More real estate developers and investors than ever before are using commercial property assessed clean energy financing to launch their projects. “By the end of 2023, we will have surpassed $2 billion in financing since our inception in 2015, with nearly $1 billion of that financing having been in 2023 alone,” said Jessica Bailey, co-founder and CEO of Connecticut-based Nuveen Green Capital, currently one of the most active C-PACE lenders in the nation. And the surge in demand for this source of financing shows no signs of slowing down.
Related article: CRE experts predict upcoming opportunities
NGC's average C-PACE loan size also nearly tripled, as overall projects got bigger and NGC's ability to access financing quickly allowed it to cover a larger portion of borrowers' construction budgets, Bailey said.
C-PACE is a green financing mechanism made possible by state policy that provides fixed-rate, long-term, non-recourse, non-dilutive loans for up to 30 years for any aspect of construction that improves a building's energy or water efficiency.
The system is structured so that assessments are levied on the parcels of property, not the sponsors, who are not required to post collateral, and because the debt is collected on the property tax bill, some owners could pass on the financing costs to tenants who benefit from the improvements as common area maintenance costs, Bailey suggested.
The most “preferred” option
Last August, Bay Area developer TMG Partners secured a $172 million C-PACE loan from San Francisco-based Greenrock Capital and Cleveland-based KeyBanc Capital Markets for sustainability upgrades at 300 Lakeside Drive in Oakland, California, completing the largest C-PACE office deal to date.
In preparation for occupancy by new tenant Pacific Gas & Electric Co., C-PACE provided funding to upgrade or replace fire, electrical, plumbing and mechanical systems with more efficient equipment and materials, seal the building's exterior for energy efficiency, perform a complete seismic retrofit and install energy-efficient lighting throughout the workspace.
PG&E is relocating its headquarters here from San Francisco, signing a 35-year lease on the iconic midcentury, 28-story office tower in the heart of the vibrant Uptown district along Lake Merritt. However, PG&E has exercised an option to acquire the LEED Platinum-certified office building for approximately $900 million, announcing plans to complete in 2025.
“This was our first time using C-PACE, and while this type of financing was very difficult to obtain in the current (interest rate) environment, it was effective for financing a large, single-tenant office,” reported Matt Field, co-CEO of TMG Partners, who noted that C-PACE loans are transferable to the new owner, meaning PG&E can either assume the loan balance or pay it off when it takes over the building.
“C-PACE is an increasingly attractive option from an investment perspective due to its relatively low leverage, its ability to finance the sustainability essential to the development and redevelopment of buildings today, and its being a very safe financial instrument,” says Joe Euflat, managing principal at Greenrock. “When competing with other sources of financing, C-PACE is not only more favorable today, it is one of the most favorable options,” he argues.
Public and private interests
C-PACE lenders are able to offer such favorable terms because it's a public-private partnership that leverages private capital but uses public interest financing mechanisms typically used to finance public infrastructure, Bailey explained.
Under this program, the debt can be paid off as a benefit assessment on your property tax bill over a period matching the useful life of the improvements or newly constructed infrastructure (usually 20-30 years) and transferred to the new owner as a real estate lien.
This type of loan can cover up to 40% of a project's total cost, is available for all types of commercial real estate assets, does not require equity investment, and can be used to upgrade or install sustainability features in existing buildings or for ground-up construction that reduces energy consumption, water conservation and associated labor costs. It also funds earthquake, storm, fire and flood resilient infrastructure upgrades in markets affected by earthquakes, hurricanes and floods, such as California and Florida.
Jason Schwartzberg, president and co-founder of MD Energy Advisors, lists other benefits for developers: “If a project starts to go over budget or leases don’t close as quickly as projected in the proforma, as long as the certificate of occupancy was issued within 36 months, the financing can be obtained retroactively,” he explains, noting that C-PACE also eliminates the need for costly mezzanine financing to fill funding gaps.
