Commercial Property Assessed Clean Energy (PACE) financing is an innovative program designed to incentivize commercial businesses to undertake green efforts. By utilizing PACE financing, governmental bodies encourage commercial entities to invest in improvements or technologies that will save energy, produce renewable energy, and/or, in some states, conserve water. This concept is growing in popularity because it is a creative method to efficiently and effectively provide capital for sustainability projects.
How Does Commercial PACE Financing Work?
A potential borrower interested in securing commercial PACE financing must first determine whether the state in which the project is located has passed commercial PACE financing enabling legislation and, if so, whether the applicable municipality or county has established a program for which the project qualifies. A state must pass authorizing legislation to enable a governmental entity or other inter-jurisdictional authority to form a special tax district or special assessment district to operate a commercial PACE program. This is a key feature of the PACE financing model because the model requires the imposition of assessments or special taxes against the property that benefits from such improvements.
PACE enabling legislation has already been adopted in 32 states,1 including Illinois, California, and New York, as well as the District of Columbia. Once the state legislation has been passed, a program sponsor (a state, consortium of governmental entities, or a single local governmental body) must design and implement a commercial PACE program to achieve its objectives, which may include economic and workforce development and greenhouse gas reduction targets. Accordingly, there may be numerous programs within a particular state, each with its own customized parameters. For example, in California there are 11 different commercial PACE programs2 and, as a result, PACE financing is available in most California municipalities.3
When establishing a commercial PACE program, the program sponsor must make a number of preliminary determinations, including the following: (a) the types of properties that will be eligible (e.g., office, retail, industrial, warehouse, agricultural, and multifamily properties); (b) the kind of improvements (e.g., windows, lighting, HVAC, or roofs) or technologies (e.g., solar, wind, or geothermal) that will qualify for financing; (c) the environmental targets to be achieved; (d) the content of the application; (e) the criteria and mechanics of the approval and underwriting process; (f) the scope and methodology of the audit regarding energy/cost savings; (g) whether specific energy savings will be guaranteed and, if so, by whom; (h) the source of financing and whether it will involve a closed market (e.g., one that secures a line of credit from a pre-selected financial institution or public fund) or an open market (e.g., one that allows entities to arrange PACE financing with private lenders of their choosing who are willing to accept the PACE securitization and payback framework); (i) whether credit enhancements will be offered; (j) the requirements for participating contractors; and (k) strategies to successfully promote the program.
Depending upon the particulars of the program, the timeline to complete financing will likely be comparable to conventional financing and soft costs (including legal fees) may potentially be financed under such PACE program. Owners who apply for PACE financing are also encouraged (and sometimes required) to take advantage of local, state, and federal energy savings incentives, including utility rebates.
While there are variations in program design, PACE financing normally allows a local government’s property taxing office to act as a loan servicer by adding the PACE assessment as a line item on the owner’s property tax bill, collecting the special assessment, remitting it to the entity that funded the PACE project, and enforcing remedies in the event of a delinquency or default.4 Amounts financed through a commercial PACE program are repaid over a set period of time, generally 10 to 20 years.
Because PACE is a novel and unconventional financing tool, if a building owner desires to have its tenant(s) bear the cost of the PACE assessment, the owner should ensure that the terms of the respective lease(s) clearly provide that the PACE assessment is passed through to the tenant(s).
What Are the Benefits of Utilizing Commercial PACE Financing?
In a successful commercial PACE financing program, a property owner should expect to achieve cost savings that exceed the assessment payment, thus creating a net positive cash flow and increasing the value of its property. By utilizing PACE financing, an owner can realize immediate benefits from implementing a long-term sustainability project, without the burden of making a significant up-front cash payment. Governmental entities benefit by promoting implementation of environmentally friendly projects and stimulating their local economy. Additionally, contractors benefit from increased work generated by these programs.
A distinctive feature of PACE financing is that the financing is typically tied to the property and not the owner. Therefore, depending upon state legislation, if the owner sells the property, the purchaser takes title subject to the PACE lien and the PACE assessment is transferred automatically to the new owner. Similar to a tax lien, the holder of a PACE lien may only pursue collection of the amount in default, plus interest and penalties. Unlike traditional financing, the full PACE loan may not be accelerated upon default. This structure provides an owner enhanced flexibility to transfer a property in unpredictable economic times and constitutes a significant advantage over other available financing mechanisms.
The PACE lien is generally given the same priority as tax and special assessment liens. In the event of a default, a PACE lien will normally, by statute, take a senior position to all existing mortgage liens. Because the PACE lien is usually a “super lien” and commercial PACE financing will likely violate existing loan covenants, nearly all commercial PACE programs require the consent or acknowledgement of mortgage holders as a condition to approving PACE applications. Securing a lender’s approval can present a critical obstacle. A lender will need to carefully evaluate the economic benefits of the project to determine whether the PACE financing is likely to result in diminished operating costs and enhanced collateral value sufficient to justify granting its consent.
Where Has Commercial PACE Financing Been Implemented?
The following 16 states and the District of Columbia have active commercial PACE programs: Arkansas, California, Colorado, Connecticut, Florida, Kentucky, Maryland, Michigan, Minnesota, Missouri, New York, Ohio, Rhode Island, Texas, Utah, and Wisconsin.5 Although precise figures are difficult to ascertain, it is estimated that over 750 commercial buildings have utilized commercial PACE financing totaling approximately $250 million through June 2016.6 Commercial PACE financing has been used to facilitate a wide range of projects, including the following:
The Department of Energy’s Better Buildings Challenge recently recognized California’s Placer County for a comprehensive retrofit and energy audit of the 14,680-square-foot Granlibakken conference center and resort.7 PACE financing was utilized to replace refrigerators, dishwashers, and the stove-hood exhaust systems with energy efficient models and install new heating and air conditioning systems to increase the efficiency of the natural gas boilers, which upgrades are expected to result in a 43 percent reduction in energy use and a savings of up to $44,000 each year.8
A $1.702 million PACE loan for the Mackie Building in Milwaukee was recently used to finance elevator upgrades, low-flow water fixtures, an upgraded hot water system, and a high-tech variable refrigerant flow heating and cooling system as part of a major $13.7 million redevelopment and restoration plan.9 It is estimated that the improvements will result in $2.2 million in savings over the life of the project.10
In Hartford, Connecticut, $8.4 million in PACE financing was utilized for the design and implementation of premium-efficiency chillers, natural-gas fired condensing boilers, steam boilers, cooling towers and a plate- and-frame heat exchanger for State House Square, a Class A office building.11 By eliminating its reliance upon steam and chilled water purchased from a local utility, the property has achieved almost a 90 percent cost savings.12 The closing for the PACE financing took place in December of 2015.
The Terra Tile & Marble project in Ossining, New York, involved the installation of a roof mounted solar electric system on a warehouse, showroom, and offices consisting of 30,000 square feet which was financed with the assistance of PACE financing, a New York State Energy Research and Development Authority incentive, and a federal investment tax credit.13 It is estimated that the owner will obtain an electric offset of 95.5 percent in the first year and achieve a $26,029 net annual cash flow as a result of project savings from energy generation less financing costs.14 The amount financed was $204,102.15
What Is the Future of Commercial PACE Financings?
The market for and availability of commercial PACE financing is expanding as more governmental bodies and owners learn about the significant benefits of this unique financing vehicle. Property owners interested in this financing mechanism should determine whether such financing is applicable in the jurisdictions where potential projects are located.