At HOTELS Opportunities Conference on March 31, 2021, Property Assessed Clean Energy (PACE) financing will be among the topics discussed to help owners and developers better understand this unique capital solution for new hotel construction, as well as hotel renovations. Developers looking to lower their operating costs (through energy efficiency) and potentially lower payments for their debt financing are increasingly taking advantage of PACE financing.
PACE financing is available for energy-efficient upgrades or the installation of renewable energy sources, as well as seismic-related costs. Launched in 2010, the PACE Program, which is overseen by the U.S. Department of Energy (DOE), allows local and state governments, as well as inter-jurisdictional authorities authorized by state law, to provide funding for the cost of qualified building systems for commercial properties. This money is then repaid over time by the property owner.
Over the past five years, PACE financing has gained wider acceptance, and moved from a novel curiosity to a widely-accepted practical solution to financings according to hotel attorney David Sudeck, a senior member of JMBM’s Global Hospitality Group based in Los Angeles. He said it has gained traction with both lenders and borrowers. But its gradual early adoption was greatly accelerated by the COVID pandemic’s impact on the hospitality industry and hotel construction financing.
The disappearance of such financing in March 2020 supercharged the importance and role of PACE financing. Over the past few months alone, Sudeck and other Global Hospitality Group attorneys have worked on the lender and borrower-side of transactions of more than a dozen PACE financing transactions, including one in excess of US$40 million.
PACE financing may be used to fund the cost of eligible energy-efficiency, water conservation, renewable energy or seismic strengthening measures. This typically results in PACE financing of up to 25% of total project costs. This financing is typically non-recourse and fully assumable upon the sale of the subject property. Any remaining balance on a PACE financing remains intact when ownership of the property changes hands, unless the PACE financing is prepaid at the time of property transfer.
PACE financing has generally been thought of as a type of construction financing, according to Sudeck, but it can also be available for certain completed or operating properties. This is called “retroactive financing,” which can provide the ability to refinance qualified improvements.
The retroactive financing calculation for certain completed or operating properties can include costs relating to improvements made as much as 36 months earlier, in certain jurisdictions. The PACE proceeds from such retroactive financing can be used for working capital, reduction or payoff of existing loan obligations, or payment for PIPs or improvements.
Sudeck said PACE financing takes the form of a voluntary tax assessment on real property, having the same features and priority as an ad valorem real property tax (typically paid only twice per year, when real property taxes are paid). Here are some of the features that may be negotiated which can make it attractive financing:
- Meaningfully lower rates than traditional mezzanine debt and equity
- Terms up to 30 years with fixed-rate financing
- No personal recourse guaranty (though a completion guaranty is often required)
- Ideal for renovation or PIP financing
- Capitalized interest component allows years without any payment due
- Interest-only period
- A growing number of cities, counties and states have active PACE financing programs
- Fully assumable financing (no due-on-sale component)
- Pre-payable (often with a declining pre-payment fee)
- Meaningful portion of the capital stack (often up to 25% or more of the property value
- Fast and efficient process (PACE financing documents are less complex than typical real property-secured loan documents, and the due diligence process is usually much faster and less exhaustive)
- Limited default triggers (the most material being failure to complete the development and failure to make a payment; there are no financial covenants or tests)
- No acceleration on default – if the property owner misses a payment or payments, the default can be cured by the property owner or the lender with the late payment or payments that include penalties and interest; the entire amount of the PACE financing does not become due as a result of a default
PACE financing typically does not involve the same underwriting process as a traditional mortgage. Property owners have the ability to finance 100% of the cost of energy-related improvements and creditworthiness is not a significant component of the approval process. Individual PACE programs are administered by state and local government agencies, which have some discretion in setting approval guidelines.
During this COVID-induced downturn, despite the abundance of capital sitting on the sidelines, Sudeck said traditional capital sources have pulled back significantly. “Some believe the hospitality industry is too volatile and want to see how long the downturn lasts. Some have tougher underwriting requirements or have reduced funding as a result of lower values derived from lower comps from distressed sales, reduced NOI, lower loan-to-value requirements and/or higher pricing for more conservative financing,” he said.
Yet many hotels need a capital infusion in the current market to avoid a loan default and foreclosure. PACE financing has emerged as a popular solution to provide capital to fund senior loan debt service, pay down senior loan principal balances, fund renovations and brand conversions, and in some circumstances, where the property owner has substantial equity, to fund new construction.
Again, click here to register for HOTELS Opportunities Conference on March 31.