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In A Risky Market, Can PACE Financing Give Hotels The Time They Need To Recover?

It could be years before hotel owners and developers see a market they recognize.

Expedia and Booking Holdings both reported a roughly 90% drop in gross bookings in Q2 2020, and data from STR and Tourism Economics from the 2020 Hotel Data Conference predicts that U.S. hotel demand won’t see a full recovery until 2023.

Until the market normalizes, hospitality players are searching for ways to lower their operational costs, including lowering payments for their debt financing.

“What they may not realize is that there is recovery financing that can help them pay down part of that debt, lower their payments and buy them time until the market returns,” K2 Clean Energy Capital Managing Director Stephen Tsu said. 

Tsu is referring to Commercial Property Assessed Clean Energy, or C-PACE, financing. PACE finances eligible energy-efficiency, water conservation, renewable energy or seismic strengthening measures, which typically make up 25% to 30% of total project costs. It allows developers to finance up to 25% of the property value ratio, and use the funds to repay their existing loan, to service debt and/or for operating capital.

PACE can finance operating hotels and other asset types that have been completed within the past three years, depending on the regional program. It is nonrecourse, off-balance sheet financing and is secured by a special assessment on the property taxes.

While over $1.5B of C-PACE projects have been funded to date, a number that Tsu expects to grow rapidly, he said he believes that many CRE stakeholders don’t fully understand how PACE financing works, or haven’t grasped the potential benefits.

Bisnow sat down with Tsu to learn more about PACE and why he believes now is the right time for hotel developers and owners to be considering this unique type of financing. 

Bisnow: How can hoteliers use PACE financing to help them through the current crisis?

Tsu: Now more than ever, hotel owners and developers need ways to raise capital and decrease their short-term operational costs and debt load. PACE financing offers a unique opportunity for them to raise capital that is leveraged against the investment they’ve already made on green technologies in their property.

PACE financing can buy time for the market to recover since it usually includes a capitalized interest period of up to 24 months with no payments due. After that, payments are made semi-annually along with regular property taxes in December and April.

PACE is fixed-rate long-term financing up to 25-30 years, and rates are currently in the mid 5% to 6% range. The financing is based on the as-stabilized property valuation, and as it is a property tax assessment and senior to all debt, it requires approval from any debt lenders.

As U.S. interest rates continue to remain historically low, it may be a good time for developers and lenders to make a long-term bet on hospitality and take advantage of these low rates now, and then reap the rewards when the hospitality market recovers in the next few years. 

Bisnow: How can PACE help mitigate risk for the existing debt lender?   

Tsu: Developers can use PACE funds to make payments on existing debt, to pay down their debt and lower the remaining monthly payments and/or for operating capital to help cover for the lower hotel revenue.

All of these actions improve the operator's financial stability and lower the short-term risk of default. This greatly benefits the lender who sees an immediate influx of capital. It also helps ensure the lender gets paid and avoids both a debt default and the resulting high-risk property sale in a down market.

Depending on the debt term, the 24-month capitalized interest period, completely or at least for this time frame, eliminates risk to the existing lender when it comes to any default events on PACE payments. Also, any subsequent defaulted PACE payments after the cap-interest period only put the amount of the payment plus penalties and interest in a senior position to the lender, since tax assessments are non-accelerating.

Bisnow: What benefits does PACE financing offer developers and owners of other asset types? 

Tsu: Developers can use PACE financing on almost all asset types. What’s great is developers can utilize the funds on retrofit and new construction projects as well as for recovery financing.  

In many deals, developers can use PACE to extend leverage beyond the 50% to 60% debt threshold, which helps deals to pencil out. When replacing mezz debt or preferred equity, it can also lower the overall cost of capital.

Bisnow: What recommendations would you make to someone considering PACE financing for the first time?

Tsu: It’s important to work with a group that is experienced in C-PACE financing. We’ve been working exclusively on C-PACE financing for eight years in California and have closed deals on hospitality, office, retail, multifamily, senior living, industrial and student housing properties. 

We spend time with our clients to thoroughly explain the PACE financing process, develop the engineering report to document all the eligible measures and maximize the amount of financing and work collaboratively with the debt lender to gain their approval. We also have a network of “PACE friendly” debt providers that have previously approved deals. 

Our process ensures that developers are obtaining the most competitive rates and terms on the financing, and we manage the underwriting process to expedite closing

This feature was produced in collaboration between the Bisnow Branded Content Studio and K2 Clean Energy Capital. Bisnow news staff was not involved in the production of this content.