Let your building pay for its own seismic retrofit, or facelift.

Written by Landlord Property Management Magazine on . Posted in Blog

by Philippe Hartley

Alan Stone stands on the edge of the roof parapet, his 18-unit apartment building beneath him, arms akimbo and heels sunken into the blinding white of the brand-new surface membrane.  Workmen are affixing the last seams, but his eyes sweep the street 30 feet below, scoping the comings and goings of his tenants.  He’s been keeping turn-over low, intends to keep it that way.   It’s an hour drive here from his house in good LA traffic (which means never), and he’d like to see more revenue for the work. Eighteen months into this purchase the cash flow is still tight. He needs to scale up with another building but values are on fire, as far as his eye can see.

“Isn’t this beautiful?” screams the roofing salesman as he emerges from the top floor’s access ladder, “It’s a work of art… and this is going to kill your power bills!”  Stone catches him out of the corner of his eyes, his gaze focusing on a scene below.  “It better! I could have bought the Mona Lisa for what I’m paying here, and I like her more…”

He hears the pitch of a response from the sales guy but, across the street, two folks walking out of the building in animated conversation hold him transfixed and focused.  Traffic, dogs barking, distant sirens…it’s impossible to tell what they are saying, but Stone has a hunch. One of those folks is the top commercial agent in the area, and the other looks like a young version of the man who has owned that building for 25-years.  The two shake hands and stride off in opposite directions. 

Seconds later, Stone has the agent on the line.  A veteran sales pro, Darla Lee is quick to pick-up.  “Ha! Congratulations, Alan.  You are the first to know” she confirms his gut, “the family is selling.  The dad had a heart attack, snap, like that. Yeah, the kids are cashing out.  They don’t want to deal with the seismic retrofit, the tenants; ya know.” Alan pivots and bounces around the workers energetically as if needing to get nowhere in a hurry, then bites his lips to regain a poker demeanor.  Darla had sold him his property. She knows it had been a big financial lift at the time, and buyer’s credibility was needed here again.  Alan brings his voice to a resolved confidence. “I might be interested.”   Staying engaged, Darla probes. “Sure.  It’s an amazing opportunity, but it’s hot… will go fast.  You’d said you would be doing a lot of work on your building, so I didn’t think you were in the market.  There’s probably eighty grand of seismic work to do here, Alan, maybe more once you start. Do you think the timing is good for you, credit-wise?” 

Stone smirks.  He glances back over the roof at the three stories across the street. ”My access to capital is bigger than when you and I did this transaction, Darla.  And I don’t go to my credit facilities to improve my building, so I wouldn’t need credit for that retrofit either.”  Stone stops; the silence on the other side is pregnant with a question mark, so he drops the other shoe. “I put my equity to work.  I use Commercial PACE, Darla. Six percent money for 30-years.  So, I’m seismic-retrofit ready, Darla, see?  And now that I’ve told you the secret, I need you to sell me that building.”

A solicitous laugh returns over the cellular connection. “Wow…OK. Alright, I’m turning around. Let’s talk about your next acquisition, Alan.”

The scenario is Hollywood, but the situation is real.  In multi-unit ownership, it’s hard to grow value, maximize cash flow and keep a winning P&L, all with cash and credit alone. In an environment where city and state are imploring you to upgrade this, retrofit that, and enable such and such, it becomes especially challenging.

Multi-family building owners and managers have historically relied on “the juggle” for cap-rate maximization…timing the use of sacred cash and sacred credit for maintenance and capital improvements as well as portfolio growth.  Arguably the industry has done well with those two instruments alone.  But typically, an ambitious multi-family real-estate owner constantly faces the conundrum between keeping-up values in existing assets or taking advantage of acquisition availabilities.  And if you want to grow your portfolio, it means being financially pre-disposed to move quickly on opportunities as they come on to the market.  

Enter Commercial Property Assessed Clean Energy financing, or “C-PACE”. The program is the result of a social and political imperative to address issues critical to public welfare: issues of public safety, cost of (and access to) resources critical to quality of life, and significantly improved efficiencies in the use of natural resources. C-PACE is a form of private financing which is serviced (re-payed) through the commercial property tax collection system.  The fundamental mechanism goes back to our very foundation in the US: municipal bonds are sold for specific public benefit projects, then paid back through a property tax assessment.   PACE is a modern iteration of that mechanism. It provides a method for financing energy, water and structural infrastructure upgrades in California buildings that almost any property owner can have access to, independently of their credit situation.   

