PACE Financing – Everything You Need to Know
April 24, 2020
As ocean levels and temperatures rise, the U.S. population is increasingly interested in environmental stewardship. One aspect of this interest is an openness to clean energy sources that are renewable and efficient. The Property Assessed Clean Energy (PACE) program addresses commercial (C-PACE) and residential (R-PACE) renewable energy installations and upgrades. In this article, we’ll answer what is PACE financing and how does PACE financing work. It’s important to understand the pros and cons, C-PACE vs R-PACE, and the PACE financing tax deductible. In addition, we’ll sample PACE financing programs in a few states.
What is PACE Financing?
What is PACE financing? A PACE loan finances energy-efficient additions/upgrades to commercial and residential properties. The program initiated in 2010 and the U.S. Department of Energy oversees it. However, it is state and local governments that provide the loan funds to eligible properties. Thirty-nine states have enabled C-PACE financing and at least 20 states are operational. Three states (Missouri, Florida, and California) have R-PACE programs. Governments (including municipal financing districts and state agencies) can finance PACE programs via bond offerings. Alternatively, private lenders can provide PACE funds as well. Sponsors may package and securitize PACE bonds. In some cases, these securities receive green certification.
Video: What is PACE Financing
C-PACE vs R-PACE
Some differences arise between commercial and residential PACE programs that affect adoption and implementation. Both types have in common that the loan attaches to the property rather than the owner. However, there are three main differences.
- Income Creation: C-PACE applies to income-generating properties (commercial properties which of course includes multifamily (5+ residential units)), either through lease payments or profit-sharing arrangements. R-PACE applies only to residential properties (what is commonly known as residential 1-4, SFR, duplex, triplex and fourplex).
- Lender Notification and Consent: Existing property lenders must receive notification and give approval for C-PACE financing in most states. This is important because C-PACE loans displace other liens. Normally, R-PACE loans don’t require consent from the mortgage lender.
- Underwriting: Typically, C-PACE financing requires stricter underwriting standards.
How Does PACE Financing Work?
How does pace financing work? There are many ways you can use PACE financing to improve your property’s energy efficiency. Some examples include:
- Installation of solar equipment.
- Seismic retrofitting in earthquake zones.
- LED lighting.
- Energy-efficient roofs.
- Building envelope improvements (insulation, sealing, etc.).
- Water conservation.
- Hurricane preparations.
To see how pace financing works, we must identify the participants in the PACE market.
The participants in the PACE market include:
- PACE Administrator: Manages a PACE project and enforces observance of the program requirements. Sometimes, the local government directly administers the program.
- Local Government: The local tax authority collects PACE payments when collecting property taxes. It forwards the payment to the PACE funding source.
- Contractor: The contractor or energy services company performs the work, installs equipment, etc.
- Property Owner: This is either the homeowner for an R-PACE loan or the landlord for a C-PACE loan. It can include tenants working in cooperation with the landlord.
- Funding Source: The lender can be a private investor, bondholder, or government entity. It can be a mix of two or more sources, or a single-source turnkey program.
Program Set Up
In general, these are the steps necessary to set up a C-PACE program:
- The state legislature enables C-PACE program.
- The managing state or local entity makes basic decisions regarding a new C-PACE program.
- The entity creates program guidelines that supplement enabling legislation.
- The entity selects an administrator and initiates the program.
- Localities join program or start their own.
Project Approval and Financing
- The program administrator approves a project request.
- The local government entity assesses property tax.
- The financing entity funds the project.
- A PACE-eligible contractor completes the project.
- The property owner pays for project via tax assessments.
- The tax collector passes the PACE payment to the lender.
Your property collateralizes PACE loans. The loan balance transfers to a new owner if you sell the property before completing repayment. PACE financing has a few unique features:
- No Down Payment: PACE financing requires no up-front down payment.
- No Monthly Payments: You do not pay a regular monthly amount.
- Repay Through Assessments: You repay PACE financing through property assessments in addition to your real estate property taxes. The loan agreement specifies the assessment period in advance, typically 5 to 30 years based upon loan amount. You’ll be liable for penalties if you fail to repay your assessment on time.
- FHA Mortgages: As of July 2016, the FHA began insuring mortgages that include liens from PACE loans. In this case, you repay PACE loans with your usual property taxes via escrow.
