from the New York Times By Joe Gose
Published Aug. 27, 2019 Updated Aug. 28, 2019
Developers grappling with the cost of new laws enacted to combat climate change are taking advantage a little-known finance tool to help pay for green-building requirements.
The model for the loans, known as Property Assessed Clean Energy, was created in 2008 to fund improvements that create environmentally sustainable and resilient properties. Now, developers are turning to PACE loans to help create more energy-efficient buildings and meet tougher environmental standards.
In Omaha, for instance, the Capitol District, a $205 million mixed-use entertainment development, has become the latest milestone in a long-running effort to revitalize the downtown area. The project’s developer, Shamrock Development, tapped a PACE program to pay for LED lighting, heat pumps, low-flow water fixtures, and other building materials and equipment to enhance energy and water efficiency.
Promoters say a PACE loan is better than conventional debt used for similar upgrades because it is typically cheaper, it has a fixed interest rate and terms are 20 to 30 years instead of three to five. Shamrock Development’s $24.9 million PACE loan, for example, has an interest rate a little below 6 percent and a 22-year term.
What’s more, unlike conventional loans, PACE financing becomes an assessment on the property. It is paid annually along with the real estate tax bill, and it transfers to new owners.
“Developers are always on the lookout for new tools to make their projects better,” said Michael T. Moylan, president of Shamrock Development. “We saw that PACE was going to be good for us — it made our buildings more energy efficient, and long-term fixed-rate financing is always attractive.”
Emerging from years of relative obscurity, the PACE model was used to finance $660 million of sustainable building improvements from 2016 through 2018 after funding only $208 million in the six previous years, according to PACENation, a nonprofit organization in Pleasantville, N.Y.
In addition, institutional investors such as Starwood Capital, Vulcan Capital and CarVal Investors are pouring hundreds of millions of dollars into PACE lenders. Petros PACE Finance, a loan provider in Austin, Tex., with a national platform, announced last year that it had received billions of dollars in commitments, including a $10 million round led by the retired baseball star Alex Rodriguez.
“It’s like we’re holding the tiger by the tail,” said Mansoor Ghori, chief executive and co-founder of Petros PACE, which originated the Capitol District loan. “Market awareness is taking hold, and volume could grow exponentially very quickly.”
The PACE model originated in Berkeley, Calif., when the city was looking for ways to help residents pay for solar panels and other energy modifications. Financing programs for commercial properties soon followed. So far, 36 states and the District of Columbia have passed legislation to allow the use of PACE financing for commercial properties.
Laws fighting climate change in California, New York and elsewhere are expected to accelerate demand for PACE. New York City approved a PACE ordinance to help landlords comply with its Climate Mobilization Act, which, among other measures, requires owners of buildings of more than 25,000 square feet to curb their greenhouse gas emissions. The city’s PACE program should be up and running early next year, said Fred Lee, co-chief executive of the New York City Energy Efficiency Corporation, a nonprofit green building lender and the city’s PACE program administrator.
“States and cities are putting a heavy burden on commercial real estate owners, who see these ambitious climate targets as unfunded mandates,” said Jessica Bailey, chief executive and co-founder of Greenworks Lending, a PACE lender in Darien, Conn. “So PACE is a carrot to the stick that gives property owners a way to finance more energy-efficient systems.”
Better yet, PACE will help developers meet the requirements of green policies without using subsidies, said Jake Baker, managing director of Starwood Sustainable Credit, an affiliate of Starwood Capital that has committed $500 million to CleanFund, a PACE loan platform.
“It allows market mechanisms to work,” he said, “and has the best chance for success.”
PACE’s original mission was to finance green upgrades in existing buildings. But developers are increasingly using the programs to fund new construction and the gutting and renovation of old buildings. Lenders expect this activity to accelerate in the coming months, especially in light of PACE’s flexibility and affordability.
Developers can borrow up to 20 percent of a project’s cost in PACE funds, for example. Banks generally finance only around 60 percent of a project’s cost, and a PACE loan can help bridge the gap. Additionally, PACE is replacing more costly financing, such as mezzanine debt. Mezzanine interest rates are around 12 percent or more, while PACE rates are generally 6 percent to 8 percent.
“The financial industry recognizes that as a form of commercial real estate finance, PACE is here to stay,” said Lain Gutierrez, chief executive of CleanFund, which is based in Sausalito, Calif. “Apart from the public policy benefits, it has intrinsic value.”
In Columbus, Ohio, the developer Michael Tomko is putting the final touches on a $22 million preservation of the Hayden, two long-vacant adjacent office buildings on the downtown square that date to 1869 and 1901. He used $4.6 million in PACE financing from Greenworks, combining it with bank financing, federal and state tax credits for historic buildings, tax abatement and other funds.
“The challenge of these projects is developing all of the financing sources,” he said. “But PACE was a big part of the package and was an exceptional fit.”
The momentum behind PACE is attracting buyers for the loans, too. Like commercial mortgage-backed securities, PACE loans are being bundled, graded by credit-rating agencies and sold to institutional investors as bonds. Nuveen, the asset manager for the giant insurance and investment company TIAA, has acquired $225 million of PACE loans originated by Greenworks.
“PACE checks a lot of boxes — it’s a secure, safe investment, and its long-term duration is a good match to help fund our long-dated liabilities,” said Chris Miller, director of private investments at Nuveen. “Nuveen and TIAA are also very progressive when it comes to things like energy savings and green causes.”
Still, how PACE bonds would fare in an economic downturn is unknown. It’s a timely concern given the anticipation of an economic slowdown and the infancy of the PACE bond market.
Yet because PACE is assessment financing, a lien is placed on a property, which gives the PACE loan priority over a senior mortgage, said Kenneth Cheng, a senior vice president at Morningstar Credit Ratings. Consequently, even if a PACE borrower defaults, senior mortgage holders, who have a much bigger stake in the property than PACE lenders, have an incentive to pay any missed assessments to maintain their collateral interest in the asset.
Early on, this structure stymied PACE’s adoption. Senior mortgage lenders feared that a missed assessment payment would put their interest in the collateral at risk. As a result, they refused to allow their borrowers to use the programs. But today, mortgage lenders better understand how they are protected, Ms. Bailey of Greenworks said.
“Once mortgage lenders started digging into this, they realized that the upgrades we’re financing add value to the properties and that we’re not putting them in a higher risk position,” she said. “Reluctance has faded away.”
Correction: Aug. 27, 2019
An earlier version of this article, using information from the Morningstar website, gave an incorrect title for Kenneth Cheng at Morningstar Credit Ratings. He is a senior vice president, not a managing director.