Deidre Woollard: Hello fools, and welcome to another Millionacres Spotlight interview. I recently heard about a type of commercial financing that I don't know too much about, C-PACE and I decided I want to learn a little bit more today. So I'm talking with Thomas O'Connor, who is the Chair of real estate finance group and a member of the real estate practice group at Duvall & Stachenfeld, a law firm based in New York City. Mr. O'Connor practices in the area of commercial real estate transactions with particular emphasis on real estate finance and has been active in PACE financing throughout the country. He's got expertise in this emerging area of real estate finance. Welcome.
Thomas O'Connor: Thank you. Great to be here.
Deidre Woollard: Let's get right into it. I'm even say get right? Is it C-PACE and PACE financing?
Thomas O'Connor: Yes. There are two types of PACE. There is residential PACE, which is the homeowner would use and it's not what I work with frankly. There's C-PACE which refers to commercial PACE. That's PACE that you would use for commercial buildings of all size and PACE stands for Property Assessed Clean Energy.
Deidre Woollard: How is it used?
Thomas O'Connor: I'm only speaking about commercial PACE as residential is similar. If a owner of a building, wants to prove the energy efficiency of his building or reduced carbon, which is a big trend now for all reasons. They want to put an improvements to do that. Solar panels or high efficiency glass, that lets the sun in the winter, but blocks it out in the summer so to improve air conditioning and heating, to pay for those improvements, making financials improvements through PACE. PACE is not a government program. People think it is, it's not. It's privately funded with government collaboration, government assistance. Government enables PACE to take place. They can get 100 percent financing for those improvements to pay for them, and they pay them back over a long-term assessment against the property and determines long in terms it will go. I don't want to get too deep, but stop me, if you already could. To determine the payment, there will be this average useful life of those improvements you put in. If you put in solar panels and they're going to last 25-years, you're paying it back over a 25-year period.
Deidre Woollard: Interesting. It's not a government program.
Thomas O'Connor: No.
Deidre Woollard: It's funded through individual lenders. How does that work?
Thomas O'Connor: PACE funding is familiar with ESG type investment, Environmental Social Governance. PACE is right down the middle of the fairway when you talk about ESG. You can only have PACE where the government has stepped in and passed legislation to enable it. It's something that governments are trying to encourage. Energy efficiency, reduction of carbon, so they pass legislation that provides for a private lenders, private funds, private equity funds to lend money to these owners, but the local taxing authority places the assessment on the property, collects the repayment back like a tax, and then pays the private lender. The local taxing authority is there to enable the assessment that's putting its profit in the collection of tax. If you don't pay your PACE assessments, the same consequences if you don't pay your taxes. It acts like a special tax or assessment on your properties because the PACE repayment is treated like a tax. It comes in front of other debt on the property, like mortgage debt. That causes a lot of discussion amongst mortgage lenders, you can imagine.
Deidre Woollard: Does that mean that mortgage lenders don't necessarily have a fondness for PACE?
Thomas O'Connor: You could say that. Yes. As a matter of fact, [laughs] mortgage lenders don't like to get paid in front of them. The only ones that do that today are taxing authorities. Commercial PACE started probably 15 years ago, you can give or take on that year. It's been a slow rollout because there's been a lot of resistance to it from the commercial lending market. As matter of fact, if you picked up a lot of loan documents in the last 15 years, you will find a specific provision written, especially the page that says, '''thou shalt not have any PACE on this property.'' That has changed dramatically.
Deidre Woollard: You mentioned that in order for PACE to work it has to be available on the local level. I know with New York, there's all of this green movement and the need to retrofit a whole bunch of buildings. I'm assuming there's a lot of energy around PACE in New York City, is that right?
Thomas O'Connor: There's an incredible amount going on right now. Then people really should be taking a look and paying attention to what's going on in stereo. Let me backup for a second because you're right. PACE is first pass at state-level, and right now, 38 states in the United States have PACE legislation that has passed the state level. Remember as we said, the PACE tax is collected at the local level, be it the City, the County, whichever collects the taxes. The state can pass it but the local jurisdiction, village county, whatever, has to adopt it. New York state passed PACE five years ago. New York City, which I see as a major center of financial and capital markets, never adopted it. It wasn't until April 2019, when New York city passed something called the Climate Mobilization Act and we shall have another show about that. I'll bring one of my colleagues [inaudible 00:05:51] big news. People are paying attention to it. The Climate Mobilization Act requires any building owners of buildings 25,000 square feet or more, and that's roughly 40,000 -50,000 buildings in New York City, but biggest buildings around, they have to reduce their carbon emissions to certain levels that are prescribed. By 2024 and 2030 maybe. It's big news. If you don't reduce your carbon to these levels, the city is imposing fines on your building and they're real fine, they're serious fines. It's not slaps in the wrist. The city council passed and said, ''We don't want your money, we want your carbon.'' Get your act together, meet these carbon levels." While at the same time, the city passes, what some might see as an owner's legislation saying, ''Reduce your carbon.'' Saying, "We going to help people pay for that." We're going to finally pass PACE on our own. They didn't adopt the state legislation. New York city passed it's own uniquely independent PACE legislation for New York City that was passed in April 2019, two years ago. We're still waiting for it to go live because with the legislation at the city passed, you need the forms, you need guidelines. They just came out, the guidelines, we're waiting for the forms. The good news is the New York City PACE legislation is about to go live. With that, you're going to see a lot of New York city landowners who have to comply with the CMA taking PACE loans to pay for them. That's why PACE is going to became bigger. By the way, once PACE starts being in New York City, my view, forgive me, I'm a New Yorker. Once it happens in New York City it has a big impact on capital markets.
