In a market where escalating borrowing costs are making commercial real estate financings difficult, C-PACE specialty lenders are reaching out to banks and credit unions as potential partners to highlight their profit potential, with the hope that greater securitization activity in the sector will follow.
According to industry advocacy group PACENation, C-PACE closings rose to $1.5 billion in 2022 from $1.29 billion in 2021, bringing the cumulative 2009–2022 total to nearly $5 billion. At least one appeal to landlords is clear: C-PACE loans offer lower interest rates compared with mezzanine loans, preferred equity and commercial mortgages.
Lower rates alone, however, are not enough to power a boom in the C-PACE market. Non-bank lenders, private debt funds and investment managers such as CastleGreen Finance, North Bridge, Petros and Nuveen Green Capital dominate the space. To a much lesser extent several large banks—including Bank of America, JPMorgan Chase and Wells Fargo—have entered the C-PACE market. When they have, they've played secondary roles in C-PACE deals, industry professionals say.
That leaves enormous opportunities for community banks and credit unions to participate, and the partnerships offer potential for new ABS issuance, say industry professionals.
The appeal to banks and landlords
Adding C-PACE is a good way for commercial real estate borrowers to add funds to the capital stack and make deals work that wouldn't work otherwise, according to Randy Eckers, a real estate finance attorney at Reed Smith, an international law firm based in Pittsburgh, Penn.
It's not just that C-PACE loans have a reduced impact on a financed property's capital stack, Eckers said. Compared to interest rates on mezzanine loans and preferred equity that can run in the mid- to high teens, a C-PACE loan can carry an interest rate of around 6.5%-8.0% in today's environment.
Colin Bishopp, CEO of Allectrify, aims to increase the number of participating community-based lenders by making it simpler for financial institutions to issue C-PACE loans.
"C-PACE has very low credit risks for banks and is capital-efficient, since it allows flexibility on how the assets are held on the issuing bank's balance sheet," Bishopp said, adding that Allectrify standardizes the underwriting process for small banks across the U.S., and facilitates the trading of assets.
"Once there is scale for C-PACE in the banking sector, there will be a need to securitize those assets," Bishopp said.
Lenders are offering different models of C-PACE finance. Smaller banks and credit unions, for instance, can add C-PACE loans to their existing commercial lending facilities.
C-PACE loans also have several other characteristics that make them a relatively higher credit quality asset compared with CMBS, according to Ken Cheng, DBRS Morningstar's senior vice president of U.S. ABS global structured finance. The C-PACE loan-to-value ratio is lower than most other asset classes, the debt is senior to other mortgage loans and delinquencies to date have been low.
Unpaid C-PACE assessments are considered delinquencies, not defaults, so they do not trigger debt accelerations. Because the debt is a property assessment, the repayment obligation is attached to the land and is the new owner's responsibility, Cheng said.
Federal subsidies play a role in new opportunities, too, specifically President Joseph R. Biden's goal of retrofitting four million commercial buildings for energy efficiency. The initiative could put some $500 billion of liquidity into the industry, according to Mary Luévano, acting executive director of non-profit PACE advocacy group PACENation.
"Our $500 billion energy-efficiency retrofit estimate includes at least $100 billion for smaller projects costing under $1 million, which provides opportunities for community-based lenders to issue C-PACE loans for smaller retrofits," she said.
The solid foundations for C-PACE
Drivers for C-PACE include legislation for energy-efficiency measures and retrofits such as the Inflation Reduction Act (IRA) plus net zero commitments by large commercial real estate asset managers, said Kevin Fagan, a senior director at Moody's Analytics.
Banks hoping to fund C-PACE loans need to comply with state-level C-PACE legislation, which has been enacted in 38 states plus Washington, D.C. In 29 of these states, there are active C-PACE programs, Mike Centore, PACENation's director of market research, said. "A total of 40 community-based lenders have been approved in 15 of these 29 states," he said. "We've heard from C-PACE program administrators that they want to do more outreach in 2023 to community-based lenders and get them approved into their programs."
"C-PACE momentum is expected to continue as additional states enact or expand PACE-enabling legislation to address climate and resiliency initiatives," said Stephanie Mah, DBRS Morningstar's senior vice president, structured finance research.
One significant legislative expansion has been to allow the use of C-PACE for retroactively replacing existing but more expensive loans that were used for C-PACE-eligible improvements. Another is to allow C-PACE financing for new construction.
DBRS Morningstar expects the performance of C-PACE securitizations to remain stable in 2023.
John Kinney, CEO of C-PACE financing provider CleanFund, has a different approach to facilitating C-PACE loans. He works with partners—mainly smaller banks—that use their own capital to offer the loans.
"By topping up existing loans with C-PACE loans, they can reduce the weighted average cost of capital for borrowers and gain ESG credits," Kinney said. "They also contribute to the borrower's financial health by funding upgrades that lower utility bills and reduce future IRA non-compliance penalties."
The lending is structured as a single-project C-PACE micro-bond issued by CleanFund. These bonds are taxed as municipal bonds, paying federal but not state tax.
"I'll be the bank's C-PACE administrator, get an investment grade rating for the bonds, and offer securitization access if they chose to sell," Kinney said. "The average issue is currently $3 million, but the size of C-PACE bonds is growing, and I've arranged funding for much larger projects."
Bringing creative structures to C-PACE
Yet another model for C-PACE financing is used by PACE Loan Group (PLG), which holds its loans in debt pools on its own balance sheet. These pools are credit-rated by DBRS Morningstar and used as collateral for raising finance from insurance money funds. PLG's CEO Rafi Golberstein calls this arrangement a pseudo-CLO on the back end, where PLG is effectively warehousing the loans without the risk of mismatched duration or floating rates.
"The public securitization of C-PACE loans is emerging slowly, and there isn't much activity yet," Golberstein said. "However, C-PACE is increasingly developing a secondary market. As it grows and the true securitization market becomes viable, we'll interact more regularly with mainstream institutional investors who are buyers of mortgage-backed securities or other securitizations products."
C-PACE has done well recently when traditional lending sources slowed down, Golberstein said. "Another attraction is that, in a rising interest rate environment, PLG offers long-term fixed rate debt, often at lower rates than those available from equity or mortgage financing," he said.
