SF Apartment : March 2018
Pick Up the PACE
by Lance Mald
Since 1736, when Benjamin Franklin proposed the idea of a property tax to pay for the Philadelphia Fire Department, tax assessment financing has funded public service projects from new sidewalks to schools. Today, PACE (Property Assessed Clean Energy) is the nation’s first voluntary property tax assessment applied to improvements within individual buildings.
You may be thinking, “Why would I want to pay a voluntary property tax?” But, think again. While it’s true that paying your tax bill rarely results in any excitement—and if your pulse does quicken as you’re writing out that check, it’s most likely due to the fact that you’re parting with your hard-earned cash—the PACE program is an intriguing and innovative way to finance green and seismic property tax improvements without tying up capital.
An alternative to a traditional loan, PACE financing places a non-ad valorem assessment on a property, which means it is based on an improvement or service cost allocated to a property rather than on the property’s value. This assessment allows owners to repay their building improvements on their annual tax bill. The repayments appear as an additional line item on the bill, similar to a local assessment, such as a parcel tax.
Unlike conventional infrastructure financing, which requires hefty upfront expenditures, PACE assessments cover 100 percent of hard and soft development costs, including design, labor and service contracts. No out-of-pocket costs are incurred, and closing costs can be capitalized with no upfront expenses to the owner.
PACE financing is also unique in that it allows for almost full financing of related projects, as well as the main improvement. In San Francisco, for example, a PACE-financed multifamily seismic retrofit project may also include the addition of accessory dwelling units (ADUs) with a substantial amount of the costs covered. ADUs, also called secondary units, are apartment units added to existing residential buildings in an attempt to create more housing for San Francisco residents.
ADUs make use of underutilized areas such as basement storage, boiler rooms or parking spaces by converting their square footage into rentable residential dwellings. In San Francisco, the addition of new ADUs to a property can mitigate the costs of a property’s city-mandated seismic retrofit. When performing a seismic retrofit, owners can raise the height of a basement ceiling up to three feet to make the space suitable for residential use without having to comply with certain San Francisco Planning Code notice requirements.
This long-term funding is available for building improvements spanning everything from solar panel systems to green roofs to seismic upgrades—even drought-tolerant landscaping is eligible. PACE assessments are financed over the useful life of the new equipment or improvement, with terms up to 30 years. Owners retain all federal, state and local tax incentives, rebates, deductions and depreciation for the upgrades.
With most energy-efficient enhancements the cost savings outweigh the financing payments from year one. Imagine: you could improve your property and be cash flow positive in the first year. Improved properties have the added benefits of increasing tenant retention and netting higher rents.
PACE financing also solves the dilemma of split incentives for most property owners. No longer does the property owner bear the financial burden, with the tenants receiving all the benefits. The costs of these property improvements can often be transferred directly to tenants.
For example, owners of San Francisco soft-story apartment properties that use PACE to finance their seismic work can pass through 100 percent of their PACE assessments to tenants. This is a significant benefit to owners dealing with the costs of the city’s soft-story seismic upgrade mandate. By aligning landlord and tenant interests, this financing works to improve aging infrastructure and increase property value and net operating income.
Now the big question: is your property eligible for PACE financing? PACE is a national program, though financing is approved state by state and then adopted by individual municipalities, incentivizing building owners to make sustainable and energy-efficient improvements on their properties. San Francisco has allowed property owners to finance sustainable property infrastructure improvements through this innovative tool since 2014.
Within San Francisco, PACE eligibility is ultimately determined by the overall strength and value of the real estate, not the financial wherewithal or personal guarantees of the owner. For PACE eligibility, it’s vital that owners are up to date on all mortgage payments with no late tax payments in the past 36 months (or since the purchase of the property if owned for less than 36 months).
Also, all improvements must be permanently fixed to the property and the total amount of the annual property taxes (including PACE payments) must not exceed 5 percent of the property’s fair market value at the time PACE financing is approved. Also note that a multifamily property as defined by the California PACE Authority is one comprising four or more units. Multifamily properties qualify for financing of up to 35 percent of the estimated property value, with payments fully amortizing over the life of the assessment. As the funding is directly tied to the physical property, it passes on to the next owner upon sale.
The proof of PACE’s efficacy is in its popularity. As of December 2016, PACE had already been adopted by 480 cities across California. PACE-enabling legislation is active in 33 states with active programs in 20 states, as well as Washington, D.C. Initially, PACE was limited to residential housing but due to high demand from other sectors it has been modified to include commercial, retail and multifamily, among other property types.
Since its inception, this unique financing tool has seen exponential growth in its implementation, improving thousands of properties across the country, creating jobs and providing countless benefits to owners. Judging by the welcome adoption of PACE financing, and the number of smiling property owners happily paying these additional tax assessments, its influence will only continue to grow.
Lance R. Mald is the CMO of Counterpoint SRE, which works in conjunction with the city to provide financing for green property improvements and seismic upgrades. He can be reached at email@example.com.