With commercial property owners and tenants still seeking sustainable building designs that incorporate energy efficiency or green building features, Property Accessed Clean Energy (PACE) financing will continue to rightfully receive more attention.
Sustainable building designs are not a trend, but rather an important design component that is here to stay, especially as the population increases, the number of businesses grows, and the amount of developable land remains finite. PACE financing is a mechanism that encourages property owners to adopt sustainable building designs. (For example, an approximately 28,000-square-foot office building in Anaheim, California, recently used PACE financing to install solar panels.) While there have been many articles written about PACE and its potential advantages, this article explains why property owners and mortgage lenders should consider PACE financing even before any sustainable building designs or upgrades are actually identified.
Although collected with property taxes, PACE financing derives from contractual assessment bonds and has priority over other liens. PACE financing can be used to fund green or energy-efficient upgrades to a property. The most commonly thought-of upgrade is the installation of solar panels, but PACE financing may be used to install water conservation or efficient improvements, electrical vehicle charging stations, insulation upgrades, and window and door upgrades. The repayment terms vary and can range from 5 to 20 years, and if a property owner later elects to sell the property that is subject to PACE financing, the new owner assumes the repayment obligations (through the property tax payments). In California, CaliforniaFIRST, a public/private financing program that allows building owners to receive up-front funding for energy efficiency, renewable energy and water saving improvements, is considered the largest PACE program participant. CaliforniaFIRST is growing rapidly in the California marketplace and currently administers a PACE financing program in multiple counties, including Alameda, Contra Costa, Marin, Monterey, Napa, San Francisco, San Mateo, Santa Clara, and Sonoma.
For property owners, the incentive to incorporate sustainable building components or upgrades is driven by the potential to increase the value of the property, to reduce operating costs and to attract the best tenants. However, that drive may be mixed with a reluctance to invest in sustainable improvements if the economic benefits cannot be readily realized. Specifically, although incorporating energy-efficient construction materials or equipment into a building may attract a particular type of tenant, in most cases the tenant, and not the property owner, will be the one that readily realizes the savings from the reduction in his/her water bill, energy bill, or other savings created by the sustainable designs. Moreover, the initial capital costs associated with the usage of such materials or equipment to the property owner may not be recoverable from a tenant given that most commercial leases allocate capital improvements to the landlord.
To bridge this gap, PACE financing better aligns the landlord-tenant incentives associated with sustainable designs. PACE financing covers portions or all of the purchase and installation costs while repayments are collected with property taxes and other assessments; this allows commercial property owners to pass the costs associated with sustainable upgrades onto the tenants over a period of years as property taxes under the common triple net (NNN) lease structure. Although tenants may pay portions or all of the financing costs under the PACE programs depending upon the applicable lease terms, they also will reap the benefits of lower utility bills. Such savings over the term of a lease achieve a net savings to most tenants.
Given the benefits of PACE financing to both tenants and property owners, commercial property owners should be forward-thinking and consider PACE financing early on when they are financing or refinancing a property. This is true even if the property owner has not yet identified the sustainable improvement associated with PACE financing. Discussing PACE financing with mortgage lenders before the mortgage is in place allows the property owner to seek and obtain any necessary mortgage lender consents that may be associated with PACE financing later on. Similarly, due to the priority status of the PACE financing, lenders financing or refinancing a property should ask whether the property owner desires to later use PACE financing for sustainable improvements. Lenders can then set controls such as, in addition to other applicable PACE requirements being met, limiting the PACE financing amount to a certain percentage of the assessed property value. Approaching the subject early on is more efficient for both parties as it allows for any necessary reviews or underwriting to be done during the financing or refinancing due diligence phase.
As more property owners and/or tenants start to think about sustainable design improvements, commercial property owners will continue to approach more and more lenders about PACE financing. For the reasons noted above, property owners and lenders should, however, be more proactive in assessing the future likelihood of PACE financing for a project and building. By addressing the future needs in existing financing documents, both sides will be well served and avoid unnecessary delays in having to rework transactions to accommodate PACE financing when the opportunity presents itself.