A new financing mechanism is gaining traction in Colorado’s commercial real estate community. Commercial Property Assessed Clean Energy, better known in the industry under the acronym C-PACE, has the potential to improve net operating income for property owners, reduce the cost of capital for building improvements, and attract and retain tenants by reducing the overall carbon footprint of properties. In growing markets like Denver and Boulder, C-PACE financing will increase the availability of improvements that generate energy with solar and create energy efficiency in buildings, without the upfront cost or short durations of traditional commercial debt finance.

Although C-PACE recently launched in Colorado, it is based off of the decades-old concept of “improvement districts.” Through this voluntary program, individual commercial property owners agree to become “members” of the district. The district then provides funds from private investors to finance improvements on commercial buildings in order to reduce energy or water use or generate alternative energy.

In return, the district levies a tax assessment on the property to repay the private investor, which the property owner then repays with his real estate taxes. More than 17 counties covering 60 percent of the Colorado population are eligible for this type of financing and seven additional counties are expected to opt-in soon.

C-PACE solves a number of problems that historically have prevented commercial property owners from implementing energy-efficiency retrofits or environmentally minded new construction projects, including the following:

• Upfront cost. Given tightening standards by traditional lenders, financing for energy-efficiency or solar improvements often don’t cover the full cost of the improvements. Even worse, some property owners end up paying for the improvements out of their capital reserves. With C-PACE, property owners can receive 100 percent financing, including soft costs, without any out-of-pocket expenses.

• Split incentives. Under most triple-net commercial leases, the tenants typically pay for the utility expenses. If property owners reduce utility costs with traditional debt (or cash), they will see their common area reimbursements drop, which ultimately means lower net operating income. Because C-PACE is structured as a tax assessment, it can be passed along to tenants under many triple-net leases thereby solving the split incentive.

Key Features of C-PACE

• Short duration. Most traditional financing options for solar PV systems and energy-efficiency improvements have a duration of seven to 10 years, leading to annual debt service payments that exceed the utility savings. Because C-PACE financing can be spread out over 20 years, projects typically will show savings in the first year.

• Creditworthiness. For many property owners, debt for these types of improvements can be hard to come by, unless the building is occupied with credit-rated tenants or the building’s owner puts up a personal guarantee. Because C-PACE financing is based on the value of the property, not on the assets of the property owner, underwriting for C-PACE transactions is focused on income generated by the property, not the personal financials of the owner (and, therefore, there are no personal guarantees).

• Investment. If a property is purchased and held for investment purposes, it can be hard to justify taking on additional debt for projects that show a return on investment longer than the hold period. C-PACE financing is nonaccelerating and is automatically transferred to the new owners upon the disposition of the property.

• Interest rate risk. Traditional debt often carries an adjustable interest rate, which makes it hard to forecast future debt service payments, especially for projects where the property owner is looking to increase net operating income. C-PACE offers fixed-rate financing, which, in combination with the long duration, provides certainty to building owners. Additionally, C-PACE interest rates are lower than other forms of alternative financing, including mezzanine debt or preferred equity.

• Construction financing. For property owners who are either building new construction or completely retrofitting a building, having to make burdensome debt service payments before a building is fully occupied can be a financial strain. C-PACE can be structured with “capitalized” interest payments, which allow the building to generate income before the first payment is due from the property owner.

• Reimbursement. Some projects are time sensitive, such as roof replacements in the winter or a chiller in the summer. For proper owners who do not have the luxury of waiting for financing before starting the project, C-PACE can be used to reimburse building owners for work that already is completed, allowing them to replenish their capital reserves or free up cash flow.

C-PACE financing represents a unique and innovative structure that solves problems facing commercial property owners while filling the gaps in traditional financing. It does not involve any government money and since property taxes are operating expenses, C-PACE is not debt.