Last week, Lotus was fortunate to speak with Paul Scharfenberger, the Director of Finance and Operations at the Colorado Energy Office, about the new financing tool being rolled out called Colorado’s Commercial Property Assessed Clean Energy (“Colorado C-PACE”). C-PACE financing is an innovative, yet proven, financing mechanism for commercial, agricultural, institutional, industrial, non-profit and multifamily (residential units with 4 or less units are excluded) properties to obtain low-cost, long-term financing (up to 20 years) for renewable energy, energy efficiency and water conservation upgrades.
Since many of our clients are interested in C-PACE, we were thrilled to ask him a few questions:
Recent conversations with private sector entities has highlighted that the interest in commercial PACE is growing and many believe it is a “game changer” for Colorado’s commercial and multifamily property owners. How is C-PACE different than other financing mechanisms for energy efficiency, renewable energy, and water conservation?
C-PACE is different from other financing mechanisms used to support energy and water improvements in the commercial and industrial sector in a variety of ways, but one of the most important distinguishing characteristics associated with C-PACE is the long term nature of the financing. C-PACE can be used to provide financing up to 20 years for these improvements, whereas standard commercial loans – the next likely alternative that a commercial property owner would pursue - typically only extend to 5, 7, or 10 years depending on the loan recipient, the project being financed, and the lender providing the financing. By offering 20 year financing terms, C-PACE more closely aligns with the payback periods often associated with energy and water improvements and, in doing so, dramatically improves the cash-flows associated with these projects.
Beyond the long-term nature of C-PACE financing, the fact that it can be used to finance 100% of the project costs is unique to C-PACE. It can be used to finance the soft-costs associated with a project (e.g. any associated energy audit, feasibility study, etc.) as well as the hard costs (e.g. equipment and construction), whereas other financing mechanisms typically can be only used to finance the hard costs associated with a project. What this means is that a commercial property owner participating in C-PACE doesn’t have to bear any out of pocket costs for these improvement projects. This is particularly attractive for small to mid-size (Class B & C) building owners who often lack the capital budget for capital-intensive equipment upgrades, yet have pent-up demand to modernize their building. Moreover, the importance of this aspect of the program cannot be understated, especially in terms of how this provision of the program impacts our contractor communities’ ability to leverage this program to convert prospective projects to sales.
Finally, C-PACE is founded on the premise that it allows the financing obligation to transfer to the new owner of the property in the event of a sale of the property. With other financing mechanisms, the commercial property owner would have to be assured that he/she would remain in the property long enough to enjoy the financial payback associated with it. For deep energy/water retrofits, that payback period can be in excess of 10 years and, although it might be counterintuitive, commercial property owners do change locations quite frequently. By allowing the financial obligation to be tied to the property as opposed to the property owner, PACE ensures that the project costs and savings are always connected and, in doing so, addresses one of the primary barriers that commercial property owners face when considering whether to pursue an energy/water improvement project.
Approximately 19% of Colorado’s energy is consumed by commercial buildings, yet implementing energy efficiency and renewable energy upgrades in commercial buildings can be a (sometimes insurmountable) challenge. Which major roadblocks for energy efficiency, water conservation, and renewable energy upgrades does C-PACE address?
As I alluded to in my last response, the lending terms (typically 5-7 years) associated with other financing mechanisms and programs often don’t align well with the economics associated with energy and water improvements. These projects can have lengthy payback periods and it is imperative to structure the financing terms associated with these projects accordingly in order to make financing an attractive option to property owners considering these improvements – otherwise, commercial property owners likely won’t pursue these improvements due to their other competing budgetary demands. C-PACE addresses this issue head-on by enabling long-term financing (up to 20 years) that is more commensurate with the payback of these projects. As a result, C-PACE provides an attractive (“too good to be true”) financing option to commercial property owners that is difficult to overlook.
The transferability of the C-PACE financial obligation at the point of sale also addresses a major barrier that commercial property owners face when considering these improvements. If a property owner isn’t 100% positive that they’ll remain in the same location long enough to enjoy the financial payback associated with an energy/water improvement, then it makes financial sense for them to err on the side of caution and not pursue the project. This is a huge issue in the commercial property sector - this barrier keeps many property owners who are interested in improving the energy/water performance of their buildings and enjoying the related utility costs savings from ever pursuing these improvements. Again, C-PACE addresses this issue head-on. A commercial property owner can pursue an energy/water improvement and if he/she decides to move and change locations a few years down the road, the financial obligation associated with the PACE improvement will remain with the property and fall to the next owner of that property, as will all of the utility cost savings that that project produces on an annual basis.
Lastly, triple net leases are extremely prevalent in Colorado’s commercial sector. With a triple net lease, a building owner can pass increases to their property taxes (i.e. in the form of the PACE special assessment that is included on the property owner’s annual property tax bill) through to their tenants who often pay the utility bills. With other financial mechanisms, property owners are often deterred from paying for these building improvements because they will bear the cost, but their tenants will enjoy the benefit of the reduced utility costs – a barrier often referred to as the “split incentive”. Obviously, most property owners will not choose to pursue such an arrangement, but because the PACE obligation is tied to the property taxes and can be passed through to the tenants with a triple net lease, property owners can finally pursue these projects and pass the costs and savings to their tenants, thereby addressing the “split incentive” barrier.
Now that we understand the many benefits, can you outline how C-PACE works?
