Optimizing Capital Stacks with C-PACE Financing

Today’s Thesis Driven is a guest letter from Laura Rapaport, founder and CEO of North Bridge, a national real estate lender and servicer.

C-PACE is an often misunderstood but highly beneficial financing option in commercial real estate today. While C-PACE has been around since 2008, institutional real estate owners and their lenders have started to take note of its potential amid the current uncertainty in the market.

Having spent my career in capital markets and development at firms like Lehman, Tishman Speyer, and L&L, I have structured creative capital stacks for some of the most ambitious real estate projects. However, I had never encountered C-PACE until I came across it while exploring financing options for my own portfolio. Initially, it seemed like a niche product limited to small scale clean energy improvements. But as I examined it in the context of traditional capital stacks, I realized I was mistaken. Now at North Bridge, I work daily with borrowers, lenders and brokers to leverage C-PACE to meet capital needs while supporting the integration of sustainable improvements.

Although C-PACE requires some additional steps, such as obtaining lender consent and meeting certain local eligibility requirements, it enables real estate sponsors to lower their cost of capital and increase access to proceeds by unlocking an additional source of private capital. 

Despite its potential, I have found that there are many misconceptions about how C-PACE works. In this letter, we'll delve into C-PACE and cover:

• The fundamentals of how C-PACE works;
• Real-world examples of C-PACE in action; and
• Challenges and considerations when using C-PACE

C-PACE and Sustainability 

C-PACE, which stands for “Commercial Property Assessed Clean Energy”, was initially developed to incentivize developers to make property investments in energy efficiency, water conservation, resiliency, and renewable energy. In practice, C-PACE can be broadly applied to cover a wide range of construction costs that are already included in new development and retrofit projects. 

Most high-quality institutional buildings have already incorporated many elements that count towards C-PACE eligibility. Notably, C-PACE can be used for up to 40% LTC of an entire construction project or 100% of hard and softs costs for eligible features. In a renovation, if the new systems are more efficient than what was there before–and they usually are–they’re probably C-PACE eligible. Most borrowers and lenders are unaware that their project or a portion thereof already qualifies even if they are neither net zero nor passive house.

The list below highlights some elements that may qualify and is exemplary, not exhaustive.

Energy efficiency features:

• High-efficiency HVAC systems
• LED lighting and controls
• Building automation systems
• Improved insulation and air sealing
• High-performance windows and doors
• High performance building enclosure (curtain wall)
• Elevators and escalators

 Renewable energy systems:

• Solar photovoltaic (PV) panels
• Solar thermal systems
• Wind turbines
• Geothermal heat pumps

Water conservation measures:

• Low-flow plumbing fixtures
• Rainwater harvesting systems
• Greywater reuse systems
• Smart irrigation controls

Resiliency measure:

• Seismic retrofits (even if required by code)
• Hurricane-resistant windows and doors
• Flood mitigation measures
• Backup power generation

Other sustainable features:

• Electric vehicle charging infrastructure
• Green roofs and cool roofs
• Energy storage systems

The particulars of what can be financed vary state by state. Over time, states like Florida, Washington, Tennessee and Nevada and others have created or amended their statutes to expand the list of eligible improvements and make C-PACE more accessible and user-friendly.   

Typically, the program is run by public or non-profit C-PACE program administrators who review the projects for compliance with eligibility requirements while leaving the negotiation of project financing terms to qualified lenders such as North Bridge who are authorized in those markets. 

The capital for the loans is all private capital and not from the government nor subject to government approval of financial details. Unlike programs like New York’s 421a tax abatement that had an expiration date, C-PACE is a permanent program.

How C-PACE Works: The Nuts and Bolts

C-PACE is a form of low-cost, long-term, fixed-rate financing secured by a voluntary special assessment on the property that is repaid alongside property taxes. It is both flexible and highly structured. The financing is non-accelerating and attaches to the property, not the owner, meaning it transfers upon sale, and is also fully pre-payable. 

Although the financing technically has a 20-30 year duration, it should be viewed by borrowers and lenders as having a shorter duration with the option for a longer-term hold. The reason is that C-PACE can be pre-paid at any point in time; however, there is never a balloon payment due. This enables C-PACE to be structured around other lenders in the capital stack and can create synthetic maturities to match term with the desired business plan of a borrower and its senior lender. C-PACE can be taken out upon a refinancing or a sale or can be kept on and used as seller financing. The lack of leasing, financing, or sale approval rights creates a positive arbitrage for the other lenders in the stack given the ability for C-PACE to act as leverage with limited rights. As an assessment, C-PACE can often be passed through directly to tenants especially in a triple net transaction. 

Some key features of C-PACE financing include:

• Loan amounts up to 20-35% of appraised stabilized property value
• 20-30 year terms with ability to be taken out at any point
• Rates currently ranging from 10yT + 300-450 fixed at inception
• Capitalized interest period of up to 5 years before payments begin
• Interest only periods of up to 10 years (in most markets)
• Fully amortizing over the term with flexible structuring in most markets 
• Non-recourse to the property owner
• Priority repayment akin to property taxes
• Annual call protection that burns off over time with no yield maintenance or lockout provisions

C-PACE can be used to finance any commercial property type, including data centers, industrial facilities, hotels, multifamily and office-to-residential conversions. Non-profit institutions can also qualify for C-PACE. 

In many states, C-PACE allows for a one to three year look-back from TCO (Temporary Certificate of Occupancy) on completed improvements. That means C-PACE financing can be placed on a property retroactively, making it a great solution to replace more expensive financing, as a bridge to permanent financing, acquisition financing, seller financing or as a way to have a passive liquidity injection in today’s capital-constrained market.

