PACE (Property Assessed Clean Energy) Financing is a finance tool every real estate investor needs to know about to help acquire or renovate your property.
Scott Krone, principal at CODA Management Group, a real estate design & design firm. CODA as designed & built single family, multifamily, commercial property convert to mixed use, and churches. Most recently, CODA has focused on re-adaptive use, converting empty warehouses into self storage facilities.
Property Assessed Clean Energy (PACE) is accessed through the US Department of Energy, but not widely available throughout the country. To access PACE Financing, the state where the property for which the funds will be utilized must be located in a state that has adopted the PACE program.
The purpose of PACE is to encourage and improve the energy performance of a structure or building. The money provides financing of these improvements through real estate taxes instead of traditional debt. This structure changes the picture of debt for lending, as lenders look at the obligation as equity versus a liened debt position against the property. Your payments are now operational, property taxes. Banks love it!
There are two forms of PACE financing; public and private. Public is run through the Port Authority. Private
The structure of Pace financing is similar to traditional debt financing in that the principal & interest which is spread out over the life of the improvement. For instance if the HVAC system has a life expectancy of 20 years, they will amortize the payments over 19 years.
Like any construction project with financing, the monthly draws are submitted to the bank after the work has been completed. For those elements that are recognized as energy related and included under the PACE financing, a separate draw is requested.
Your PACE payments are an additional tax assessment usually split into two annual payments.
Tax Structure with PACE
The tax structure for PACE provides multiple benefits.
- Funding for your qualifying project needs is provided as a loan through PACE.
- Repayment is spread out over the life expectancy of the improvements.
- PACE financing is considered equity, not debt.
- Lower capital raise from investors.
- Property taxes are frozen for the duration of the repayment schedule.
- PACE financing and property tax lock is transferable.
PACE Eligible Components
The list of qualifying building components look to three areas for improvement; water, energy and renewal energy. Structural components are generally excluded, however a new roof with additional energy saving insulation is included. An easy way to think of what is qualified, is to think of LEED certified buildings and the components.
Capital Stack with PACE
In a typical property purchase with debt, the borrower brings the down payment, equity and borrows the balance from a lender. For PACE qualified projects, your down payment can be lowered because the PACE financing is recognized as equity in the project. For instance:
Project Total $1,000,000
Down Payment: $ 150,000
PACE Financing: $ 150,000
Debt Financing: $ 700,000
Typically PACE can provide up to 20% of the appraised value of the property after construction.
While you have 30% equity in the project, your investors only had to raise 15% of the equity, which dramatically increases the return on the project to your investors.
To qualify for PACE, you first have to establish a baseline for the existing building systems in place. Once the baseline is established, the systems to be replaced are evaluated for the estimated savings. CODA has worked with Petros PACE Financing, a lender that specializes in PACE.
Each week I ask my guest, “What is the Biggest Risk Real Estate Investors face?”
Well, you know, people ask me about this in terms of real estate, what’s going to happen with the economy, as you know, with political elections, what is it going to go up or down a recession or continue in this? You know, We’re in one of the longest expansion periods in a long time. And for me, on a national level, I don’t see that there’s going to be a lot of risk within real estate as a whole.
Based upon the interest rates, I think if the market does begin to slow, you know, the Fed is going to lower the prime. We wait. We may get down to two or even zero interest rates just to keep the economy going. So from that perspective, I think that real estate is still a solid play.
But if I’m looking for us. What we have determined internally is that there’s too much political instability here where we are in Illinois. And so what you were saying in terms of like, can we can we avoid it? You know.
Illinois is having a decrease in population of 6 percent over the past 10 years, which is putting a greater burden on the people that are remaining. And we have the pension problems. And, you know, historically, you know, people say, well, you know, they just did a bunch of things to approve legislation which are basically sin taxes.
But my concern is the money is not actually going to pay off those pensions. It’s just going to be used to spend in other areas, which is historically have happened in Illinois for the past 20, 30 years. So why is it going to be different?
What we have done is we’ve stopped buying in Illinois. And for us, that’s how we are mitigating or perhaps even transferring because we’re looking at states that are more tax progressive and where we’re seeing growth.
And so that is what we’re trying to do is and that’s why we’ve expanded throughout the Midwest. That’s why we have the properties in Ohio. We’re looking in Louisville or we’re looking in Kentucky. We’re looking in North Carolina. We’re looking at Michigan.
We’re looking at places that are trying to encourage economic development. So either through PACE the Opportunity Zones or the tax benefits for it so that we have greater stability and less risk.
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