A lit match
The increase in C-PACE loans is due to a few factors. “The extreme volatility that we've seen in the capital markets has pushed traditional commercial real estate lenders to the sidelines, creating a gap in the capital stack. C-PACE was strategically positioned to fill that gap,” Bailey said. “And it wasn't until we got involved in C-PACE lending that we were able to price it within the senior mortgage range.” Bailey noted that C-PACE already has some structural advantages that make it attractive to developers. “When you combine the structural advantages with the pricing advantages, we've seen a surge in lending.”
C-PACE transactions increased last year as the Fed raised interest rates, slowing the pace of commercial bank lending, Schwartzberg said. With Fed interest rates at their highest in decades, capital lenders are tightening lending terms and policies and raising capital requirements. His firm did four C-PACE transactions in the fourth quarter of 2023 alone.
As a result of the Fed's move, PACE interest rates are now lower than or on par with “go-to lender” rates for construction loans, he adds, noting that banks' rates were sometimes lower in the past. According to Commercial Loans Direct, interest rates on C-PACE loans range from 7.5 percent to 8 percent, while bank construction loan rates range from 10 percent to 15 percent, depending on the loan term, location, property type and the sponsor's credit rating.
However, this funding tool is only available in states that have passed PACE implementing legislation and in counties or localities that allow it. For example, California has 10 localities that allow PACE benefit assessment, property tax financing. PACE implementing legislation is currently in place in 38 states and Washington, D.C., and is up and running in 30 states and Washington, D.C. Additionally, three states are considering PACE implementing legislation: Arizona, North Carolina, and South Carolina, according to Schwartzberg.
Schwartzberg also suggested the increase in C-PACE loan issuances could be due in part to the recent adoption of PACE implementing legislation in the states of Alaska, Hawaii, Massachusetts, Nevada, Tennessee and Washington, as well as more local governments approving them.
The possibilities are endless
C-PACE loans have no size cap. Loan amounts are based on the energy savings of the project and are limited only by the sponsor's credit rating and underwriting to ensure sufficient cash flow to repay all debt. As a result, C-PACE loan amounts are reaching record highs. “PACE is increasingly becoming part of a developer's capital stack, even for blue chip and strong sponsors, to fill capital gaps,” says Schwartzberg.
What's more, the PACE lending market is expanding: There are currently about 300 national, regional and local mortgage lenders across the country that offer PACE financing, but other lenders, including major banks, are considering acquiring PACE shops or taking steps to become approved PACE providers, according to the Crittenden Report.
But Schwartzberg lists three hurdles to qualifying for a C-PACE loan: (1) underwriters must prove the project will generate enough cash flow to repay both the lead mortgage and the C-PACE loan, (2) the project must pass a technical review that uses permit plans, a schedule of values and a COMcheck form to quantify and verify that the project’s energy and water content is above standard, and (3) the borrower must get written consent for a C-PACE loan from the lead mortgage lender.
Meanwhile, the amount of capital available to developers is also growing as investors, including institutional investors, view C-PACE as an attractive, low-risk investment. According to PACENation, which facilitates and supports the growth of PACE market participants, capital investments by private and institutional investors to fund commercial projects now exceed $5.2 billion.
For example, last year NGC and parent company Nuveen launched a fund to give insurers access to a portfolio of investment-grade clean energy assets after a survey found that 82% of insurers planned to consider impact investing in the next year and 55% of North American insurers said they were considering climate strategies in their impact investing approach.
As a result, six leading insurance companies have allocated a combined $525 million to NCG funds to fund energy efficiency and sustainability projects. “As an investment product, C-PACE typically offers higher yields compared to similarly rated products such as commercial mortgage-backed securities and municipal and corporate bonds,” Bailey notes. “The underlying securities have proven to be a good fit for life insurance companies as they offer strong capital-efficient returns, duration, diversification and impact investment opportunities without sacrificing risk-adjusted returns compared to other fixed-income products.”