Alternative Financing … Commercial PACEPosted to Willdan in the Energy Efficiency Group
- Aug 3, 2020 9:24 pm GMT
Hurdles to Energy Efficiency
Energy efficiency projects face three main hurdles: 1) lack of technical knowledge (Do you know what measures you want to implement?); 2) minimum required return on investment (Is the return worth the investment?); and 3) capital constraints (Do you have the money to do it?). To drive energy efficiency, utility programs need to address all three. Commercial Property Assessed Clean Energy (C-PACE) is an emerging tool that is used to address capital constraints. Paired with utility technical assistance and financial incentives programs, C-PACE offers distinct advantages that can encourage greater adoption of energy efficiency by addressing financing gaps in today’s tumultuous markets.
Gaps in Financing
For the average commercial new construction demand-side management (DSM) project, energy use and conservation typically accounts for 15% or more of the total cost. Even in the best of times, once the capital stack financing (all available funding) is in place, it is often difficult or impossible to find additional funding to incorporate higher performance energy systems, despite their resulting in permanently higher net operating income (NOI) on the property. With the uncertainties introduced by the worldwide pandemic, a well-executed capital stack may now have new funding gaps, construction delays, changes in lending covenants, or other issues that challenge the desire for higher performing energy systems.
C-PACE is an alternative financing source for energy efficiency, water conservation and renewable energy projects, helping building owners and developers resolve capital constraints. Commercial real estate developers can replace higher cost mezzanine debt and/or equity with C-PACE to lower the weighted average cost of capital (WACC) and significantly improve equity returns—allowing for profitable investment in energy efficiency with lower return on investment. At the same time, C-PACE can help the project adopt high-performing, cost-saving energy/water and renewable components – 21st century sustainability features that may otherwise seem out of reach.
What makes C-PACE so different from conventional debt and equity is that it represents 100% long-term financing, meaning no additional upfront capital is required from the developer. Further, 100% of the C-PACE loan is attached to the real estate and repaid (typically over 20 years) through the property tax assessment. This cost is then incorporated into the triple net lease rate for future tenants, reducing split incentives (when the developer pays for improvements from which the tenant benefits). Those tenants will enjoy higher performing energy systems and lower energy costs while repaying the increased property tax costs. Thus, developers can meet the high standards of top-tier tenants who may demand high building performance standards for corporate sustainability requirements.
Out with the Old … Value Engineering
The debt, equity and partner equity are in place. The project is getting construction bids. Along come higher estimates from several trades including mechanical systems. Now throw in a 100-year pandemic. What does a developer do? The go-to method of mitigating funding gaps has been value engineering (VE). Also, energy, building envelope and mechanical systems are easy, invisible targets for reducing costs through lower performing systems, which decrease net operating income (NOI).
And in with the New … Alternative C-PACE Financing
While VE will always have some merit at this stage, C-PACE represents a new additive way to fund cost overruns (regardless of whether they are energy related or not) without disturbing the existing capital stack. C-PACE can reduce the amount of sacrifice on the project from VE alone. Because it is attached to the property over a long term—typically 20 years or more—the annual increase in property tax is often equal to or less than the projected energy and net operating cash savings. Tenants assume both the cost and benefit through typical triple net leasing. The property developer uses no additional capital of their own.
Key Features of C-PACE Financing
Because C-PACE financing is attached to the property, not the business, it is often accounted for “off the balance sheet,” and no covenants or owner guarantees are required; additionally, the obligation transfers with the sale of the property to future buyers—a fair and equitable system.
Summary features of C-PACE financing:
Comparing C-PACE to Traditional Capital Sources
The table below compares C-PACE to other traditional forms of financing. C-PACE often will lower the overall weighted average cost of capital in a development project. In this example, a $5M project is being funded. For new construction, where permitted, typically 15% to 20% of the total building cost minus the land is eligible for C-PACE financing.
More About C-PACE
Utilities can leverage C-PACE for their DSM programs to achieve the best and highest-performing energy solutions for commercial new construction projects. C-PACE is a relatively new form of financing that can often stretch capital budgets and close funding gaps to ensure that energy systems lower net operating costs—while providing new buildings with 21st century energy solutions. Is your commercial new construction program saving, on average, twice as much energy per project as the industry average and reaching up to 70% market penetration? C-PACE is one more tactic to help get you there.
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