By Anne Alexander, Of Counsel, Pircher, Nichols & Meeks
“Green” building may once have been considered a fad, but with more jurisdictions adopting mandatory energy efficiency building standards, the financing of these improvements has become a focal point. Although green buildings may command higher rents and be more attractive to quality tenants and prospective purchasers, they don’t always pencil.
Historically, property owners were faced with a number of obstacles when deciding whether to invest in energy efficiency improvements, including lack of available funds, concerns about return on investment and the disconnect between landlord and tenant interests.
Enter Property Assessed Clean Energy (PACE) financing. This public-private financing vehicle, designed to incentivize energy efficiency improvements, is a form of debt paid back over a period of as many as 30 years through a voluntary property assessment. Depending on the program, PACE financing can be used for window and door replacements, HVAC systems, lighting upgrades, cool roofs, water conservation measures and seismic improvements (in California) in both existing buildings and new construction.
PACE financing highlights include:
- Availability of funds. It can provide as much as 100 percent financing for eligible improvements.
- Shorter time to recoup investment. Because it is repaid over a longer period of time than most commercial property loans, property owners are able to break even on their investments faster.
- Low interest rates. It typically has low interest rates compared to the cost of equity or mezzanine financing, thanks to the senior position of the PACE lien and the secure repayment mechanism, whereby the local government acts as a servicer by including the PACE assessment as a line item on the property tax bill.
- Balancing landlord and tenant interests. Capital improvements (including energy efficiency improvements) typically cannot be passed through to tenants under commercial leases, even though tenants enjoy reductions in operating expense pass-throughs and utility bills as a result of these upgrades. Because PACE assessments can typically be passed through to tenants, PACE financing facilitates the allocation of green building costs to the party receiving the immediate benefits.
- Assumable financing. Unlike most commercial property loans, PACE financing is not required to be repaid upon sale of the property. The obligation can be transferred to the new owner, with the assessment lien remaining on the property.
- Increased rents and value. A more efficient building can potentially command higher rents and attract higher-quality tenants, resulting in increased property value.
- Can replace equity in the capital stack. Because of the repayment mechanism and the lack of an acceleration feature, some believe PACE financing is most appropriately accounted for off balance sheet. This treatment minimizes the debt-to-equity ratio and may make it easier for the property owner to obtain additional debt for other projects.
In order for projects to be eligible for PACE financing, the state where the property is located must have adopted enabling legislation and a local government must have formed a PACE district with its own PACE “program.” Each program specifies the types of eligible improvements, source of capital and mechanics of the approval, underwriting and funding processes.
The biggest hurdle to closing a PACE transaction is generally the need for consent from the existing (or prospective) mortgage lender, which will want to evaluate the economic benefits of the project to determine if the reduced operating expenses and increased value of the collateral will justify the risk of the senior lien and the additional property tax-like expense.
As more parties acknowledge “green” design is here to stay, it’s likely that additional PACE programs will be developed and property owners will increasingly turn to PACE financing. With more participants in the field, the economics are likely to become even more favorable, allowing PACE financing to facilitate economic and environmental benefits for communities nationwide and to help keep green building in the black.