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As Popularity of PACE Clean-Energy Financing Increases, Lawmakers See Need for Reforms

Property Tax-Backed Financing More Popular Than Ever in CRE, But Some in Congress See Need for Predatory Lending Protection
July 20, 2017
Alterra International is using PACE financing to help convert the old Butler Brothers Building in Dallas to a $120 million mixed-use  apartment and hotel project.
Alterra International is using PACE financing to help convert the old Butler Brothers Building in Dallas to a $120 million mixed-use apartment and hotel project.
Commercial real estate owners and developers who have discovered the flexibility and affordability of Property-Assessed Clean Energy (PACE) financing have boosted the program to its largest financing levels in the program's eight-year history, increasing aggregate volume by 25% in the first six months of 2017 alone.

The financing innovation that lets property owners borrow up to 100% of the cost of adding energy-efficiency features or renewable energy upgrades to their properties has been a boon to commercial property owners. The program is now available in 30 states. Last month, the Illinois Legislature overwhelmingly passed a bill authorizing PACE loans for commercial, industrial and multifamily buildings.

While by all accounts the PACE financing program has worked very well for commercial property owners, the corresponding residential PACE financing program available in a handful of states has raised the ire of a coalition of housing groups, including the Mortgage Bankers Assn., the American Bankers Association and the National Association of Realtors.

They took issue with last year's decision by the Federal Housing Administration to insure mortgages that also carry liens created under the PACE energy retrofit programs. Specifically, they are concerned that delinquent PACE loan amounts will retain a first lien position under certain conditions.

“Allowing any PACE loan amount to hold a senior priority undermines the lender’s (and the government’s) collateral position and disrupts the very nature of secured lending," the groups wrote in a letter sent to the FHA.

They also object to PACE financing's treatment as a tax assessment instead of as a loan, citing consumer protection concerns, and want PACE assessments to require the same extensive disclosures and documentation required for mortgage loans.

“PACE loans are not typically accompanied by federal Consumer Financial Protection Bureau disclosures and protections associated with home mortgages, including the new Know Before You Owe disclosures, right of rescission protections, or the Ability to Repay standards," the groups stated in their letter.

Reports have surfaced of unethical contractors abusing the PACE program. Several homeowners in California and Florida have filed complaints claiming they were taken advantage of by home improvement contractors who failed to fully disclose the impact that higher property tax assessments placed on their homes to pay for the energy upgrades would have on their mortgage payments.

Elder Law and Advocacy, a legal services and Medicare counseling agency based in San Diego, recently issued a solar panel installation 'scam alert' after it received reports of contractors reportedly entering consumers into the PACE financing program without making them fully aware that an increased tax assessment would be placed on their homes to pay for the improvements.

"We have received complaints that elderly individuals with dementia, or who were on medication, were entered into electronic PACE loan contracts they never saw, on terms they did not understand," the advocacy group reported.

PACE programs for residential homes are currently only available in California and two other states, although they account for a majority of PACE securitizations and are expected to emerge in other states in the coming years.

Opponents of the program have seized on the reports of predatory-lending and persuaded their representatives in Congress to introduce legislation calling for PACE financing programs to be reclassified as mortgage loans, requiring them to follow the same rules and disclosures as banks and mortgage lenders under the Federal Truth in Lending Act.

In April, Sens. Tom Cotton, R-Ark.; Marco Rubio, R-Florida; and John Boozman, R-Ark.; and in the House of Representatives by Reps. Brad Sherman, D-Calif.; and Ed Royce, R-Calif.
introduced companion bills in both houses that would bring PACE loans under the Truth in Lending Act. Sherman noted the bill would ensure that PACE lenders are subject to the “same basic disclosure requirements that apply to traditional lenders, including providing to consumers the annual percentage rate, a schedule of payments, and the total cost of a loan.

Will Reforms Scuttle Program?


While advocates for the PACE program agree that improved disclosure agreements and consumer protection measures are needed for the residential programs, they hope the proposed legislation doesn't result in 'throwing the baby out with the bath water' by adding extensive disclosure requirements - and related costs -- similar to mortgage loans that could scuttle the successful energy-efficiency financing option for commercial property owners.

PACENation, a PACE industry advocacy group, called the bills “a thinly disguised effort to kill PACE by subjecting it to extraneous federal regulations.” The group accused the proposed legislature as “being driven by banking interests that only see PACE as competition for market share.”

Brian Grow, a managing director for the Morningstar Credit Ratings, recently issued a report noting several common misperceptions regarding the PACE program. In particular, the report stressed the distinction between a PACE assessment, which is structured as an asset-based obligation, not as a loan, and said PACE assessments should be subject to different credit analysis. Specifically the report said lien-to-value ratios, more than a borrower's credit score, offers a more appropriate risk indicator.

Another key distinction is that a PACE assessment remains attached to the property, not to the property owner. Also, a PACE property assessment is usually small in proportion to the mortgage, and the improvements that PACE finances often enhance the property’s value while adding to cost savings.

Commercial Activity Continues Apace


Despite the recent controversy, a growing number of property owners continue to tap into PACE assessment programs to finance energy-conservation initiatives in their properties. In the largest commercial project to date financed through PACE, Seton Medical Center in the Bay Area community of Daly City, CA, obtained $40 million for a mandated earthquake retrofit upgrade. The seismic upgrade loan for Seton Medical Center operator Verity Health Systems is four times larger than the previous record PACE loan of $10 million for a single project and represents a major step forward for CRE's utilization under the program.

All told, commercial PACE assessments have increased its aggregate total by more than $100 million in the first half of 2017 alone.

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In another recent example, Dallas-based law firm of Munsch Hardt Kopf & Harr, P.C., arranged the financing which will allow Alterra to build out energy-efficiency and water reduction systems at the nine-story, 107-year-old Butler Brothers building at 500 S. Ervay being redeveloped into 238 apartments; a 270-room, dual-branded Fairfield Inn/Town Home Suites by Marriott; retail; and a small office complex.

“PACE financing pairs incredibly well with historic buildings that are typically inefficient and require additional capital in order to renovate the property to modern energy efficiency standards,” said Munsch Hardt attorney Phill Geheb. “In my practice, I am beginning to see greater interest in the utilization of this program for historic and non-historic renovation projects," added Geheb, who credits the flexibility and relatively low cost of the non-recourse PACE property assessments for its recent rise in commercial popularity.

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Specialized commercial PACE (C-PACE) financing is now available in nine states and in Washington, D.C. through 26 different programs, with 12 new programs in development in nine other states. Projects have been initiated or complete on 200 buildings through 18 programs with loan values ranging from $5,000 to $7 million.

While not amounting to huge sums, the size of the C-PACE loans has grown in recent years since Hilton Worldwide secured $7 million in PACE financing in 2013, at the time the largest commercial PACE financing, to fund energy efficiency upgrades at its Hilton Los Angeles/Universal City property. Hilton said it expected the renovations financed by the PACE assessment would save an estimated $800,000 in energy costs and water savings of $28,000 annually and conserve more than 2.8 million gallons.

News Director Tim Trainor contributed to this report


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