Recent legislation and increased upward activity in the commercial property assessed clean energy (C-PACE) market indicate lender's consent remains key to net-zero, carbon emission funding, according to DBRS Morningstar.
Advocacy nonprofit PACENation reported that more than 300 institutions have provided lender's consent for C-PACE projects year to date, bringing the cumulative C-PACE financings total to $3.4 billion, with another $700 million expected to close by the end of 2022.
A fresh incentive came in August with theInflation Reduction Act of 2022, which will offer up to $369 billion in federal funds to clean energy and climate friendly initiatives, including property upgrades.
C-PACE financing can be a major factor in funding locally mandated energy efficiency and net zero carbon initiatives, note DBRS analysts Kevin Augustyn, senior vice president, North American CMBS, and Stephanie Mah, senior vice president, Global Structured Finance, in a report "Climate Goals of the Inflation Reduction Act May Spur Interest in C-PACE, Lender's Consent in Focus as Market Grows.".
How PACE works
PACE financing uses borrowed capital to pay upfront costs associated with energy efficiency or renewable energy improvement projects, then repays the loan with property taxes.
If a property owner subsequently defaults on a commercial or residential PACE payment, only the overdue amount is owed, hence "there is no acceleration of the PACE lien… a significant factor in helping senior lenders provide consent," analysts wrote.
However, lender's consent in commercial PACE financing is not exactly the same as in residential PACE.
A residential PACE obligation has the super senior position over a mortgage loan, which is why the Federal Housing Finance Agency prohibits Fannie Mae and Freddie Mac from buying mortgages with PACE assessments.
A credit positive with risks
DBRS views the lenders' consent requirement in C-PACE as a credit positive because it ensures the financing, which is senior to the mortgage loan, will not create an event of default under the mortgage documents.
Lender's consent mitigates potential mortgagee disapproval concerns if a borrower considers C-PACE financing invalid or a violation of constitutional rights, the report notes. It also helps property owners "avoid fines and penalties that would significantly affect project cash flow and value."
Secondary market investors could face not-so-obvious risks, explained Kevin Augustyn, senior vice president, North American CMBS at DBRS, co-author of the report.
"C-PACE financing used as part of a capital stack for new construction or gut rehab" might expose the investor to development or construction risk, said Augustyn, especially in an inflationary environment when escalating costs could throw off the budget, and supply chain disruptions could stall construction, jeopardizing deadlines.
Glitches and incentives
While industry advocacy groups see receiving a lender's consent prior to recording a C-PACE as a best practice, it is not mandatory.
DBRS found lender's consent typically is required in new construction projects. Only two major C-PACE originators have required lender's consent in all their C-PACE financings to date.
Legislation should accelerate property owners' interest in C-PACE financing, said Stephanie Mah, senior vice president, global structured finance at DBRS, co-author of the report. State legislation and localities strategizing how to combat climate change may mandate lender's consent, Mah added.
DBRS expects PACE-enabling legislation now active in 38 states and D.C., to expand over time.
