The outbreak of COVID-19 has had a devastating impact on commercial real estate.
Nationwide shutdowns of restaurants and non-essential commerce has curtailed traffic at retail shopping centers and malls. Hotels have had few tourists or business travelers checking in. Multifamily apartment buildings have tenants who experienced sudden job loss and are in need of rent forbearance – and are located in states like New York that have a moratorium in place on evictions.
These business interruptions are threatening a secondary ripple with lenders and investors in mortgage-backed securities that finance these properties.
For some of these properties, the halt in revenue has resulted in a stoppage in projects aimed at securing improved energy-efficiency standards and other green-friendly upgrades.
The disruption is creating an opportunity, however, for alternative finance sources to fill the gap. More specifically, the sponsors of property-assessed clean energy (PACE) financing in the commercial sphere.
Last month, an executive with Greenworks Lending penned a blog on a PACE industry trade-group Web site promoting commercial PACE programs as a potential stopgap for property owners and developers facing a sudden cash-flow crunch from the shutdown brought on by the coronavirus pandemic. Aaron Kraus, the vice president of market activation for Greenworks, wrote that commercial PACE programs in certain states have the capability of filling in “retroactively” for a property’s project costs.
“Commercial and multi-family properties that have recently had qualifying energy work done may find themselves with temporary financial challenges from a reduction in cashflow,” Kraus wrote. “In these cases, C-PACE can come in and help replenish a property’s reserves, provide liquidity for operational costs, and even potentially help other lenders in the capital stack reduce their exposure.
“For properties nearing completion, C-PACE can also offer funds for cost overruns and lender pullback, helping to fill that difficult gap,” he added.
Traditional lenders have taken a 90- to 120-day pause to assess the health of their portfolios, said Mansoor Ghori, CEO, co-founder and managing director of Petros PACE Finance, headquartered in Austin, Texas.
“Borrowers are saying ‘let’s figure out how to get these done,’ as they see other sources of capital drying up,” Ghori said.
For Petros, business is carrying on despite of the effects of COVID-19. The company last month announced a doubling of its available credit facility to fund projects through a consortium led by ING. Petros also completed its seventh privately rated securitization for an undisclosed client asset.
While the lending sector grapples with two overarching effects of containing the coronavirus outbreak — the tightening of available capital to support new lending and almost feverish demand from their customer base, C-PACE lenders have been able to carve out business and keep operating.
“One of the great things about our financing is we have not had to pull back, and we have not been subject to some of the capital calls that other lenders have been subjected to,” said Jessica Bailey, co-founder and CEO of Greenworks, headquartered in Darien, Conn. “We have got stable and committed capital that we are deploying in some of the same ways we have before.”
Retroactive C-PACE financing has come to the fore since outbreak responses have disrupted the regular cycling of capital through commercial buildings. This has been a good time for building owners to move on retroactive deals, says Bailey, especially since stay-at-home orders have kept tenants out of the buildings, pushing up vacancy rates and missed rents, or for building owners in the manufacturing sector, whose companies have seen a supply chain disruption.
“Our financing has been able to retroactively help finance what they would have paid cash for,” Bailey said, adding that building owners can also “pull a little equity from their buildings.”
Not all of the states with C-PACE programs (22 at the end of 2019) authorize retroactive funding, according to Greenworks’ Kraus. In addition, there may be locality differences on the rules (Prince George’s County in Maryland permits retroactive financing, but neighboring Montgomery County does not). “Further, the length of time can differ between markets,” he wrote. “In Michigan, the look-back period is 3 years. In Connecticut, that look-back is only 1 year.”
What makes C-PACE attractive for borrowers in the first place are the favorable rates and terms offered. C-PACE is a public/private financing tool that uses private capital to finance projects via annual or semi-annual property tax assessments by local governments that guarantee the financing. This results in property liens, which is a source of controversy for opponents of these types of loans (the Mortgage Bankers Association vehemently opposes PACE as a vehicle for residential energy upgrades, such as solar panels).
Last month, according to published reports, officials with a Colorado county opted out of the state’s C-PACE program with concerns taxpayers would be on the hook for a sports tourism complex being constructed with C-PACE funds. One of the Weld County commissioners voting to pull the county out told a local newspaper that “government shouldn’t be involved in a personal transaction,” he said. “You don’t need the government to do your collections.”
Nevertheless, Petros PACE’s Ghori says C-PACE holds much more potential than just as a sustainability tool until conventional sources of lending are revived, Ghori said.
“Tons of jobs are being created to finish these projects,” he said. Currently unemployed skilled workers are going to be looking for certain jobs that might not come back, but they might have a chance at finding work in an economy that prioritizes climate and green initiatives. “New York has passed several initiatives requiring property owners to upgrade their properties in a period of time. This will absolutely be a tremendous help to New York in its recovery from this pandemic.”