C-PACE in Action

In a Thesis Driven letter a few weeks ago, Brian Carrico and Collin Bibb, Co-Founders of Byways Hospitality, shared how they used C-PACE as part of creative capital stacks. Here are several more examples of how we leveraged C-PACE to address a developer’s needs:

• Unlocking Additional Liquidity: We worked with the developers of Snow Pine Lodge in Alta, Utah to provide $19.5M retroactive C-PACE financing as part of a loan extension and modification. The construction of this 5-star hotel already incorporated significant energy efficiency and resiliency measures prior to even considering C-PACE as an option. The inclusion of those features in the design created the opportunity for the developers to utilize the C-PACE to pay down the existing lender and blend and extend thereby allowing for a better path to stabilization for both the borrower and lender by increasing reserves and liquidity at the property.
• Renovations for Sustainable Growth: Sunny Isles Beach, Florida had yet to do a C-PACE deal when the owners of the Newport Beachside Hotel & Resort in Sunny Isles Beach, Florida secured a $42.7M C-PACE loan as part of its major renovation and repositioning. Proceeds are going to fund upgrades like new HVAC, low-flow plumbing, impact glass, and a seawall restoration. C-PACE ultimately financed the renovations to the hotel’s pool and beachfront amenities.
• Reducing Overall Cost of Capital: The Battery is a mixed-use redevelopment in Philadelphia with $26.6M of retroactive C-PACE proceeds as part of a construction loan modification at temporary certificate of occupancy. The financing provided additional capital to reduce the at-risk dollars for the existing senior lender and reduced the weighted average cost of capital for the Qualified Opportunity Zone project for the borrower.

Supersized C-PACE Deals on the Rise

Mega-deals are becoming more common, with several recent transactions exceeding $100 million. Over $7 billion has been funded to date across more than 3,100 C-PACE projects, with major acceleration over the last two years and that is just scratching the surface of the overall opportunity. The more comfortable sophisticated lenders and sponsors have gotten with the inner workings of doing a C-PACE deal, coupled with the inflationary capital markets environment, the larger the deal sizes have become and the more users have adopted C-PACE as part of their capital stacks.

Supersized C-PACE loans are now funding ground-up construction and gut rehabilitations of large-scale mixed-use, hospitality, and industrial projects. In one of the largest transactions to date, The Black Desert Resort project in southern Utah used $153 million in C-PACE proceeds as part of the $820 million, 580-acre resort development. The deal was heralded as an indicator of “the growing acceptance of C-PACE as a mainstream financing mechanism for developers and owners seeking enhanced returns on capital and speed to close while investing in critically important sustainability initiatives.”

In Oakland, California TMG Partners secured $172 million in C-PACE for upgrades to the company's headquarters building. Originally built in the 1960s, the proceeds will be used for a full HVAC system overhaul, envelope sealing to enhance energy efficiency, water conservation measures to reduce water consumption, and a complete seismic retrofit, ensuring the building's resilience and safety, while creating an effective roadmap for similar office buildings across the country to modernize. Today’s flight to quality in the office market has made these types of upgrades even more urgent as tenants focus not only on the energy efficiency of the buildings they occupy, but also on their comfort, air quality and operating expenses.

Challenges and Considerations with C-PACE

While C-PACE offers compelling benefits, there are some potential drawbacks and challenges to consider:

• Lack of Standardization: The programs vary state by state and are implemented at the municipal level. In a state like Nevada, up to 35% of the loan-to-value can be financed for all improvements meeting the 2018 IECC Energy Code. In New York, a property owner must meet a strict savings-to-investment ratio, limiting both the types and scope of C-PACE financeable construction. National organizations like the C-PACE Alliance and PACENation work to increase standardization and adoption of best practices nationwide.
• Lender Consent: The mortgage holder must consent to the C-PACE assessment which can be a hurdle if they are unfamiliar or uncomfortable with the structure. Early conversations with senior lenders are important for borrowers considering C-PACE. As its utility has become more obvious and lender comfort with the product grows, some senior lenders are seeking out C-PACE as a possible liquidity solution to be used to reduce their at-risk dollars on an existing transaction or to act as leverage in lieu of a warehouse line or A-note.  Most lenders are unaware of how many of their competitors (regional banks, commercial banks and debt funds) have already consented to C-PACE or are actively working with the product to their benefit. 
• Additional Time: Because C-PACE requires an assessment to be placed on the property, some level of interaction with a program administrator and/or a local authority is required.  While the municipal approval is often several weeks long, it is run in parallel with the diligence and documentation process and does not affect the terms of the deal agreed to with the capital provider at the term sheet stage. This additional time means that C-PACE cannot close in less than 30 days and could take additional time. Transparency in timeline and alternatives from a C-PACE lender is key to a successful transaction.

Despite these challenges, C-PACE continues to gain traction as more stakeholders become comfortable with the unique structure and recognize its economic and environmental advantages. Experienced C-PACE program administrators and private C-PACE capital providers can help navigate the nuances and execution.

The C-PACE Opportunity

C-PACE is quickly gaining traction as more property owners, capital providers, and municipalities realize its potential as a tool to fill financing gaps, reduce cost of capital, and achieve long-term sustainability objectives. Savvy players are moving quickly to capitalize on this emerging opportunity. For property owners, C-PACE provides a unique structure that is more flexible and lower cost than mezzanine debt or preferred equity. For lenders, C-PACE can reduce risk and provide time to help struggling projects reach stabilization. For cities, it is a way to enable building owners to make the upgrades needed to reach ambitious climate goals.

—Laura Rapaport

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