Deidre Woollard: That is what they say. Is it only for retrofitting? Can it be used for ground-up construction?
Thomas O'Connor: Great question, really good question. These are the questions that people, when we speak to people, developers, owners that they're asking us. Generally, I'm going to answer your question in a general scale, it varies by state. PACE is legislatively enabled, so if you want to know if you can do ground-up or retrofits wherever state you are in, you go look at that legislation. When we go do a PACE loan in a particular state, the first thing we do is we get the law, we read it, we see how it works. They're generally similar, but they are nuances. But let's talk about New York. New York state, which had PACE legislation five years ago, and it was only for retrofits, just amended it to allow some ground-up. It's big news. New York state though. Remember we said in New York City didn't adopt the state legislation, they have their own. New York City does not yet have ground-up, it's only for retrofits. It was designed to help existing owners retrofit their buildings to comply with the Climate Mobilization Act. But now that the state has amended the PACE law to allow ground-up the word on the street is that the city is going to follow, the City council will amend the New York City legislation to allow ground-ups. We're expecting that will pass. It makes sense. You want to encourage energy efficiency at all levels, whether it's retrofits or ground-up as well.
Deidre Woollard: That makes sense. What kinds of things are encompassed in PACE? You mentioned solar panels. What types of other things can PACE be used for beside solar?
Thomas O'Connor: Again, I'm going to say as a lawyer always says, ''Well, it depends.'' What PACE will finance is determined by the legislation that you're working under. If you're in any given state and you want to know what can I fund with PACE, I am going to go read the legislation. The legislation generally similar across-the-board finances what we've heard too commonly as qualified improvements. Qualified improvements are generally anything that improve energy efficiency or reduce carbon. It's pretty broadly defined. If you are thinking about using it, if you are putting in anything that's going to improve your energy efficiency, it's likely it's going to qualify for PACE financing. The best way to know is, call PACE lender. This is what they do, they will come in, will take a look at what you're wanting to finance and they'll say whether it qualifies or doesn't qualify. But it's pretty broad. I have even seen people in New York City local lab and you have to service skins of buildings repaired. Some people get to the point where they have to replace the entire outside of the building. There's views that if you do that and there are certain services and skins that could be used and improving energy efficiency. You may be able to qualify for PACE financing for that, that's huge expense. To answer your question, it's pretty broad. Any improvements that are going to lower your energy costs are probably going to comply. New York City excludes light bulbs, can't finance light bulbs.
Deidre Woollard: Interesting.
Thomas O'Connor: Probably the idea is because I guess you want things that are fixed and attached to the building. So light bulb specifically exclusion. You can get energy efficient light bulbs.
Deidre Woollard: You said PACE lenders. Not every lender is a PACE lender?
Thomas O'Connor: No.
Deidre Woollard: Which types of lenders tend to offer PACE?
Thomas O'Connor: You just can't be a PACE lender. If you are a lender, first thing you need to do is, would I want to make the loan, has a legislation been passed, has the taxing jurisdiction wherever this property is located adopted PACE? It's all good. But to be a PACE lender, you have to underwrite the improvements you're financing. You have to actually do an energy audit. There's stuff to know. You have to really qualify yourself as a PACE lender who knows how to underwrite and do the audit for the energy efficiencies and qualify those improvements under the local legislation. Lenders are not just PACE lenders. PACE lenders are PACE lenders. The large institutions have not jumped into PACE yet, although I believe they will, and they'll get up to speed. Because so far, the scale of commercial PACE has been fairly small compared to the rest of the markets, but it's growing dramatically. So I'll give you an example, not an example. In 2018, there were approximately 6-700 million of PACE loans based in the commercial PACE made in the country. That's small in terms of capital markets. But from 2018 to 2019, it more than doubled, one year. In 2020, but for COVID, certainly would have doubled again. Now, we're getting back to that. Now that it's being rolled out in New York City, you can expect expense growth. When you see that. then you're going to start to see the larger institutions figuring out, "Hey, I have to make these PACE loans." It's a great economic deal for the borrower and the lender. The terms aren't enough very attractive. The trick is getting the mortgage loans to go along as we spoke about. But yes, there were probably a dozen major PACE lenders in the last year, but a lot more players are coming onboard. Because everyone is expecting a tremendous boom and growth in the number of PACE loans that are going to be made. So there's more and more players coming to life. But no, you have to go to a PACE lender who's doing this. New York city, in order to be a PACE lender in New York city, they just came out with the guidelines, you have to qualify. There's an application process. It's pretty detailed. Any financial institution are worth a salt, will be able to do so, but you have to qualify and apply and be approved by New York city. Those guidelines were literally just out in the last two weeks, and I'm sure people are now looking [inaudible 00:13:52] and figuring how to qualify.
