Why You Should Continue to Pay Attention to PACE

Michael Polentz, co-chair of the real estate and land practice group at Manatt, Phelps & Phillips LLP

PALO ALTO, CA—As commercial property owners and tenants continue to seek sustainable building designs that incorporate energy efficiency or green building features, Property Accessed Clean Energy (PACE) financing will continue to receive more attention, and rightfully so. That is according to Michael C. Polentz and Ann Levin . Polentz is co-chair of the real estate and land practice group at Manatt, Phelps & Phillips LLP , located in the Palo Alto, CA office. Levin is an associate in the group, and is located in the San Francisco office. The views expressed in the column below are the authors’ own. With the increasing population, growing number of businesses, and finite amount of developable land, sustainable building designs are not a trend, but rather are an important design component that is here to stay. PACE financing is a mechanism or tool that encourages property owners to adopt sustainable building designs. (By way of example, an approximately 28,000-square-foot office building in Anaheim, California recently used PACE financing to install solar panels.) Although there have been many articles written about PACE and its potential benefits, this article explains why property owners and mortgage lenders should be thinking about PACE financing even before any sustainable building designs or upgrades are actually identified. Although collected with property taxes, PACE financing derives from contractual assessment bonds and has priority over other liens. PACE financing can be used to fund green or energy efficient upgrades to a property. The most commonly thought of upgrade is the installation of solar panels, but PACE financing may be used to install water conversation or efficient improvements, electrical vehicle charging stations, insulation upgrades, and window and door upgrades. The repayment terms vary and can range from five to twenty years, and ***if a property owner later elects to sell the property that is subject to PACE financing, the new owner assumes the repayment obligations (through the property tax payments). In California, CaliforniaFirst, a public/private financing program that allows building owners to receive upfront funding for energy efficiency, renewable energy and water saving improvements, is considered the largest PACE program participant. California First is growing rapidly in the California marketplace and currently administers a PACE finance program in multiple counties, including Alameda, Contra Costa, Marin, Monterey, Napa, San Francisco, San Mateo, Santa Clara, and Sonoma. For property owners, the incentive to incorporate sustainable building components or upgrades is driven by the potential to increase the value of the property, to reduce operating costs and to attract the best tenants. However, that drive may be mixed with a reluctance to invest in sustainable improvements if the economic benefits cannot be readily realized. Specifically, although incorporating energy efficient construction materials or equipment into a building may attract a particular type of tenant, in most cases the tenant, and not the property owner, will be the one that readily realizes the savings from the reduction in their water bill, energy bill, or other savings created by the sustainable designs. Moreover, the initial capital costs associated with the usage of such materials or equipment to the property owner may not be recoverable from a tenant given that most commercial leases allocate capital improvements to the landlord. To bridge this gap, PACE financing better aligns the landlord-tenant incentives associated with sustainable designs. PACE financing covers portions or all of the purchase and installation costs while repayments are collected with property taxes and other assessments; this allows commercial property owners to pass the costs associated with sustainable upgrades onto the tenants over a period of years as property taxes under the common triple net (NNN) lease structure. Although tenants may pay portions or all of the financing costs under the PACE programs depending upon the applicable lease terms, they also will reap the benefits of lower utility bills. Such savings over the term of a lease achieve a net savings to most tenants. Given the benefits of PACE financing to both tenants and property owners, commercial property owners should be forward thinking and consider PACE financing early on when they are financing or refinancing a property. This is true even if the property owner has not yet identified the sustainable improvement associated with PACE financing. Discussing PACE financing with mortgage lenders before the mortgage is in place allows the property owner to seek and obtain any necessary mortgage lender consents that may be associated with PACE financing later on down the road. Similarly, due to the priority status of the PACE financing, lenders financing or refinancing a property should ask whether the property owner desires to later use PACE financing for sustainable improvements. Lenders can then set controls such as, in addition to other applicable PACE requirements being met, limiting the PACE financing amount to a certain percentage of the assessed property value. Approaching the subject early on is more efficient for both parties as it allows for any necessary reviews or underwriting to be done during the financing or refinancing due diligence phase. As more property owners and/or tenants start to think about sustainable design improvements, commercial property owners will continue to approach more and more lenders about PACE financing. For the reasons noted in this article, property owners and lenders should however be more proactive in assessing the future likelihood of PACE financing for a project and building. By addressing the future needs in existing financing documents, both sides will be well served and avoid unnecessary delays in having to re-work transactions to accommodate PACE financing when the opportunity presents itself.