Developers of commercial real estate are negotiating a challenging market. Completing a ground-up construction deal in today’s market is difficult due to pressure on construction prices from supply chain challenges and labor shortages, the present interest rate environment, and a constricted financing market that limits realistic funding alternatives.
Although it can take some time for new financing vehicles to gain traction in the market, Commercial Property-Assessed Clean Energy (C-PACE) funding has completed more than $3 billion in transactions since its launch over ten years ago, making it a preferred green finance option for many owners, investors, and developers.
The unique benefits of C-PACE’s long-term, affordable, fixed-rate, non-recourse financing make it preferred over more costly mezzanine loans or preferred equity. The financing is now offered in 37 states and the District of Columbia.
However, many still need to familiarize themselves with the concept. What is C-PACE? What makes it lucrative to commercial real estate owners and developers? What are the latest updates regarding this that have further fueled its adoption?
How does C-PACE Financing Work?
Enacted by state legislation, C-PACE is an alternative financing mechanism that offers low-cost, long-term financing for energy efficiency, water efficiency, renewable energy, and resilience projects to developers and owners of commercial and industrial buildings. Like municipal water and utility bills, C-PACE payments are recovered and secured by a voluntary property tax bill assessment. The C-PACE evaluation is referred to as a “debt of property.” This implies that the financing is linked to the property through its tax bill rather than the owner, and thus, if the property is sold, the repayment obligation is transferred along with it. For almost 200 years, municipal bonds affixed to property taxes have been repaid with the help of assessment financing. These bonds have been used to finance public works projects, including fire stations, street lighting, sewage and sidewalk upgrades, and more. The distinction is that C-PACE applies the paradigm to sustainability and energy efficiency initiatives that help building owners and the broader good.
How can Developers Benefit?
Improvements impacting the environment or energy are usually eligible for C-PACE funding. These include mechanical systems related to air conditioning and heating (HVAC), electrical upgrades like LED lighting, modernized fenestration and building envelope with high-performance windows, water efficiency with low-flow plumbing and irrigation, and comprehensive energy systems with solar power and backup capabilities. C-PACE can also be utilized for seismic strengthening and resilience, such as seismic bracing, foundation upgrades, shear-wall reinforcement, and similar projects in some areas, such as Washington and California.
Developers who design their building to meet or surpass the IECC 2018 may be eligible for C-PACE financing, which enables them to obtain inexpensive, fixed-rate, non-recourse financing for up to 20% of their total qualifying construction cost. Furthermore, there is no upfront out-of-pocket cost, and no personal guarantee is needed. The money may be used to lower other high-cost capital sources, such as the developer’s equity contribution, and the builder will still have a more valued, competitive, and efficient building.
Reducing High Debt Expenses Using C-PACE
C-PACE is an opportunity to obtain fixed-rate financing on a portion of the debt stack that is more palatable than current rates offered by senior lenders. Cost control is a primary objective for developers. Interest rates for C-PACE are now between 7.5% and 8.0%.
Furthermore, the spread savings between C-PACE and your construction financing has widened, driving more value for developers.
It should also be noted that developers have the added benefit of a fixed-rate loan on a construction deal, which is a tremendous value in a market where interest rates are rising and volatile. They also benefit from prepayment flexibility in case interest rates drop after the first three to five years. This is in addition to locking in a lower rate.
Furthermore, the availability of C-PACE financing is unrestricted, in contrast to bank financing. Developers don’t have the same accessibility challenges as in traditional loan markets, as Yamauchi points out because there is now more money in C-PACE than transactions being funded.
Which Offers Fit Best with C-PACE?
Although hotel transactions have historically been excellent candidates for C-PACE finance, multifamily, mixed-use, and hospitality projects can benefit from the program today.
States have different laws for C-PACE, which is localized. Depending on the area, the state will approve a loan for between 20% and 40% of the stable property value. However, the amount that the first mortgage lender may approve also affects the amount of PACE financing.
The different maturity lengths of the construction loan and the PACE present one possible challenge when adding PACE to a building capital stack. With pre-payment arrangements, PACE offers a fixed interest rate for 25–30 years. On the other hand, a construction loan usually lasts three to five years. Even if the C-PACE is entirely transferable, the cost of withdrawing and paying off the C-PACE should be included in the total cost of capital analysis, depending on the sponsor’s departure plan and whether it calls for prepayment or staying in place.
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C-PACE is an appealing option that will probably gain traction over the next 12 months, even with some modifications. The availability and presence of C-PACE will help bridge some of the financing gaps.
Adding C-PACE to the project capital stack to reduce loan costs and access additional finance is one way to ease some of the strain on newly constructed projects. Finding a senior lender willing to deal with C-PACE financing is a challenge that many face when implementing C-PACE. Consulting with CPACE providers, local governments, or industry experts can help clarify misunderstandings and guide property owners. The National Tax Group can offer long-term, fixed-rate financing through C-PACE for all energy-efficient measures, including roofing, HVAC, lighting, water conservation, building envelope, and renewable energy, at 100% of the cost.