What is C-PACE?
C-PACE is a less understood form of financing in the commercial real estate world but is gaining momentum in the age of higher interest rates. C-PACE is an acronym that stands for Commercial Property Assessed Clean Energy. C-PACE is a public-private financing regime enabled at the state level through legislation that authorizes this type of financing for projects within the state. The purpose of the program is to finance certain elements of a real estate project (new development or existing building retrofit) that increase energy efficiency or contribute to renewable energy initiatives. As you would expect, only certain project costs qualify for C-PACE financing and every state administrator has differing requirements and processes for full project approval. However, 100% of the costs relating to the C-PACE program are eligible to be financed. The financing itself is fully amortizing over a 25 year period. There are approximately 30 states that have an active C-PACE program with more legislation in the pipeline. It is key to check the state in which your real estate project is located to see if it is eligible for C-PACE financing.
How does C-PACE financing work?
There are many capital sources that fund deals in this market and the C-PACE program is gaining popularity, especially for ground up developments like hotels. C-PACE lenders roughly finance 20% – 25% of the total project cost on long-term loans. Their security interest in the property is a bit different than a standard secured mortgage lender. In a C-PACE deal, the C-PACE lender places a tax assessment on the property that secures its investment. The annual property tax assessment that the C-PACE lender receives is senior in priority and repayment to the secured mortgage lender so there can be friction between C-PACE lenders and secured mortgage lenders in the case of a default by the borrower. Now, let’s show a simple example to further illustrate how this works in practice. Let’s say you are building a 100 key hotel with an estimated cost of $20,000,000. Let’s assume that C-PACE will give you 20% of the costs in the form of a C-PACE loan and another secured mortgage lender will give you the balance of the financing up to 70% of the total project cost (note: many C-PACE lenders may be willing to finance up to 75-80% of costs). In this case, you would end up with $4,000,000 of C-PACE financing and $10,000,000 of mortgage financing to bring the total financing up to $14,000,000. Secured mortgage lenders view the C-PACE financing as additional debt so their loan amount represents 50% of the total cost of the project. From a mortgage lender risk perspective, they typically do not allow for priming of their position. With C-PACE, the risk to the secured lender of C-PACE foreclosing the secured lender out is somewhat muted in the case of a default. C-PACE financing is long-term in nature so a maturity default is remote. Non-payment by the borrower of the tax assessment can be cured by the senior mortgage lender through payment of the assessed taxes. Non-payment of the assessment by the borrower will typically be an event of default just like non-payment of county level property taxes so secured lenders are accustomed to this type of risk. However, it is magnified due to the larger tax assessment payments when C-PACE financing is utilized. Not all secured mortgage lenders will allow for C-PACE financing so it is important to pair the C-PACE financing with a C-PACE friendly mortgage lender.
Why should I consider C-PACE financing?
Due to the seniority of the C-PACE financing and overall lower risk to the C-PACE lender, it is a cheaper option than mezzanine debt, preferred equity, or common equity to finance a development. The rationale being that this type of financial engineering reduces the overall cost of capital for a real estate project. At 70% loan to cost on a development, adding C-PACE could reduce your overall cost of capital by a decent amount compared to utilizing subordinated debt, such as mezz. C-PACE also tends to be longer term financing so there is flexibility to hold on to the financing post construction unlike mezzanine debt or preferred equity. It does not have a short-term maturity like a construction loan. Construction loans, mezzanine loans, and preferred equity typically need to be paid off within 3 years of origination so there is an impetus to payoff the construction financing as quickly as possible. With C-PACE, the note can stay outstanding when permanent mortgage debt is secured although many borrowers opt to payoff the C-PACE lender at the same time they payoff the construction debt but they are not necessarily required to.
Can I get C-PACE for any project?
Any real estate project could theoretically qualify. However, it is more likely that hospitality related projects are a better fit in the current environment. One major reason is the ability to pass through the property tax assessment to the end users on a dynamic basis. The hotel operator has the ability to raise nightly rates to pay for this tax assessment and potentially the ability to bill for it separately on guest folios (eg: a “Green Tax”). Each state program has their own eligibility requirements on which project costs are eligible for C-PACE financing, however, we have seen the bulk of C-PACE financing funneled into hospitality projects. Renewable energy and energy efficiency are also a great way for operators to reduce their fixed costs like utilities. Multifamily deals often bill back their tenants for utility costs through a resident utility billing system (RUBS) program so there is less financial incentive to utilize energy efficient build-outs or retrofits. In the case of a hotel, the owner picks up primarily all of the fixed costs so any savings on energy costs flows directly to the bottom line.
C-PACE financing could help solve some of the funding gaps that many real estate developers are currently facing. With the increase in interest rates being felt in the construction financing markets more developers are exploring this structure as an option for getting projects out of the ground.
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About Schelin Uldricks & Co.
Schelin Uldricks & Co. is a firm offering investment banking services with a focus on providing capital solutions to real estate companies and other mid-sized businesses.
Headquartered in Huntington Beach, CA, Schelin Uldricks & Co. embodies a progressive entrepreneurial culture focused on integrity, transparency, execution, and ingenuity. The company offers a broad array of services, including debt and equity placement, M&A, GP advisory, divestitures, and financial restructuring.