C-PACE projects may need to achieve a minimum energy savings, as measured by the savings-to-investment ratio (SIR). In some cases, you can receive exemption from certain SIR measures. Also, you can improve your SIR by grouping together low-return and high-return measures. In addition, some programs enforce a maximum loan-to-value limit.
Pros and Cons
Evaluate the pros and cons of PACE financing before applying.
- You can finance 100% of the energy improvement with terms up to 30 years, thus providing lower annual payments. This frees up capital for other uses.
- Some property owners can deduct payments from their income tax.
- You don’t need to make a down payment or monthly payments.
- Underwriting for these loans is minimal as compared to typical bank financing.
- PACE financing doesn’t preclude FHA mortgages.
- States may allow you to use PACE financing to pay some new-construction costs.
- The loan is non-recourse (no personal guarantee required) to the borrower and attaches to the property. In other words, the loan is transferable to a new buyer.
- PACE financing can also finance power purchase agreements and leases.
- C-PACE financing may be on-balance sheet or off-balance sheet (but check with your accountant).
- Cities can reduce greenhouse gas emissions and increase the use of renewable, energy-efficient sources. This requires no liability on the city’s funds, as finance comes from bonds and private lending.
- PACE projects create jobs and spur local economic development.
- PACE programs are opt-in, so only participants pay for them.
- Tax incentives lower net project costs.
- You can benefit from lower utility costs, better air quality, and more comfortable interiors.
- Your credit score isn’t an important consideration.
- PACE disclosures may be weaker than those accompanying traditional loans. However, some states (e.g., California) require similar disclosures.
- You cannot finance portable items (like appliances).
- Currently, PACE is not available in all states.
- Typically, your interest rate exceeds that for a traditional mortgage by 2 to 4 percentage points. Additionally, you must pay about 4%, or slightly more, in administrative fees, which may surprise you at closing if undisclosed in advance.
- PACE financing tax liens take priority over other lien-holders, who may object if notified in advance. This is not a problem for C-PACE loans which require pre-notification as long as the mortgage lender approves.
- State and/or local governments control the program, which gives them considerable discretion as to who receives approval. This can invite corruption.
- A high credit score doesn’t necessarily help you get PACE financing. Rather, acceptance depends upon timely mortgage and property-tax payments. You may not be eligible if you had a recent bankruptcy.
- Loans are limited to individual properties, complicating portfolio-wide initiatives.
- You may be able to get PACE financing even if you can’t afford to repay it. You may end up in financial difficulties including delinquency, default, and foreclosure.
- PACE contractors may understate financing costs, saddling property owners with higher-than-anticipated assessments.
Reasons Why Mortgage Lenders Would Approve a PACE Loan
Normally, banks or other existing mortgage providers must approve a PACE loan. Even though past-due payments have the same priority as tax payments, banks have good reasons to approve PACE loans:
- No Acceleration: Only the past-due portion of a defaulted PACE loan are senior to the mortgage lender’s lien. The PACE lender cannot accelerate future payments, which maintain the same priority as that of the mortgage lender.
- Foreclosure Rights: Senior mortgage lenders can foreclose on defaulted loans without regard to PACE loans. In other words, PACE loans don’t restrict, prevent, or impact a foreclosure by the senior lender.
- Required Escrow: Frequently, mortgage lenders can require that the property owners deposit monthly escrow for PACE loans. This helps to mitigate default risk.
- Collateral Appreciation: A PACE project can improve the value of the underlying property. That is, the savings-to-investment ratio is greater than 1.0. This reduces a building’s operating costs, boosting NOI and valuation. The higher value benefits the mortgage lender by reducing default risk.
- Immediate Funding: The borrower receives the full PACE loan amount at closing. That allows the project to commence immediately. The funds deposited in escrow, from the beginning, reassure the mortgage lender.
Is PACE Financing Tax Deductible?
Is PACE financing tax-deductible? Subject to certain restrictions, homeowners can deduct their R-PACE payments from their income tax liabilities. These are not deductible real estate taxes.
The situation is more complicated for C-PACE loans. If the building owner owns the energy improvements, the loan would qualify as non-recourse financing. The owner can depreciate the cost of the improvements and expense the interest costs.
However, if the building owner doesn’t own the improvements, then the C-PACE payments add to the annual real estate tax deduction.
In the end, total deductions are the same. But the first C-PACE option requires more time to recoup the capital expenditure, depending on the depreciation period.
