Legally Speaking
C-PACE Financing and Affordable Housing
By Jerome L. Garciano
4 min read
Given the recent focus on energy and climate policy nationally, as exemplified by the Inflation Reduction Act establishment of the Greenhouse Gas Reduction Fund and expansion of many clean energy and energy efficiency tax incentives, many multifamily property owners and developers are looking at greening their projects and including solar and energy efficiency improvements. One financing tool established by states to encourage the adoption of such green improvements is Commercial Property Assessed Clean Energy (C-PACE) Financing. But while C-PACE financing has been around since 2008 and is currently established in 30 states plus DC, the integration of C-PACE financing into affordable housing and other tax credit transactions continues to be elusive.
C-PACE financing is a state-enabled mechanism that allows commercial property owners to finance energy improvements for existing buildings or new construction. Typically, a state or quasi-state agency administers the program through which approved private third-party lenders provide financing to commercial property owner borrowers for qualifying energy improvements. The repayment of C-PACE financing is done through the local property tax regime through a benefit assessment process administered by local municipalities that have opted into the state program. This unique repayment mechanism allows C-PACE financing to provide relatively long-term financing (20 to 25 years, often matching the useful life of the financed property) for energy-related equipment and sustainability-focused improvements separate from (and senior to) any financing to the building owner. Since the repayment of a C-PACE financing is done through the local property tax betterment assessments, the financing is essentially tied to the building as opposed to the property owner borrower. A sale and transfer of the building with the energy improvements to a new owner does not accelerate the C-PACE financing but instead provides the option to also transfer the C-PACE financing to the new owner.
There are hurdles to incorporating C-PACE financing in the affordable housing and tax credit finance capital stack. The biggest hurdle is probably that since the C-PACE financing is structured as a betterment assessment and repaid through the property tax payment system, the C-PACE financing is senior in priority to the first mortgage lender, similar to a municipal sewer district assessment. This senior priority for C-PACE financing is difficult for many traditional mortgage lenders to accept. It should be noted though that the full amount of the C-PACE financing cannot be accelerated upon a default. Many banks and mortgage lenders nationwide have gotten comfortable with being a secured lender in this structure as only the current amount of assessment would be due at any point in time. Another hurdle to C-PACE adoption is that, while the terms and costs of capital for C-PACE financing might be favorable when compared to traditional equipment finance when viewed as a substitute for the standard sources in a tax credit development capital stack, the financial benefit of C-PACE is not as great – if there at all. Relatively low interest rates, long amortization terms and flexible payment arrangements are already common features of many affordable housing developments, especially in the subordinate soft debt sources. Finally, the inherent complexity of most tax credit deals, which include features such as multiple development financing partners, a heavy regulatory framework and limited net operating income (NOI) and cash flow, all work against incorporating C-PACE financing.
Given these hurdles, will we ever see the acceleration of green improvements in affordable housing projects using C-PACE as a financing tool? Not unless there are changes to the current approach of developers, C-PACE lenders and other project financing parties. Perhaps there are new creative structures and approaches that have yet to be developed, which might be able to overcome some of the hurdles described. Some ideas include new approaches on the financing side, such as collaboration or partnerships between C-PACE lenders and senior mortgage lenders that could reduce the risk of the overall financing structure. Could creative reserves and other assessment set-asides make C-PACE more feasible? Could loan-to-value constraints be addressed by combining C-PACE financing and traditional mortgage financing? Other ideas include being creative about the ownership and deployment of projects. Could C-PACE projects be incorporated into projects through separate ownership structures, like condominiums or ground lease structures? Could third-party energy-as-a-service structures be an alternative approach where per-unit cost constraints or tax credit basis limitations apply? Should affordable housing developers look into developing on- or off-site stand-alone community solar projects where their own multifamily project portfolios could be the energy off-taker and beneficiaries of the fixed and perhaps lower cost of electricity? These and other ideas should be explored to give affordable housing developers the widest range of options for maximizing investment in all cost-effective clean energy and energy efficiency improvements to their properties.
