First introduced in California in 2009, Commercial Property Assessed Clean Energy (C-PACE) programs offer long-term, fixed-rate loans that provide capital for improved energy and water efficiency in commercial building projects, and they have been growing in popularity. Over the last 15 years, more than 3,300 development projects in 22 states and Washington, D.C. have leveraged C-PACE loans in their financing. And with the ongoing liquidity crisis and elevated interest rates expected to continue in the hospitality industry for at least another 12 to 24 months, C-PACE loans will gain even more momentum in 2024. In fact, I predict this year will outpace 2023.
There are a few reasons for this phenomenon. First, C-PACE loan interest rates are currently equal to or lower than other construction loans. There’s also less liquid capital available today from traditional bank lenders than there has been in the past, and that capital is coming at a higher cost, so people are leveraging PACE as part of their capital stack. And finally, awareness. Both borrowers and lenders are more aware of PACE lending than they’ve ever been before.
But despite all they offer, C-PACE loans aren’t a perfect solution to the “capital crunch” that so many commercial real estate developers are experiencing. If you’re considering pursuing a C-PACE loan for a new development project, there are some factors you should keep in mind.
Capitalized Interest
Unlike a traditional construction loan, where you’re only paying interest on money drawn, with C-PACE loans, you’re paying interest on the full amount from the day you close, whether you’ve used those funds or not. This heavily increases your cost of capital.
Heavier Fees
C-PACE loans may also be subject to heavier fees. While most C-PACE lenders charge a 1 percent origination fee, you’re also paying third-party fees to the local PACE administrator, additional third-party reports, etc. (The cost of increased fees adds up quickly when you’re doing a $30 million deal!) Also, while there is room to negotiate on lots of deals, there is no way around third-party fees. They’re always going to be there.
Rate Additions
Further, some PACE Program Administrators have what they call a “rate adder.” I’ve seen C-PACE loans where the rate adder tacks on an additional 10 basis points to your interest rate over the life of your loan. When you’re talking about a long-term, permanent loan, this can add up to a significant amount of real dollars over 25 or 30 years.
Pre-Payment Penalties
This is a big one. C-PACE loans typically have a 1 percent to 5 percent prepayment penalty that in some instances goes out as far as 10 years. The reason for this penalty is that C-PACE loans are touted as long-term options, and there is a dearth of permanent debt lenders in banks, life insurance companies, and commercial mortgage-backed securities. This means that C-PACE loans aren’t just another part of the capital stack. Instead, what happens most often is that C-PACE loans are used with debt funds to bring down the cost of capital in repositioning or ground-up construction projects that utilize short-term loans. If and when the borrower goes to refinance, they have to pay off the C-PACE loan early, which incurs prepayment penalties.
Refinancing stabilized properties is just another part of doing business, so all borrowers need to keep this in mind when negotiating their initial terms with C-PACE lenders. Luckily, pre-payment penalties can usually be negotiated down during this process.
Not a True Mezzanine Replacement
We often see C-PACE advertised as a cheaper alternative to mezzanine loans. While this may be true on a high level, it rarely works out that way. Most lenders view C-PACE as a senior position lien versus the senior mortgage, essentially because C-PACE works as a tax assessment, so lenders view it as a priority position to their debt. Due to this, most traditional bank lenders won’t allow it in the capital stack or allow it to increase leverage of what they would typically offer. So, a common theme we see is that by adding C-PACE to the capital stack, you end up working with higher cost senior lenders such as debt funds versus bank lenders.
A Time and a Place
While hospitality developers should take care when considering leveraging a C-PACE loan in their capital stack, that’s not to say that there isn’t a time or a place where C-PACE loans are useful. There are many, many examples in our industry of these loans being used to great effect, like when a property needs some energy-efficient capital improvement. Just be sure you’re using C-PACE loans to meet a specific goal when financing your next project, rather than as a vague component of your capital stack. They are not a fix-all solution to the capital crunch.
