By Joel Poppert, managing director, Imperial Ridge Real Estate Capital
In looking for ways to incentivize the creation of higher-performing buildings, states around the country have authorized programs like C-PACE, or Commercial Property Assessed Clean Energy financing, which allows property owners to borrow money from private investors for a variety of capital improvements that impact building performance and then make the repayments via an assessment on their property tax bill.
This kind of financing provides a host of benefits and can help companies meet increasingly aggressive ESG goals for themselves and their tenants. C-PACE is made more attractive because the repayment is an assessment, so owners, developers and asset managers can pass through all, or a portion of, the annual assessment costs to their tenants through their triple-net lease contracts, or to guests for hospitality projects. These assessments are also tied to the property, so they’re fully transferrable to the new owner if the property is sold.
But, while C-PACE financing is gaining momentum across the Front Range (including most recently in Colorado Springs), there are still a number of misconceptions about what it can (and can’t) do on a project that often results in a cumbersome, if not outright painful process. Reaping the environmental and bottom-line results from C-PACE financing starts with understanding the basics of this relatively new financing mechanism and partnering with a capital provider who will shoot straight with you through the process.
Avoiding C-PACE Myths
For all its benefits, there are hurdles with C-PACE that often frustrate new users, chiefly the legislative requirement to secure consent from all lienholders on the property, i.e. mortgage holders. Many times, for development projects, the owner has been sold on the idea that C-PACE can replace equity, a common marketing angle to get an owner in the door. Spoiler alert: It can’t. And for building owners looking to retrofit an existing property, timing can be tricky when it comes to securing lender consent. Generally speaking, lenders are much more likely to consent during refinancing, for example, than they would be if the mortgage hasn’t reached its tenure.
Leveraging C-PACE for Better Buildings
C-PACE can typically provide between 10% and 30% of the capital stack for a development project and up to 100% financing for rehabilitation/retrofit and renewable energy projects. While ‘clean energy’ is embedded in the C-PACE name, a more apt description would be ‘capital expenditures,’ because while C-PACE can cover investments like solar panels and battery storage, investing in onsite energy generation is certainly not a requirement to reap the financial benefits of the program. More common applications include everything from building systems and envelope improvements to roofs, water and sewer system upgrades, and hazard mitigation (seismic, wildfire and windstorm, for example).
Determining if C-PACE is a Fit
C-PACE financing can be used during a variety of milestones for a building. For development, it can help complete or enhance the project’s capital stack to get shovels in the ground as quickly as possible. For rehabilitation/retrofit projects, C-PACE might be a fit if an owner/operator has perhaps deferred maintenance on their property during COVID and are looking to make improvements to future-proof the asset. It’s important to understand that lenders typically aren’t incentivized to do anything that would impact their security on an existing loan, so we typically see more success during the refinancing process. C-PACE is so attractive that many owners actually decide to refinance their loans early to incorporate C-PACE.
Since C-PACE is relatively new to the market, many developers and owners don’t know where to start. Too often, they are first approached by well-intentioned third parties who are unfortunately ill-equipped to help them secure C-PACE. (Assume that anyone that doesn’t have any practical experience with commercial real estate financing and underwriting is ill-equipped.) Alternatively, for development projects, beware of brokers who avoid C-PACE because it adds complexity to their capital raise. There are certainly cases where they are justified, but it is good practice to have an understanding regardless.
The best place to start to determine if C-PACE is right for a project is with the capital provider. They should be able to quickly help assess the viability of the planned project and determine the appropriate next steps, including providing an honest perspective of how the lender would underwrite the deal. Assuming the owner has reason to believe their lender will consent, the next step for a retrofit project is a pragmatic, unbiased energy audit. This is particularly helpful up front if a property owner isn’t sure which upgrades will make the most financial sense for their building – both in terms of improving operating income and overall valuation. In the case of a development project, this process is much simpler, as there are benchmarks typically tied to local energy codes that the project would need to exceed to leverage C-PACE in the capital stack.
Securing Lender Consent
From there, the project moves to approval, underwriting and lender consent. To ensure certainty of close here, it’s vital to have expert coordination of the capital stack and especially debt sources. For this reason, it’s most effective to work with a capital provider who can verify they are the direct lender of their capital. As the direct lender, they have a fiduciary responsibility to manage risk, just like a bank, and will not waste anyone’s time chasing an unrealistic promise (like the idea you can replace all your equity with C-PACE!).
As more people become comfortable with C-PACE financing and understand its environmental and financial benefits, it has the potential to become a more readily accepted participant in the capital stack. Successful adoption will ultimately hinge on the commercial real estate industry developing a more realistic understanding of the fundamentals of C-PACE, setting more practical expectations of this financial product, and coordinating with direct C-PACE lenders to make it easier to gain lender consent
and ensure certainty of close.