Five Considerations: Using Commercial PACE for Condominium Construction – Real Estate and Construction

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United States: Five Considerations: Using Commercial PACE for Condominiums

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With the adoption of stricter and costly environmental regulations affecting buildings across the country, commercial properties rated as clean energy (CPACE) financing offers a unique mechanism that can be used to finance related energy efficiency and renewable energy projects at a lower cost-effective rate than traditional borrowing. CPACE recently became available in New York for
modernization commercial real estate projects, and the city is expected to pass legislation to make CPACE funding available to new development projects already in September 2021.

A key element of CPACE financing is that, unlike traditional debt financing, the CPACE loan is repaid in installments through a tax charge on the property concerned, which typically allows for long loan terms that can last anywhere from 20 to 30 years. This structure leads to an interesting dynamic in the context of residential condominium development, where real estate is subdivided into several units and usually transferred to third parties rather than owned by a single individual or legal entity. IN Principles of the CPACE program indicate that “residential condominiums currently jointly owned by a commercial entity” are eligible for CPACE funding “if and until such a unit is sold.”

Here are five considerations this requirement raises in condominium developers, apartment owners retrofitting and converting their property into condominium ownership, and lenders regarding the applicability of CPACE to their property:

  1. Prepayment penalties… In the case of the sale of individual condominium units, the CPACE loan will have to be partially repaid at each closure. Thus, the lender will seek to establish prepayment penalties and exit fees that compensate for the increased likelihood that all or a significant portion of the loan will not reach maturity. In turn, the borrower will need to account for this penalty in its own underwriting to determine if the total cost of the CPACE loan provides the desired projected net sales.
  2. Interaction with the senior lender… The preemptive loan documents stipulate that each unit may be exempted from a preemptive loan only if a minimum selling price is obtained, which usually also takes into account a limit on the amounts that can be deducted from the gross proceeds of the unit’s sales … Partial early repayment of the CPACE loan will have a significant impact on these calculations. This will be a critical point in the negotiations, as developers will seek senior lender approval for CPACE financing, which is almost always a requirement under the primary loan documents. Given this requirement and the requirement for a partial early repayment of the CPACE loan, together with the penalty as described in the previous paragraph, developers can view CPACE as short-term funding and seek to recapitalize the project prior to the establishment of the condominium and use the new capital. repay the CPACE loan in full.
  3. Lack of details in the program rules… The discussion of condominiums in the Program Guide is limited to one case mentioned above. It is good news that condominiums are directly referred to as eligible, but the lack of meaningful details will force market participants to figure out many of the nuances of how the program will actually be implemented to develop the condominium. This can lead to different interpretations and conflicting approaches from lender to lender and from project to project, and also created a great deal of uncertainty as to what would happen if the project was found to be in violation of the Program Guidelines. For CPACE to be as useful as possible, further guidance will be required.
  4. Bulk sales… Sometimes a condominium developer sells apartments in bulk to an operator or investor. In a scenario where the CPACE developer / borrower sells all of its units, the units will still be “jointly owned by a commercial entity,” so will the CPACE loan remain in effect? Alternatively, if only a fraction of the units are sold, is there any flexibility for the CPACE loan to remain in effect for the units sold as long as they are managed by a commercial entity? Again, the lack of details in the Program Guide leaves these questions open to interpretation by the market.
  5. Cooperatives… Unlike condominiums, cooperative ownership is owned by a single corporation, which then sells shares in that corporation to apartment owners. This structure makes CPACE funding ideal for cooperatives. In addition, some condominiums have cooperatives that exist within the condominium. The specific legal structure of ownership may lead to an easier way to obtain a CPACE loan for property that has a condominium, although condominium offers are otherwise generally seen as more attractive than cooperatives.

Kramer Levin is uniquely positioned to advise clients on CPACE financing in general and in the context of condominium construction in particular. The lawyers of our nationally recognized real estate practice and market-leading condominium group work together to provide a business-oriented, holistic and holistic approach to every transaction. In addition, market-leading securitization practice Kramer Levin also regularly advises securitization participants related to CPACE loans. Clients and contacts are encouraged to contact the authors of this article to discuss CPACE financing and condominium development and CPACE loan securitization.

The content of this article is intended to provide general guidance on the subject. You should seek professional advice regarding your specific circumstances.

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