C-PACE’s growth continues and has now been used to fund over 2,000 sustainability projects throughout the US. The program provides private capital allowing owners and developers of commercial properties to obtain low-cost, 100% financing for 20+ years for energy efficiency, sustainability and renewable energy infrastructure deployed in new or existing buildings.
The Basics of C-PACE
PACE is a source of private capital which stands for Property Assessed Clean Energy – the “C” denotes the commercial program. Such programs across the country have combined to fund 2,000 energy efficiency, renewables and resiliency projects.
Currently active in 22 states, this type of funding is unique in that it is repaid through a beneficial assessment which becomes an attachment to the building and added to the owner’s property tax bill. The program is established at the state level by statute and is adopted by legislation sponsored by the local taxing authority.
A Totally Different Approach to Credit
A C-PACE lender’s approach to credit is quite different from that of a traditional debt provider. The assessment is an attachment to the building which survives changes in ownership. Therefore, the lender is most concerned with whether any owner would value the usefulness and location of the building. This is in stark contrast to the traditional approach of senior and mezzanine debt providers who rely on a number of protections which often tie the hands of building owners.
C-PACE offers low cost funding which places no financial or operational constraints on building owners.
Funding for 100% of Efficiency Retrofit Project Costs Over 20+ Years
C-PACE allows building owners to spread payments over 20+ years which is quite beneficial for new development and redevelopment projects. For pure retrofits the low annual payments are of great benefit as described below.
Increase Net Cash Flow from Efficiency Retrofits
Since funding is repaid over 20+ years, annual payments are very low, especially when compared to a traditional 7-year loan. As a result, energy and avoided maintenance/repair savings will exceed the annual C-PACE assessment for virtually any pure efficiency retrofit.
If C-PACE is used to fund virtually any pure equipment retrofit, net cash flow will increase!
This is illustrated below for a project with the following assumptions:
Typical 7-year debt financing: the chart below shows how the project has negative net cash flow each year with a cumulative deficit in Year-7 of ($123,578).
20+ year C-PACE funding: the chart below shows how the project results in an immediate positive net cash flow due to the low annual C-PACE assessment.
The reduction in operating expenses makes the building more attractive to tenants and potential buyers. Furthermore, the assessment becomes an obligation of the buyer and does not require consent of the C-PACE lender.
C-PACE has become an important tool for some developers as part of a strategy to buy, enhance value and then sell properties.
No Guarantees Required from Ownership
This is a huge benefit to independent small business owners and developers- no personal guarantees.
Large organizations can benefit if the parent wishes to minimize guarantees of funding provided at the subsidiary level.
No Acceleration of the Assessment
The lender in this situation does not have the right to accelerate the full unpaid balance, even if a scheduled payment is past due. Only the unpaid amount that has been billed but not paid, is recoverable. This provides great flexibility to owners in case they need to restructure their debt – there is one less traditional lender involved.
Absence of Constraints Required in Traditional Debt
The C-PACE structure does not impose traditional lender protections such as cross default, restrictions on distributions, maintenance of debt covenants or quarterly reporting requirements.
Cheaper Capital for New Development and Redevelopment of Properties
C-PACE provides an excellent addition to the capital stack for development/redevelopment projects. The concept is simple – to the extent lower cost C-PACE funding can be used in lieu of mezzanine debt or common/preferred equity, it lowers the owner’s weighted average cost of capital (WACC).
New construction funding using C-PACE is offered in many, but not all of the states in which the program has been established.
When compared to Mezzanine, not only is this type of funding cheaper, it also allows owners to avoid the lengthy negotiation of a complex inter-creditor agreement. In addition, it allows owners to operate with much more financial flexibility as shown below.
C-PACE is “patient financing.” The building owner’s only concern is to pay the assessment with their property tax bill.
Freedom to Sell the Building – Assessment Assumed by Buyer
The C-PACE lender does not have the right to block a sale. As mentioned previously, the assessment is an attachment to the building and becomes an obligation of the buyer. This is a great benefit for owners who actively manage their investment portfolio, particularly for CRE private equity firms and developers.
Unique Benefits for Efficiency Projects for Owners Using Triple Net Leases
Under many triple net lease structures, building owners and tenants have misaligned interests regarding the costs and benefits of retrofits. With traditional financing, building owners absorb the risk of financing while tenants enjoy the benefits of reduced energy and maintenance/repair costs.
Since the C-PACE assessment is added to the property tax charge, it can often be passed to tenants contractually in triple net leases. However, to truly align interests, owners will want to justify that tenant comfort will improve, yet their net out-of-pocket costs will decline. This is possible because in most retrofits, energy and maintenance/repair cost savings will exceed the low 20+ year C-PACE payments.
Tenants are happy because they are saving money and are in a more comfortable environment. The owner has a more valuable building with lower operating costs and upgraded equipment.
Is there a downside to using C-PACE?
The C-PACE assessment creates a first lien on the building which generally requires a consent from the lender who has a mortgage on the building. In the developmental stages of C-PACE a few years ago, this sometimes presented a challenge. This is much less of an issue today because C-PACE lenders and program administrators have become more proficient in explaining the following:
- the reduction in operating expenses enhances the value of the lender’s collateral (the building); and
- though the C-PACE lender has a first lien related to the amount of the total assessment, the enforceable remedy runs only to the amount that has been billed, but not paid. This is a quite minimal amount when considering the overall value of the building.
As of October 2018, 167 financial institutions had granted consent to C-PACE liens including some of the largest banks in the world: JP Morgan, Chase, Bank of America, Wells Fargo, Bank of New York, Mellon (as Trustee), and many large foreign banks.
- C-PACE programs provide 100% funding for sustainability projects with repayment terms of 20+ years.
- C-PACE is being embraced all over the US with over 2,000 projects closed to date.
- For virtually any pure retrofit, net cash flow increases by using C-PACE to fund the project.
- For new construction and major renovation projects, C-PACE can be used in lieu of mezzanine debt or common/preferred equity to lower the weighted average cost of capital for building owners. With respect to mezzanine debt, owners can avoid the lengthy and complex negotiations associated with an inter-creditor agreement.
- Owners can realize a number of financial benefits because C-PACE does not require restrictions on distributions, rights to accelerate debt, guarantees from ownership, compliance with financial covenants, cross default provisions, or quarterly reporting requirements.
- Owners can realize operational benefits including the flexibility to sell the building and pass the C-PACE assessment to the buyer. In addition, C-PACE provides a valuable tool to solve the misalignment between building owners and tenants as to the risks and rewards of efficiency retrofits.
- C-PACE transactions require lender consent from the holder of the mortgage on the building. However, 167 financial institutions had agreed to grant C-PACE consents including some of the largest financial institutions in the world.
By Larry Derrett, Founder and CEO, EnFlux Building Solutions