C-PACE, which stands for Commercial Property-Assessed Clean Energy, is a form of financing that allows property owners to borrow money for energy efficient, renewable energy, and resiliency property improvements and make payments via a voluntary special assessment added to their property tax bill.
This structure allows for long-term fixed-rate financing that remains with the property even if it is sold. The C-PACE lender will engage a third party energy audit to determine the useful life of any associated improvements and determine the present value of the cost savings over the useful life. While there are cash flow constraints in most lenders’ term sheets, loan proceeds are almost always limited to LTV constraints determined by an appraisal given the low LTC of generally 25% – 30%.
C-PACE financing is supplemental to traditional senior financing but, depending on the asset and financing strategy, can offer lower interest rates than mezzanine financing or preferred equity. The funds available can cover up to 100% of the cost of any improvements determined to be covered by the program. Some typical costs include lighting upgrades, HVAC systems, building insulation, water conservation, roof replacement, solar, fire resiliency and EV charging stations to name a few.
C-PACE loans are funded by local government financing entities such as cities, counties, and special purpose district entities. In practice, these entities actually partner with private sector lenders called C-PACE Administrators. They are responsible for implementing and enforcing the program rules and regulations, processing loan applications, performing due diligence on projects, and monitoring the performance of the loans. They also work closely with the property owners, contractors, and lenders involved in the financing process to ensure that the program objectives are met.
C-PACE-enabling legislation has been approved by 38 states and Washington, D.C. There are active lending programs in 30 states plus Washington, D.C. You can view a detailed map to check the availability in your state through the PACENation Programs Map.To date, the C-PACE program has funded a total of $4.2 Billion in investments across 2,900 projects.
There are many challenges for senior lenders when financing properties that have C-PACE involved in the capital stack. The main challenge for most lenders is the implied first lien position created due to the C-PACE loan being securitized by a special assessment applied to the property tax bill, effectively taking first priority over the senior mortgage. While this is not a UCC lien and is just a voluntary special assessment, in most states any lien related to unpaid property taxes has a higher ranking than a creditor’s lien. In the event of a foreclosure sale, the only payment due to the C-PACE lender is any outstanding real estate taxes, not an acceleration of the full outstanding C-PACE balance. This does provide the senior lender with a level of protection in their position because the C-PACE loan is then assumable to the next owner of the property allowing the sale proceeds to be used to satisfy the mortgage. From the perspective of most lenders the issue then becomes finding a buyer who is willing to assume the outstanding C-PACE loan and the added real estate tax payment associated, which can be steep. In addition, it is hard for a new buyer to perceive the same benefits from energy cost savings as the original owner who implemented the C-PACE loan. The headaches this creates tends to be a common reason for lenders being unwilling to finance properties with C-PACE involvement.
Even if this is not an initial non-starter, there are further challenges for senior lenders in how the C-PACE loan affects the cash flow of the property. With C-PACE payments being made through the real estate tax bill, lenders have to incorporate the additional payment in their underwritten operating expenses which cuts into NOI. This limits the amount of cash flow available to pay debt service which is especially an issue in today’s rising interest rate environment. In the current market many loan requests are seeing leverage constraints due to the cash flow of the property being unable to cover the standard 1.25x debt service coverage ratio requirements as a result of the higher interest payments. While borrowers may view C-PACE as a creative financing solution that can be used to increase total leverage in the overall capital structure, this is frequently not the case. This is due to the cash flow issue outlined above as well as the fact that most lenders include the C-PACE debt in their maximum loan-to-value and loan-to-cost figures. For example, on a development project if a lender is currently offering up to 75% LTC and a borrower is including 10% of the total costs as a C-PACE loan, the maximum leverage that same lender will provide to the borrower is now 65% LTC. This is because the lender will view their “last dollar” as 75% LTC since the C-PACE debt is seen as a first position.
There are some characteristics of borrowers and properties that can help get lenders comfortable with C-PACE involvement in the capital stack. If the guarantor of the loan has a strong financial position demonstrating high net worth and liquidity, that can help ease the concerns of many lenders. Another mitigant could be if the cash flow (inclusive of the C-PACE debt payment as an expense) still provides sufficient debt service coverage, which could mean as much as 2.00x. Along those lines lower leverage requests are also looked upon more favorably by senior lenders. There are also certain properties and projects that may be in high demand due to the asset class, market or other factors that would lead to a lender getting comfortable with the C-PACE loan in order to provide financing on the transaction.
Jake Moore is a Capital Markets Analyst at Lev.
