Five Considerations: Using Commercial PACE for Condominium Developments

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With the adoption of increasing and costly environmental regulation affecting buildings nationwide, Commercial Property Assessed Clean Energy (CPACE) financing offers a unique vehicle that may be used to fund qualifying energy efficiency and renewable energy projects at a lower effective cost than traditional borrowing. CPACE recently became available in New York City for retrofit projects in commercial properties, and the city is expected to pass legislation that will make CPACE financing available for new development projects as early as September 2021.

A key element of CPACE financing is that, unlike traditional debt financing, a CPACE loan is repaid in installments through a charge on the applicable property’s tax bill, which typically allows for lengthy loan terms that could extend 20 to 30 years. This structure results in an interesting dynamic in the context of a residential condominium development, where a property is subdivided into multiple units, and typically conveyed to third parties rather than held by a single person or entity. The CPACE Program Guidelines indicate that “residential condominium units currently owned in common by a commercial entity” are eligible for CPACE financing, “unless and until such time as such a unit is sold.”

Here are five considerations this requirement raises for condominium developers, multi-family owners upgrading and converting their properties to condominium ownership, and lenders regarding the applicability of CPACE to their properties:

  1. Prepayment Penalties. Where individual condominium unit sales take place, the CPACE loan will need to be partially prepaid at each closing. Thus, a lender will look to establish prepayment penalties and exit fees that offset the increased likelihood that all or a significant portion of the loan will not reach maturity. In turn, a borrower will need to factor that penalty into its own underwriting to determine whether the overall cost of the CPACE loan yields the desired projected net sales proceeds.
  2. Interplay With Senior Lender. Senior loan documents provide that each unit can only be released from the senior loan if a minimum release price is obtained, which typically also accounts for a cap on amounts that can be deducted from the gross sales proceeds of a unit. The partial prepayment of the CPACE loan will have a meaningful impact on these calculations. This will be a critical point in negotiations as developers seek senior lender approval of CPACE financing, which is almost always a requirement under senior loan documents. Given this requirement and the requirement to partially prepay the CPACE loan together with a penalty as described in the prior paragraph, developers might view CPACE as short-term financing and seek to recapitalize a project prior to the creation of the condominium and use the new capital to repay the CPACE loan in full.
  3. Lack of Detail in Program Guidelines. The discussion of condominiums in the Program Guidelines is limited to the one instance mentioned above. That condominiums are expressly mentioned as being eligible is good news, but the lack of meaningful detail will leave market participants to figure out the many nuances of how the program will actually be implemented for a condominium development. This could result in a variety of interpretations and conflicting approaches from lender to lender and project to project, and has created a great unknown as to what happens if a project is determined to have run afoul of the Program Guidelines. In order for CPACE to be most useful, clarifying guidance will be necessary.
  4. Bulk Sales. Sometimes the developer of a condominium will sell units in bulk to an operator or investor. In a scenario where the developer/CPACE borrower sells all of its units, the units would still be “owned in common by a commercial entity,” so would the CPACE loan remain in place? Alternatively, if only a portion of the units are sold, is there any flexibility for the CPACE loan to remain in effect for the sold units so long as they are operated by a commercial entity? Again, the lack of detail in the Program Guidelines leaves these questions open for the market to interpret.
  5. Co-ops. Unlike condominiums, a co-op property is owned by a single corporation, which then sells shares of that corporation to the apartment owners. Because of this structure, CPACE financings are a perfect fit for co-ops. In addition, certain condominiums have co-ops that exist within a condominium unit. The specific legal structure of a property could result in a simpler path to obtaining a CPACE loan for a property that features a condominium, although offerings of condominiums are otherwise generally viewed as being more marketable than co-ops.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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