According to DBRS Morningstar, recent legislation and increased bullish activity in the commercial property rated clean energy (C-PACE) market indicate that lender consent remains the key to zero emissions financing. of carbon.
Advocacy nonprofit PACENation reported that more than 300 institutions have provided lender consent for C-PACE projects so far this year, bringing the cumulative total of C-PACE funding to 3. $.4 billion, with an additional $700 million expected to close by the end of 2022.
A new incentive came in August with the Cut Inflation Act of 2022, which will provide up to $369 billion in federal funds for clean energy and climate-friendly initiatives, including real estate improvements.
C-PACE funding can be a major factor in funding local energy efficiency and net-zero carbon initiatives, note DBRS analysts Kevin Augustyn, senior vice president, North American CMBS, and Stephanie Mah, Senior President, Global Structured Finance, in a report “Climbing Inflation Act Climate Targets May Drive Interest in C-PACE, with Lender Consent Central to Market Growth.”
How PACE works
PACE financing uses borrowed capital to pay for the upfront costs associated with energy efficiency or renewable energy improvement projects, and then repays the loan with property taxes.
If a homeowner subsequently defaults on a commercial or residential PACE payment, only the overdue amount is due, so “there is no acceleration of the PACE lien…an important factor in helping senior lenders give their consent,” the analysts wrote.
However, lender consent in commercial PACE financing is not exactly the same as in residential PACE.
A residential PACE bond has the super senior position on a mortgage, which is why the Federal Housing Finance Agency prohibits Fannie Mae and Freddie Mac from buying mortgages with PACE ratings.
A positive credit with risks
DBRS considers the lender consent requirement in C-PACE to be credit positive because it ensures that the financing, which is senior to the mortgage loan, will not create an event of default under the mortgage documents.
Lender consent mitigates potential issues of mortgagee disapproval if a borrower considers C-PACE financing to be invalid or a violation of constitutional rights, the report notes. It also helps landowners “avoid fines and penalties that would significantly affect cash flow and project value.”
Secondary market investors could face some not-so-obvious risks, explained Kevin Augustyn, senior vice president, North American CMBS at DBRS, who co-authored the report.
“C-PACE financing used as part of a capital stack for new construction or gut rehabilitation” could expose the investor to development or construction risk, Augustyn said, particularly in an inflationary environment where escalating costs could disrupt the budget and supply chain disruptions could stall construction, jeopardizing timelines.
Problems and incentives
Although industry advocacy groups consider obtaining a lender’s consent before registering a C-PACE a best practice, it is not required.
DBRS has found that lender consent is generally required in new construction projects. To date, only two major C-PACE originators have required lender consent for all of their C-PACE financings.
The legislation is expected to accelerate landowner 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 developing climate change strategies may require lender consent, Mah added.
DBRS expects PACE enabling legislation, now active in 38 states and DC, to expand over time.