Absolutely. Colorado’s C-PACE program operates within a statewide, voluntary special assessment district, called the New Energy Improvement District (NEID), that each county has the option to opt into through a resolution by the Board of County Commissioners. Once a county opts into the program, commercial business owners in that county can apply to the NEID to receive financing from private lenders for eligible energy and water improvements. The project applications, eligibility information, lists of eligible contractors and lenders, and other important program information can be found on www.copace.com. In applying to the program for financing, a property owner can either come to the table with an eligible contractor and/or lender in hand or it can apply without establishing those partnerships and the program administrator (Sustainable Real Estate Solutions, Inc – SRS) will help to connect those property owners with the eligible contractors and/or lenders who have already been approved to participate in Colorado C-PACE.
SRS will then review the project application to ensure that it meets the requirements and standards of the Colorado C-PACE program. If it does, then SRS and the NEID will begin working with the applicant to obtain mortgage holder consent which is required to move forward with the PACE special assessment. If consent is provided, then a special assessment/lien will be recorded within the county land records and the project will move forward to completion.
The NEID then provides each participating county a certified assessment roll that will include the PACE assessment amounts to be placed on the property tax bills for each property that has received PACE financing. This will be a separate line item on the property owner’s property tax bill that will be identified as the, “New Energy Improvement District Special Assessment”. The property owner will then pay their property taxes and the PACE assessment to the county treasurer - exactly as they would for their property taxes – and then the county treasurer will remit the PACE special assessments to the NEID who, in turn, will remit those payments back to the private lenders who provided the original PACE financing.
This continues until the entire PACE special assessment amount is repaid, at which time the special assessment/lien will be satisfied and removed from the property. I realize that it sounds complicated, but it is a proven model that is being used across the country and, as we discussed earlier, it offers several advantages as compared to other finance mechanisms.
One of the benefits that many individuals and companies highlight regarding C-PACE is that it addresses the split incentives dilemma. Can you provide some background on how it does this?
Yes, happy to. As discussed earlier, the “split incentive” refers to the dilemma that a property owner faces when considering to pursue an energy/water improvement to a property that contains tenants who are responsible for paying their respective portions of the utility bill. The issue is that the property owner pays for the improvements, but it is the tenants that receive the benefits associated with those improvements that come in the form of reduced utility costs. This dilemma often results in a property owner not pursuing these improvements because it doesn’t make financial sense for them to do so.
This is where PACE comes into play. As mentioned, PACE operates under the guise of a special assessment that is repaid through the property taxes. Also as mentioned, triple net lease between building owners and tenants allow building owners to pass increases to their property taxes through to their tenants. What does this all mean? It means that PACE addresses the split incentive dilemma under certain lease arrangements which are common in Colorado by allowing the property owner to pursue and pay for these building improvements and then pass on the repayment obligation to their tenants who enjoy the benefits associated with the program.
Before closing, the benefit to the tenant under this situation should not be overlooked. In the majority of cases, the savings associated with these improvements will exceed the costs associated with them – the mortgage holder consent aspect of Colorado C-PACE all but guarantees this – meaning the tenants will benefit from utility costs savings that will exceed the costs that are being passed through to them.
Are there any energy efficiency, renewable energy, and water conservation upgrades that are not allowed under the Colorado program?
The statute dictates eligibility based on utility savings and increased generation from renewables. This means that the eligibility requirements are broad and encompass a wide variety of different energy and water measures. That said, Colorado C-PACE relies on private sector lenders to provide the financing for these building improvements and the participating lender will have to be comfortable with, and ultimately sign off on, the measures being financed. In other words, a vast majority of measures that are proven and have demonstrated reliable utility cost savings will absolutely be supported by C-PACE financing, but nascent and emerging technologies may have a harder time obtaining financing because lenders may be weary of the payback expectations associated with them.
Colorado’s program is unique because Counties have to voluntarily opt-in to a New Energy Improvement District in order to participate. Which Counties have opted in to date?
Well, it should be noted that they don’t “have to” opt-in to the NEID, but we sure do hope that they choose to – I not only feel that C-PACE will produce significant benefits to Colorado’s commercial property owners, but also the counties within which those properties reside.
To-date, Boulder County is the only county that has officially opted into the program, but I have met personally with 15 other counties in the State and am extremely confident that we will see the number of participating counties increase in the very near future.
If any of our readers live in a County that has not opted in to C-PACE but they are interested what are the next steps?
Well, for one, we’d like to hear from those folks. We are compiling a list of projects in counties that haven’t opted into the program because that is compelling information for us as we engage with counties – being able to show very real demand and economic development opportunities is obviously a powerful communication tool.
Beyond engaging with the NEID, it’s important for county representatives to learn of Colorado C-PACE from a variety of individuals and organizations. Although PACE is a model that has been pursued and proven across the country, it is a relatively new program to Colorado and it will take time and effort from a variety of stakeholders to inform decision makers as to the benefits that it can produce to the counties of Colorado.
If any of our readers have additional questions, how can they find more information?
www.copace.com is a great resource for program information, testimonials, application documents, etc., but your readers should always feel free to reach out to SRS (contact information is contained within the aforementioned website) and/or directly to me if they ever have questions about the program – we’re always more than happy to field inquiries and hopefully help your readers understand and navigate this very exciting program.
Thank you so much, Paul! More information about CoPACE can be found at the Colorado C-PACE website at www.copace.com.
Note: Photo by Matthew Wiebe.