PACE is often called revolutionary because of the two essential mechanisms unique to it: the total reliance on available equity as the key criteria for providing financing, and the servicing of the debt via the levy of a special tax collected through the property tax, as has been done with Mello-Roos taxation in California for over 20 years.  

Per our opening story, C-PACE’s disruptive impact emerges from the expansion of the capital pool available to a qualifying property owner.  It’s not cash; it’s not credit; it is purely equity leveraging. The underwriting guidelines concern themselves only with identifying the

“unencumbered equity” of a property, not the owner’s financials or FICO, nor the corporation’s financials. Most C-PACE programs will fund contracts on eligible improvement for up to 20% of the current value of the property, so long as 20% of the equity in the property is free and clear.  Typically, for less than $750,000 transactions, that is the leading funding criteria.  So a $1million building will suddenly be able to use $200,000 for infrastructure improvements, for up to thirty years without the title-holder using their own cash or credit.

Keep in mind that C-PACE, like any other forms of financing, is offered by numerous competing entities, each with its preferred project profile, rates, terms, and program features.  So it’s wise to work with an entity that knows all the funders prior to committing to funding.

Here’s another new concept that C-PACE brings us: because the collection process for C-PACE funding is through a special tax, no “debt” line item will appear on a balance sheet (note; while this is generally agreed upon, the author is not providing tax advice and you should of course discuss this with your accounting professional).  Why is this a game changer?  Because it tips the scale in favor of the property owner.  It means that:

  1. Capital improvements can be financed on the value of existing equity without weighing down the Liability side of the balance sheet with additional debt, while…
  2. Improvements to buildings increase their value and strengthen the cap-rate, strengthening the Assets side of the balance sheet.
  3. That increased in Asset-side value, in turn, increases credit worthiness –  An increase of the Asset side with no negative impact on the liability side.

“What?” you ask.   “So, I can use C-PACE to increase the credit available to me while making improvements on my buildings?”  Indirectly, yes, so long as your improvements translate in asset value increase.

Property owners also inherit a key strategic additional advantage when they use C-PACE.  It leverages the county tax collection process for repayment, so you that the first financing payment is always several months behind the completion of the project.  Depending on when a project is completed, that lag will be somewhere between 5 and 16 months.  That’s long enough to establish a cost participation pass-through to tenants (where allowed) and start setting up a fund toward the first financing invoice.  

A key and critical by-product of that mechanism is “transferability”.  A change of title automatically transfers the obligation to continue paying the annual assessment to the new owner, and releases the previous owner of any such obligation (or the assessment can also be paid off).

We can end with this last feature of C-PACE that makes it a favorite for building managers and building owners alike: one simple underwriting process can fund many different improvements. The criteria is that the funds must be used for undertakings that will increase the building’s efficiency in water or electricity usage, in addition to the seismic retrofit.  The list of eligible improvements include everything from paint to solar panels, from windows to electrical modernization, from HVAC to artificial turf.

In 2015, Scientific American magazine called PACE one of the 10 ideas that can change our world.  That takes us back to our friend Alan Stone.  The reason for his excitement, when Darla confirmed that the building across the street was available, is that he knew his own building was already worth more on that fateful day than when he had bought it, because his investments had improved his cap-rate without depleting him of either cash or credit. He also knew that whatever critical improvements the building across the way would need, he had a mechanism to fund it.  Alan had understood the power of Commercial PACE, and he was eager to leverage it.

Philippe Hartley is the Founder and Managing Director for CleanFinancing (.com), a national agency that specializes in delivering C-PACE funding to commercial projects. He previously spent 2-years at Ygrene Energy Fund where he helped structure and launch the Commercial PACE program.  Philippe is also a California General and Electrical contractor (B and C-10).  He was the founder and CEO of PHAT Energy between 2007 and 2013, during which he won installation patents for solar structures and magazine covers for innovations brought to the building-integrated solar industry. Philippe has written numerous articles for leading industry journals, recently focusing on positioning PACE funding as an eventual expansion agent for the US economy and the enabler of a national infrastructure upgrade on commercial properties in the twenty-first century .  He can be reached at ph@cleanfinancing.com