By Bendix Anderson
February 2, 2018
Last December, a pharmaceutical company in Silicon Valley received $8.65 million to pay for renovations to make its research and administrative facility in Fremont, California, more energy efficient. But the money was not a loan, and it wasn’t a grant.
Instead, the pharmaceutical company, Verseon, received the cash through commercial PACE financing. It will pay back the $8.65 million through an assessment on its property tax bills.
Commercial property owners received hundreds of millions of dollars in PACE financing in 2017—more than twice the total amount of deals closed in 2016. It is now possible to arrange PACE financing in more than half the states in the United States. Also, as more property owners learn how to use this complicated financing tool, PACE deals are becoming larger.
“We are seeing more and more $5 [million] to $10 million PACE projects for complete building renovations. There is an increasing trend to use PACE for new construction,” says Jonathan Pickering of K2 Clean Energy Capital, the firm that arranged the C-PACE financing for Verseon.
The amount of PACE financings that have been completed is growing quickly. For example, borrowers completed $222 million in PACE financings in 2017, up from $132 million in 2016, according to data from PACE Nation.
“It was the biggest year ever for PACE,” says Greg Saunders, CEO of CleanFund Commercial PACE Capital, based in Sausalito, California.
The typical size of PACE financings is also getting larger—70 percent of the PACE transactions performed by CleanFund are now $7 million or larger, compared with just 20 percent a few years ago. Generally PACE has been used to renovate existing buildings, but some developers now also use PACE to help finance new construction.
“We have reached an inflection point in the popularity of PACE,” says Billy Grayson, executive director of the Urban Land Institute’s Center for Sustainability and Economic Performance.
PACE financing provides capital for building features that are specified by a local PACE program. Usually, these features cut the utility bill for the property by saving energy or water.
The financing is like a loan in that it must be paid back over a set term. But the payments are added to the property tax assessment for the property. Local property tax officials effectively become the servicers for the PACE financing.
The term of a PACE financing is typically ten to 20 years long, though some have terms as long as 25 to 30 years. The term must be consistent with the useful life of the equipment it pays for. The longer the term, the lower the payments the property owners must make to repay the financing.
“For some measures . . . the savings can potentially be higher than the PACE payment,” says Pickering.
Because PACE financings are repaid through the property tax bills for the property, the companies like CleanFund that arrange PACE financing can be confident that the financing will be repaid, even if a property defaults on other financial obligations. “If there is any money left over when you liquidate the asset, the PACE financing gets paid before the primary mortgage,” says Grayson.
That helps keep interest rates low. “Rates have not changed much over time—6 percent is normal,” says Saunders. “Lenders have adjusted their spreads as Treasuries have moved since the financial crisis. The interest on PACE financing is meant to be meaningfully lower than the interest rates on mezzanine financing or equity.”
Interest rates for PACE may fall as some finance providers have experimented with securitizing the debt from PACE financings, selling the debts as bonds. “There’s been no major variability in C-PACE interest rates yet,” says Saunders. Eventually, the extra liquidity created by securitization for PACE financings could drive interest rates 100 to 200 basis points lower, he says.
For a property to use PACE financing, the other lenders that the property has borrowed money from need to approve the financing and the new property tax assessment.
“Getting the existing mortgage holder to sign off on the special assessment is key,” says Pickering.
PACE financing takes money out of the operating budget of a building to make improvements that are highly likely to cut the utility bills for the building. But those utility savings are not guaranteed.
“About 20 percent of the time, they decline to allow PACE financing,” says Saunders. “Sometimes, they are not thrilled with the borrower’s credit to start with . . . or after the PACE project would be done, the debt-service-coverage ratio would go below the bank’s standards.”
Capital raised by PACE can also replace some of the equity that would otherwise need to be provided by the property owner. However, in most cases, the total amount of the PACE financing and the mortgage on the property cannot be more than 90 percent of the value of the property, according to Pickering. But some funds will go to 100 percent of LTV.
The oversight of primary lenders had also helped commercial PACE programs avoid some of the problems experienced by residential PACE programs designed for single-family homes. In some cases, unscrupulous contractors helped homeowners arrange residential PACE financings to pay for renovations of questionable utility and/or quality.
“In commercial properties, the primary lender and other stakeholders typically act as a checker,” says Saunders. “For most banks, commercial real estate loans have deeper underwriting than single-family home loans.”
For PACE financing to work, local tax officials need to create their own local PACE programs that will allow them to collect the payments. So far, 33 states have passed legislation that allows local jurisdictions to create commercial PACE financing programs. That number has increased exponentially in the last few years. PACE financing began in California in 2007.
“More states are passing legislation to allow PACE,” says Grayson. But different states have created different rules for their PACE programs. For example, in Texas, PACE renovations must meet one of the recognized industry standards for energy efficiency. In Florida, PACE financing can also be used to help pay for storm-proofing.
Link to full Urban Land Magazine Article: https://urbanland.uli.org/sustainability/use-pace-financing-renovations-construction-growing-commercial-buildings/