Along Key Highway in Locust Point, crews are erecting a 15,000-square-foot commercial building which is pre-leased and slated to become a Goddard School this spring. Developer Goodier Properties financed $800,000 of the $6 million project through C-PACE, the Commercial Property Assessed Clean Energy funding program.
“It was a great way to secure a piece of mezzanine debt financing and build it into the capital stack,” said Jon Selfridge, Vice President. “The cost of borrowing through C-PACE was roughly 6.5 percent, which is way below what an investor would look for on a return of equity. For us, it alleviated the need to go find additional investors to fill the capital stack and it’s a more user-friendly reporting process than reporting back to an equity group.”
C-PACE, according to some financial and CRE professionals, has become an attractive option for adding long-term, fixed-rate financing at rates lower than mezzanine debt or preferred equity. In addition to supporting new construction, it can advance hard-to-finance renovation projects and provide rescue funds for mid-stream or completed, underperforming properties.
Some financial professionals, however, warn that developers and owners need to approach C-PACE cautiously. Failure to complete meticulous financial analysis could create scenarios where C-PACE drives up the cost of financing.
“In the current economic climate, it’s tough to get construction and value-add deals done,” said Jason Schwartzberg, President of MD Energy Advisors. “Everyone is trying to figure out where interest rates are going and lenders are trying to figure out their risk tolerance for new construction and value-add deals. Developers are not receiving the leverage from lenders that they once were and equity is hard to come by. There are a lot of holes in capital stacks right now and developers have had to get very creative.”
Those circumstances have led to “a ton of interest in C-PACE across all asset classes,” Schwartzberg said.
MD Energy Advisors has facilitated C-PACE financing for projects in multiple states and the program can “be a great way to complete the capital stack and reduce the average weighted cost of capital,” he said.
Construction and renovation projects are priced on a floating rate basis tied to an index such as the Secured Overnight Financing Rate (SOFR). Over the past 12 months, SOFR has increased considerably from .05 to 4.3. Construction spreads can range from 250 bps with traditional lenders to as much as 600-700 bps with debt funds, pushing interest rates as high as 10 or 11 percent, Schwartzberg said. “We were able to reduce our clients borrowing costs by as much as 300 or 400 basis points utilizing C-PACE.”
That tool has proven useful to developers as they grapple with three common, current challenges in CRE markets, namely the escalating price of construction, labor costs and leasing velocity.
Schwartzberg points to the case of 40TEN Boston Street, the four-story, Class A, mass timber office building under construction in Canton.
“This was great application of C-PACE as we had a strong and experienced developer with an excellent project trying to solve for rising construction costs,” he said. “The project will have very strong cash flow at stabilization and could support additional debt. We leveraged C-PACE to fill the gap rather then the developer contributing additional equity.”
C-PACE financing also eliminated the need to value engineer the project and enabled the developer to retain certain sustainable features, such as the high-efficiency HVAC system.
“In addition to ground up projects or repositions, you can also utilize C-PACE as relief or rescue capital on mid-stream projects that have encountered cost overruns or leverage C-PACE for retroactive financing for projects that aren’t leasing up as quickly as anticipated,” Schwartzberg said.
C-PACE, of course, is not appropriate for every project. To qualify for C-PACE, projects must clear three hurdles – financial sizing of the project, a technical review of the project’s energy efficiency and/or clean energy aspects (those requirements change from jurisdiction to jurisdiction), and consent of the senior lender. Since C-PACE is a local-government assessment on a property and functions like a tax assessment, the C-PACE lien takes priority over any other debt in the case of foreclosure or bankruptcy. Over $4.2 billion worth of C-PACE projects have been funded nationwide and over 400 lenders have consented to C-PACE in the capital stack as the C-PACE assessment cannot be accelerated in the event of foreclosure and only the annual debt service payment on the C-PACE can prime the senior mortgage. C-PACE cannot be included in a capital stack without the consent of the project’s senior lender.
Those conditions mean that any deal involving C-PACE financing must be carefully crafted to meet everyone’s financial goals and risk tolerance, said Kevin Morse, Managing Director of Imperial Ridge Real Estate Capital, a nationwide C-PACE financing company.
“We work closely with the other cap stack providers, including senior lenders, to help make sure financing is structured so that everybody wins,” Morse said. “We work through their pain points or limits in terms of financing. Sometimes a lender might say we are okay with C-PACE but only up to a certain amount.”
Chris Nevin, Senior Vice President/IRE Mid-Atlantic Regional Manager at First National Bank, cautions that C-PACE is not necessarily a financially attractive route.
“My understanding is that C-PACE is lending at 10-year Treasury plus 375 which puts the rate around 7.2 percent and the maximum amortization schedule allowed in Maryland is 20 years. Most permanent loans currently are below that rate and have an amortization period that matches C-PACE,” Nevin said.
The inclusion of C-PACE can limit a developer’s other financing, he added. “Whatever the payment is on a C-PACE loan, the banks add that as a direct expense to the pro forma. That decreases your net operating income, decreases the value the bank can attribute to the cash flow and, based on the debt-service coverage, reduces the amount of debt that you can issue on a property.”
Nevin indicated developers will carefully assess the full implications of C-PACE in their capital stack and determine whether it would lower or increase their cost of financing. Nevin worked through a scenario of a real estate project financed by 30 percent equity and 70 percent permanent loan with a 6 percent rate and 25-year amortization. He then assessed the same scenario with 20 percent C-PACE financing (7.2 percent with a 20-year amortization schedule) included in the capital stack and the subsequent reduction of the project’s net operating income and permanent loan. The result, Nevin said, was the project with C-PACE financing required $40,000 more in equity.
“As with any real estate project, you prepare the analysis with C-PACE and without it to determine the amount of equity that will be required,” Nevin said.