Last week the U.S. Department of Housing and Urban Development and the Department of Veterans Affairs released new guidance, changing their previous positions, now widely allowing residential Property Assessed Clean Energy (PACE) financing.
With the guidance, PACE financing, where payments for energy efficiency, water conservation and renewable energy improvements to real estate are made through a building owner’s property tax bill without upfront cash from the owner could be bigger than anything in U.S. real estate since the invention of the glass window.
PACE state enabling statutes generally authorize local governments to work with private sector lenders to provide upfront low interest financing to property owners for qualified projects (e.g., HVAC system upgrades, photovoltaic systems, cool roofs, etc.), and to collect the repayment through annual assessments on the property’s real estate tax bill. The term of PACE financing can be extended up to 20 years, often resulting in utility and other cost savings that exceed the amount of the assessment payment.
The concept is not new, but nationally, residential PACE programs generally have been put on hold or foregone as a result of concerns of HUD and the Federal Home Loan Banks, that issued a directive in February 2011 to refrain from purchasing mortgage loans secured by properties with outstanding first lien PACE obligations.
There were not similar concerns expressed about commercial loans. However, the extent to which similar concerns apply to multi family commercial mortgages was not previously resolved. And the uncertainty has resulted in modest commercial PACE programs in only 9 states and next to no residential programs actively running. A directory of state and local PACE laws in available here.
Residential PACE offer a host of benefits depending upon the program design, including: removing the barrier of a large upfront cash outlay by the property owner; allowing 100% financing of improvements in amounts over loan value ratios available in the marketplace, including without disturbing existing mortgage financing; underwriting tied to the property and improvements and not individual creditworthiness; repayment over a long period of time (often up to 20 years); low interest rates resulting from high security of repayment; reduced utility bills that can offset the payments; the obligation to repay runs with the property and not the owner; the improved properties have an increased value, benefiting both the owner and the property taxing authority; the owner may be eligible to take advantage of federal, state and local tax incentives; local government can facilitate the program with no direct debt obligation; and more.
Under this July 19, 2014 guidance in the event of a default on a residential property PACE loan, the liability is a property tax lien collected by the local government with the priority associated with other real property tax liens. Sort of. The “grand compromise” announced in the guidance is actually a restatement of what exists in current commercial PACE programs. The guidance describes it as,
the property may only become subject to an enforceable claim (i.e., a lien) that is superior to the FHA-insured mortgage for delinquent regularly scheduled PACE special assessment payments. The property shall not be subject to an enforceable claim (i.e., lien) superior to the FHA-insured mortgage for the full outstanding PACE obligation at any time (i.e., through acceleration of the full obligation.)
Which, in Federal government speak, means only the dollar amount of delinquent PACE payments take priority over existing mortgages, not the full amount of the PACE loan. Again, this would be a big deal except for the fact that most State commercial PACE programs are already structured this way.
What is huge is that the HUD and VA block is now lifted on residential PACE financing for energy efficiency, water conservation and renewable energy improvements to homes.
PACE loans can provide the capital to green the existing building stock. This change in Federal policy can jumpstart green building in the U.S.
Existing state programs will have to be reviewed to see if new legislation is required; it may not in many states where there are never implemented programs on the books. And local governments will need to adopt and implement residential programs, including attracting lenders to their jurisdiction. There will be a lot of competition in this space and well drafted local government legislation will be key to the efficacy of PACE programs.
PACE programs are good for the planet and good for improving the housing stock. This dramatic shift in Federal policy will result in significantly more PACE loans, including residential PACE loans across the country.