The decision of who owns the energy improvements depends on the outcome of an eight-factor test of burdens and benefit. In addition, the facts and circumstances of each case are important. The eight tests are:
- Who has legal title?
- How the parties treat the transaction.
- Was equity in the property provided?.
- Whether the contract establishes a current requirement for the seller to execute and deliver a deed.
- Who pays the property taxes?
- Whether the purchaser gets the right of possession.
- Who undertakes the risk of property damages or loss?
- Who gets the profits from the property’s operation and sale?
PACE Loans by State
Florida PACE loans are increasing throughout the state, under Section 163.08 of the Florida Statutes. The statute includes improvements for renewable energy, energy efficiency, and wind resistance programs. These cover impact doors and windows, rooftop solar systems, insulated siding, awnings, energy-saving air-conditioning systems, hurricane-resistant roofing, and more.
Florida has 31 counties that have enabled PACE legislation. Example PACE lenders include:
- Florida PACE: An interlocal agreement between Flagler County and the City of Kissimmee.
- Sarasota County: The county has approved four PACE programs. They are YGrene, Renew Financial, FortiFi, and PACE Equity.
- Martin County: Approved programs include YGrene and Renew Financial.
- Florida Renewable Energy District: Includes Berkadia, CleanFund, Dividend Finance, Renovate America, and Twain Financial Partners
- The Florida Resiliency and Energy District: Includes Greenworks Lending, Lever Energy Capital, Rahill, Structured Finance Associates, and PACE Funding Group
- Florida Green Finance Authority: Includes Renew Financial
- Clean Energy Green Corridor PACE District: Includes YGrene
As of January 1, 2019, the California Department of Business Oversight (DBO) regulates the state’s PACE industry. Also, it licenses PACE program administrators in the state, as authorized under California AB 1284 and SB 242 legislation.
The California Statewide Communities Development Authority (CSCDA) began in 1988 under the state’s Joint Exercise of Powers Act. It encompasses more than 500 counties, cities, and special districts in California. CSCDA oversees the Open PACE program, which provides turnkey resources to property owners. Open PACE lenders provide 100% funding, prequalified program administrators, and repayment through property tax bills.
California licenses the following five PACE Program Administrators:
- Renovate America
- Renew Financial Group
- Pace Funding Group
- FortiFi Financial
- Ygrene Energy Fund
The California State License Board licenses the following two entities:
- PACE Solicitor: An organization authorized to solicit property owners to partake in a PACE financing agreement.
- PACE Solicitor Agent: An individual working for or on behalf of a PACE solicitor, typically a home improvement salesperson.
The New York State Energy Research and Development Authority (NYSERDA) provides a guidance document for C-PACE programs. The state makes PACE financing available through the Energy Improvement Corporation’s Energize NY OPEN C-PACE program (EIC). EIC is a New York State non-profit, local development corporation. Municipalities must join EIC by passing a local law authorizing PACE offerings.
The EIC approves the following capital providers:
- Counterpointe Energy
- Dividend Finance
- Greenworks Lending
- Lever Energy
- LordCap PACE
- PACE Loan Group
- Petros PACE Finance
- Twain Financial Partners
- White Oak
How Assets America® Can Help
Assets America® arranges C-PACE financing starting at $5 million. We do not provide R-PACE loans. Please contact us to discuss your C-PACE project anywhere in the United States at 206-622-3000; info@AssetsAmerica.com.
Frequently Asked Questions
How do I renew a PACE loan?
A PACE loan stays with the property. That means if you sell the property, the buyer will assume the loan balance. However, the buyer can apply for additional financing, but approval is up to the lender.
What do people have to say about PACE financing?
Generally, investors give high marks to C-PACE loans because they require complete disclosure of fees. R-PACE borrowers are sometimes surprised by fees that lack adequate disclosure. Consequently, PACE loans are popular because they don’t need a down payment.
What is the largest PACE financing project?
The largest PACE financing project was a $40 million joint financing from two Commercial PACE Capital sources. The project allowed a California hospital to receive a complete seismic retrofit.
What’s the difference between Hero and PACE?
HERO stands for Home Energy Renovation Opportunity. It is an R-PACE program that Renovate America developed in partnership with the Western Riverside Council of Governments. Importantly, greater than 85% of Californians can access the HERO program.