Heading into 2020, New York state and New York City were expected to be an epicenter of PACE activity, which in turn would spur growing levels of securitization, according to a research report from DBRS Morningstar.
C-PACE investment nationwide had reached about $1.5 billion through 2019, and almost half (49 percent) of those funds were invested in energy efficiency projects, according to data from PACENation, a non-profit, industry membership group that supports the expansion of PACE financing and provides research on PACE activity.
In its breakdown of C-PACE investment by state, PACENation found that California leads the industry, with $293 million in investments, followed by Ohio, with $241 million and Connecticut, with $144 million.
But last year, a law re-authorizing the state’s C-PACE program (Energize NY Open C-PACE) was passed out of Albany, followed shortly by a New York City Council act which aimed at reducing greenhouse gas emissions from city buildings via C-PACE financing. Both were expected to make New York the new king of PACE originations.
Last year, Cliff Kellogg, executive director of the C-PACE Alliance, said the city’s greenhouse reduction legislation could be a huge driver for originations. Some energy advocates think this is the wave of the future – to require greenhouse gas reductions and the financial means to comply, he said. “New York City is really at the cutting edge to show the potential of the C-PACE market,” Kellogg said last fall.
Those plans at the city level are temporarily stalled by the outbreak. The New York City Energy Efficiency Corp. which administers the PACE program has delayed its first acceptance period of applications, according to reports.
One example of the promise for the city and state programs was the state program’s financing of a large hemp/vegetable farm operation, Wheatfield Gardens, which was retrofitted to accommodate, among other commodities, the production of cannabis for the growing CBD market.
Around 2015, Wheatfield Gardens CEO Paal Elfstrum and investors sought to upcycle an old greenhouse that had previously produced tomatoes and cucumbers, and convert it to growing lettuce and medicines. As a consultant to cannabis and hemp growers previously, Elfstrum knew that the growing facility would have to be supplied with a lot of power, and much of that power would have to be generated onsite.
“Besides labor, energy will always be the biggest expense on a greenhouse or vertical farm balance sheet,” he said. “Therefore finding innovative ways to cut those costs is business imperative.”
Elfstrum said and his partners kept running into difficulty finding financing for the necessary conversions and upgrades, because the Wheatfield, N.Y.-headquartered company was a startup with no operating history.
“It seemed the only way they would lend you money is if you were willing to give a personal guarantee or had the money in the bank already,” Elfstrum told Asset Securitization Report in an email response.
Wheatfield’s access to C-PACE funding was made possible from the second iteration of Energize NY Open C-PACE in New York. In 2014, as the Energy Improvement Corporation (EIC), a local development corporation and state operated non-profit, PACE financing was first launched allowing clean energy financing via a property tax assessment. The EIC’s original Energize NY program was authorized to provide capital directly to commercial real estate borrowers.
The EIC’s former program quickly ran into a quagmire of difficulties. One particular issue was its closed nature. The entity appointed just one source of capital for all the financing that it extended to borrowers, the Bank of America, said Susan Morth, CEO of Energize NY, who worked at the EIC but was not the architect behind the original program.
“They couldn’t be securitized because the EIC was acting as a bank and was issuing bonds,” Morth said. “Those bonds were being purchased only by that money-center bank; that was Bank of America.”
The EIC did not run any credit checks on borrowers when underwriting the financing. It based underwriting heavily on the property’s condition and market value, Morth said. Borrowers paid high fees, such as an upfront fee of about 4.5 percent of the cost of the project. Also, the program charged an interest rate of over one percent, making the cost of funding more expensive less competitive. Another concept stymied the program: when municipalities joined the program they agreed to be contractually obligated to backstop PACE loans within their jurisdictions.
In 2018, the EIC scuttled its old program. In January, as the new CEO of Energize NY Open C-PACE, Morth began to rebuild the program from the ground up. Morth, believes that New York’s new program will bring positive revival to C-PACE financing in the state. “New York [PACE] is a good program going forward,” Morth said in an interview. “Previously, it was a closed program, as only the EIC had the capital. The differences are like night and day.”
The country’s largest cities are also putting PACE mechanisms into place. In December 2019, the Chicago City Council launched Chicago PACE. The self-financed program utilizes user fees and a city bond issue to provide start-up capital, according to the city’s planning and development office. Counterpointe Energy Solutions and Chicago-based Loop Capital Markets partnered to create Loop-Counterpointe PACE, the program administrator, and approved the first project in December. Prime Group got approval for $21.2 million to finance energy-related upgrades on a historic office building on LaSalle Street, as it becomes the 233-room Reserve Hotel, according to the Chicago Sun-Times.
