C-PACE: Higher standards for building efficiencies and sustainability
May fuel financing demand
INSIGHT ARTICLE |
Real estate businesses looking to move forward with their strategic plans during the downturn while preserving equity may just have another tool in their tool belt: Commercial Property Assessed Clean Energy programs, or C-PACE. C-PACE, a public-private financing option, allows commercial property owners to obtain low-cost, long-term financing for capital expenditures that affect energy and water performance of commercial and multifamily real estate. Because the financing comes in the form of an assessment on the property typically added to the property tax bill, the debt is tied to the property and not the property owner. This structure survives changes in ownership, which may be beneficial to investors.
Mortgage lenders may find C-PACE financing structures preferable to traditional options for a variety of reasons. C-PACE loans do not affect mortgage lenders’ foreclosure rights; assessments cannot be accelerated; and assessment payments can be put in escrow, similar to real estate tax payments. Furthermore, the qualified improvements tied to the financing likely positively affect debt service coverage ratio adherence by the owner for the mortgage lender. Lenders generally have no issues with this type of financing.
Public pressure is building for businesses across the board to adhere to environmental, social and governance standards known as ESG, and the commercial real estate industry is no exception.
Large real estate investment managers are taking note. Nuveen, a leading global investment manager, has recently agreed to acquire Greenworks Lending, a national leader in C-PACE financing. The acquisition gives Nuveen a foothold in the clean energy and energy efficiency lending market and will provide its clients access to an innovative and attractive clean energy investment.
One of the largest environmental considerations for real estate investors is reducing their carbon footprint by achieving carbon net-neutrality. By recently rejoining the Paris Agreement, the United States is doubling down on its commitment to focus on decarbonizing buildings, mirroring similar efforts by the United Nations in its Sustainable Development Goals. ESG initiatives offer additional motivation for real estate investors to explore all available incentives, credits and financing options to achieve their sustainability goals.
C-PACE is an attractive option to bolster extensive building retrofits when traditional underwriting for the investment isn’t appropriate, given the existing capital stack. C-PACE payback periods span 20 to 30 years, much longer than traditional financing’s seven-to-10-year terms; this flexibility may finally help these projects get across the finish line.
And in roughly a dozen markets, C-PACE financing may allow commercial properties that have already invested in energy-related retrofits a means to replenish their reserves through a retroactivity provision. This feature can augment other financing tools available to property owners still navigating the impacts of the COVID-19 pandemic.
Key accounting considerations
Each C-PACE contract is unique such that a property owner needs to review the terms of the contract carefully and consider its own specific facts and circumstances in order to determine the proper accounting treatment. Questions sometimes come up regarding the extent to which improvements financed through the proceeds can be capitalized. Considerations include whether the funds are used to create an asset from which the property owner will benefit in the future, including whether or not the improvement is on land, which is owned by the property owner. An asset may be created, but the overall use may not be only that of the property owner. For example, if improvements are made on infrastructure or public areas that are not owned by the property owner, an asset may not be created for the property which is bound by the financing arrangement. Consideration should be given to relevant authoritative guidance in Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 360, Property, Plant and Equipment and Topic 340, Other Assets and Deferred Costs, including that presented within relevant industry Topics, such as Topic 970, Real Estate, in determining the extent to which assets should be recognized on the balance sheet. Lastly, the definition and characteristics of assets in FASB Concepts Statement No. 6, Elements of Financial Statements, may be useful.
Typically, the financing obligations are accounted for as debt under ASC Topic 470. Repayment structures vary. In some cases, the C-PACE repayments are assessed annually with the real estate taxes, and the amount of the assessment may not be known in advance. In other cases, the contract presents an amortization schedule or terms specifying annual payments. Given the various ways these financing arrangements can be structured, it may be challenging at times to find authoritative accounting guidance that is directly on point. ASC 970-470, Real Estate—General, Debt addresses the recognition of an obligation by a property owner for assessments levied by a tax increment financing entity that based on the specific facts and circumstances of an arrangement, may or may not be appropriate to consider by analogy.
In addition to considering relevant authoritative guidance in the ASC when determining the appropriate accounting treatment and disclosure requirements for the financing arrangement, entities that report under Securities and Exchange Commission requirements should also consider relevant SEC guidance and disclosure requirements. Property owners should understand the financial reporting ramifications in the initial stages, including considering the effect on financial covenants like debt-to-equity and leverage ratios. Upfront planning may minimize the risk of unexpected accounting results, potentially result in lower borrowing rates and enable an entity to meet existing financial covenants. Again, contracts need to be analyzed to determine the proper accounting treatment for each C-PACE financed project independently. Management should discuss all considerations with their auditors, accounting advisers, lenders and other stakeholders to ensure they are making the proper assertions and conclusions with regard to the accounting for their specific contract.
Middle market takeaway
Commercial real estate owners are experiencing increased pressure to meet changing compliance standards under the emerging environmental agenda of the new administration in Washington. C-PACE is one of many programs developed to assist with environmental priorities. Financing, renewable energy purchasing incentives, and various tax credits can be used to offset current project costs and future insurance costs, while reducing energy consumption.