Deidre Woollard: In the future, do you think that the mortgage lender and the PACE lender will be the same thing that you'd be able to get your mortgage and your PACE loan within the same financial institution?
Thomas O'Connor: Giving away my secrets. These are great questions, they really are. The answer is yes. But I think some institutional mortgage lender out there has to make strategic decision that is worth their resources and time to get up to speed to make PACE loans. In my view, the mortgage lender could figure out how to do that is going to have a tremendous competitive advantage over other lenders who can. Remember, these are mostly construction loans, for the most part. There's some exceptions to that, if we can talk about. People take out these loans when they're building a building or retrofitting a building, they get a construction loan from a mortgage lender, and then they get a PACE loan to fund the green stuff. That's a great competitive advantage they're going to have. No one's done it yet, but someone's going to figure it out.
Deidre Woollard: Again, sounds like it.
Thomas O'Connor: I don't want to get off topic, but I don't know if you're familiar with mezzanine financing at all.
Deidre Woollard: Yes.
Thomas O'Connor: Think of PACE financing as the thing that could replace mezzanine financing. They're about similar size, and you have someone who's doing a retrofit on new construction, wants to borrow the money, doesn't want to use the equity. They get a construction loan for 70 percent of the costs, and then they get a mezzanine loan for 10 percent of the costs. Mezzanine loan is going to be 10, 11, 12 percent interest. The PACE loan is going to be five or six percent, half. The costs on the interest is going to be long term, it's much better long term for the borrower. Now, a lot of construction lenders, they made the construction loan and the mezzanine loan together, that's how they got the deal. They want to offer their borrower full financing. Just as those lenders figure out, I can make the construction loan the mezzanine loan, they could say well, "I can make the construction loan the PACE loan." I think the loan borrowers is knocking the doors.
Deidre Woollard: How is the interest determined for a PACE financing?
Thomas O'Connor: Like everything else in the market. It's fixed rate and long term. Right now, the fixed rate is between five and six percent, and you're talking for fixed rate, fully amortizing meaning loan get pays down for the full-term and by the end of the amortization period which is anywhere from 20-30 years is paid up. Which when you think about it, that's a very good rate for the lender because they are first in priority. They're getting five or six percent fixed rate, long term, and they get paid before any of the lenders. It's pretty good rate. I think you might see those rates come down as more and more players come to play. Go on.
Deidre Woollard: Is there any tax impact involved in PACE? Does it work with some of the tax programs that are out there? Is it deductible in any way? Is the interest deductible?
Thomas O'Connor: You are paying back interest financing. You are paying amortizing payments that have an interest and principle component. So you would write-off the interest as you would any other interest expense. Not a tax lawyer or an accountant, but I can imagine why the result will be any different than that. That's from a tax perspective, yeah.
Deidre Woollard: Just a final question. How does someone learn more about this? How do they evaluate if it's right for their project?
Thomas O'Connor: I don't want to do the commercial, but they can reach out to our firm.
Deidre Woollard: No, go ahead. [laughs]
Thomas O'Connor: You can contact me at Duval & Stachenfeld. We would put you in touch with clients we represent who make PACE loans, the contacts we know who also make PACE loans. I think the place to really start is with a law firm like us to explain to you how it works. But then really, a PACE lender who can evaluate what green infrastructure, what qualified improvements you have, how much financing you can get, and walk you through the processes. So it's a place to really own your spot is with a lawyer who does the PACE financing and a PACE lender. We know several, so there's several good partners that we've worked with out there that we can put people in touch with them and be happy to do so.
Deidre Woollard: Awesome. Well, Tom, thank you so much for your time today. This was really fascinating. I didn't know anything about this, and now I feel like I have a little bit of an understanding of what it's like, so thank you.
Thomas O'Connor: Great. My pleasure. Nice to speak with you today.