by a special-assessment lien, paid alongside property taxes and underwritten as a real estate tax.

Although the special-assessment amount is recorded on the property records, only the annual payment may be collected, even in a default situation. In other words, C-PACE assessments cannot be accelerated in the event of default.

For example, consider a $1 million C-PACE loan on a property valued at $5 million. The annual assessment for a 20-year term would be about $87,185. If the property owner did not pay the C-PACE assessment for the first year, the lender could only collect the delinquent payments. The C-PACE lender’s claim is limited to $87,185 (or 1.75% of the property value). The remaining payments are due according to the original 20-year repayment schedule.

Unlike other debt, C-PACE does not require an intercreditor agreement. In the event of default on the senior lender’s debt, the senior lender can foreclose on its mortgage interest in the property in the same manner as if it held the only lien on the property. C-PACE loans do not affect any existing remedies under the mortgage documents. A C-PACE lender may not prevent, restrict or otherwise impact the senior lender’s foreclosure.

Savings in the stack

Loans of this type are a highly adaptable form of low-cost financing and can be used as an alternative to traditional sources of capital. They can lower a property’s cost of capital while increasing cash-on-cash returns, internal rates of return and equity multiples.

One of the most common ways that borrowers use C-PACE financing is to replace a portion of a more costly senior mortgage — such as a bridge loan from a debt fund. Based on current market conditions, bridge loans are likely to be priced between 7% and 8% or higher, depending on the project, borrower and leverage, among other factors.

A C-PACE lender will evaluate the same factors as a senior mortgage lender. The interest rate for the C-PACE loan, however, is likely to be at least 100 to 200 basis points lower than that of a bridge loan. By combining a C-PACE loan with bridge debt, a borrower can achieve the same leverage but lower the combined interest rate and realize substantial interest savings over the course of the project.

C-PACE loans also are often used in place of preferred equity or mezzanine financing. With a senior lender’s consent, the maximum combined loan-to-cost ratio with C-PACE can reach 90% or higher, depending on the jurisdiction. By replacing preferred equity or mezzanine financing with a C-PACE loan, a borrower can significantly reduce the interest expense on this portion of the capital stack.

A mezzanine lender is likely to charge between 12% and 13% interest, but the interest on a C-PACE loan would be about half that, based on market conditions in fall 2021. Utilizing C-PACE financing in this scenario also would eliminate the time, expense and complexity of negotiating an intercreditor agreement since one is not needed for a C-PACE loan.

Additionally, since C-PACE can reach high into the capital stack, it can be used to supplement a low loan-to-value (LTV) senior loan, or to reduce the equity requirements of a limited partner or general partner on a project. Regardless of how it is used, C-PACE financing will help grow project returns by lowering the weighted average cost of capital.

General loan rules

C-PACE loans are rather simple, but the actual lending terms can be highly nuanced from state to state. This is because each state’s legislation stipulates which expenses are eligible for financing as well as the loan terms.

The loan amount can be wide and varied. Projects costs can range from less than $250,000 to millions of dollars. The loans can be for existing properties or new construction. They are used for a wide variety of projects, including office and retail buildings, hospitality properties, industrial and manufacturing facilities, and multifamily housing of five units or more. Specialty uses can include senior-living facilities, auto dealerships, data centers, parking structures, private educational projects and more.

The terms of the loan are usually between 10 and 30 years. Typically, the maximum LTV does not exceed 30% of the property’s appraised value. C-PACE loans have fixed rates for the duration of the loan, with the rate spread priced above the Treasury index on a deal-by-deal basis. The self-amortizing and nonrecourse loans typically have a retroactive financing period of one to three years. The loans are prepayable at any time but are subject to tiered prepayment fees. There is no lockout, defeasance or yield maintenance. The senior mortgage lender’s consent is required prior to closing.

Avoiding obstacles

To ensure success, mortgage brokers and their clients should answer several fundamental questions when they begin the process of obtaining C-PACE financing. The first is whether the property is in an eligible location. While 37 states and the District of Columbia have passed C-PACE legislation, not all of them have active funding programs. The states that have not approved legislation currently include Arizona, Idaho, Indiana, Iowa, Kansas, Louisiana, Mississippi, North Dakota, South Dakota, South Carolina, West Virginia and Wyoming.

Another snag is that even though a property may be in a PACE-enabled state, not all properties within that state may be eligible. For example, Colorado has an active C-PACE program, but El Paso County, where Colorado Springs is located, has not yet chosen to participate. The status of active programs is constantly changing, so the best way to determine if a property is eligible is to contact a C-PACE lender.

Maybe the biggest question to answer in the financing process is whether the senior lender will consent to C-PACE financing, a requirement for every loan. It is a best practice for commercial mortgage brokers to engage with a C-PACE lender early in the transaction process, since the C-PACE lender routinely has these discussions with senior lenders.

The C-PACE lender will be able to educate the senior lender on the mechanics of C-PACE financing and assessments, as well as how the C-PACE loan will improve the quality and cash flow of the collateral without impacting any of the default remedies. With the growth of the C-PACE industry, senior lenders have been increasingly motivated to accommodate a C-PACE loan into their transactions.

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Brokers looking to secure C-PACE loans for their clients should ensure that they are dealing with a direct lender that has discretionary capital to lend. Working with direct C-PACE lenders makes for a smooth closing in which the interest rate, origination fees, terms and certainty of execution are most favorable to the borrower.

Using a C-PACE loan program can help bring new life to old properties or ensure that new projects are energy efficient and environmentally friendly, all while helping developers save money in the process. It truly is a win-win equation. ●


  • Kris Jones

    Kris Jones is vice president of originations at PACE Loan Group (PLG), which is a C-PACE balance-sheet lender and a leading provider of energy-efficient and clean-energy loans for multifamily housing and commercial real estate. Based in Eden Prairie, Minnesota, PLG has offices in California and New Jersey, and the company operates as a direct originator and servicer throughout the U.S.

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