PACE: A Smart Way To Finance Retrofits For Energy Efficiency And Water Conservation

Suppose your company wishes to increase energy efficiency and reduce operating costs by retrofitting its existing properties. What if the retrofit costs could be paid without diverting funds from the company’s capital budget, impairing growth capital, reducing cash reserves or drawing on traditional credit sources? What if these costs could be financed through low-cost, long-term funding arrangements where the annual debt-service payments are less than the annual savings actually derived from the retrofits? It may sound too good to be true, but all of this is possible under PACE, the Property Assessed Clean Energy program.

PACE is an innovative, common-sense program that enables property owners to receive funding for energy-efficiency retrofits and water-conservation improvements. PACE financing is attractive because it enables property owners to avoid the high up-front cash outlays that are a common barrier to upgrades for energy efficiency and water conservation. Because the payback period may range from five to 20 years, conventional lenders often are reluctant or unable to make long-term loans to finance the upgrades.

Several different models of PACE financing have evolved, ranging from private-sector owner-arranged financing to funding mechanisms utilizing government-issued bonds. In all cases, the key to PACE funding lies in the nature of the collateral: PACE funding is secured by special-assessment liens voluntarily imposed on the property by its owner. In most cases, the liens are tantamount to, and have the same priority as, property-tax liens. For this reason, PACE loans are exceptionally safe investments for lenders and other investors. PACE loans also tend to be attractively priced for the borrower on account of their low-risk profile. Debt-service payments on PACE loans are collected by local taxing authorities as a separate line item on the property-tax bill and are then remitted to the holders of the PACE loans.

PACE financing transfers with any sale of the property so future owners assume the payments while continuing to receive the benefit of the positive cash flow derived from the energy cost savings. As a general rule, the consent of the holder of any first mortgage lien on the property will be required before applications for PACE financing are approved and assessments imposed on the property.

PACE programs exist by virtue of special enabling legislation at the state level. The first PACE program originated in California in 2007 and was successfully implemented, primarily with respect to residential property. In the summer of 2010, Fannie Mae, Freddie Mac and the Federal Housing Finance Agency (FHFA), Washington, D.C., moved to quash residential PACE programs. Specifically, FHFA, which was created in 2008 to regulate Fannie Mae and Freddie Mac, believes that PACE creates unacceptable risk for its regulated entities and has issued policies that prohibit Fannie and Freddie from underwriting mortgage loans on residential property with PACE loans. FHFA’s actions with respect to residential PACE programs have been widely criticized and challenged in several ongoing judicial proceedings, and federal legislation has been introduced that would override FHFA’s policy position. A discussion of these challenges is beyond the scope of this article, but suffice it to say that FHFA’s opposition to residential PACE programs had a chilling effect on all PACE programs.

However, as of this writing, almost 30 states and the District of Columbia have adopted some form of PACE legislation. But the statutory framework for structuring and administering PACE programs varies widely from state to state. A common thread in all PACE legislation involves authorization of special-assessment districts to be created at the local level for the purpose of financing energy-efficiency improvements. The legislation generally provides that local governments may prescribe the types of energy-efficiency improvements that qualify for PACE financing, as well as underwriting standards for the financing program.

About the Author

Stephen M. Block James C. Morriss III
Stephen M. Block is a partner in the Houston office of Thompson & Knight, where he represents clients in real estate and related transactions. James C. Morriss III is Thompson & Knight’s Austin, Texas, office leader and the firm-wide environmental law practice leader. Block and Morriss are actively involved in Keeping PACE in Texas, a non-profit business association organized to promote legislation that facilitates Property Assessed Clean Energy loans throughout Texas.

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