Property owners in the commercial real estate sector are facing multiple challenges, from construction delays to budget overruns to volatile interest rates. To navigate these hurdles, owners facing financial stress will often turn to various forms of rescue financing.
Navigating rescue financing can be complex and dependent on the context-specific needs of the property owner.
Innovative solutions for rescue financing include Commercial Property-Assessed Clean Energy (C-PACE) loans, which provide long-term, low-cost financing for green building upgrades. Another option is Ground Lease Financing, allowing property owners to sell the land underneath the property to a lender or investor, with the option to buy back later. Finally, preferred equity has emerged as a common lifeline. Despite its complexities, it can offer an infusion of capital without underlying property collateralization.
This article delves into these types of rescue financing, exploring their benefits and complexities in supporting commercial real estate projects.
C-PACE
C-PACE loans can be a novel way for property owners to secure rescue financing for their properties. They provide long-term, low-cost financing for green building upgrades, including energy efficiency (e.g., HVAC, lighting, insulation), water conservation (e.g., water saving fixtures), and renewable energy (e.g., solar). Supported by state-level policies, property owners can finance improvements with no upfront costs and repay the financing for a payment period of up to 30 years. The loan is secured by a property lien and is non-accelerable in the event of a default.
The lookback period for C-PACE loans can be up to three years, allowing the financing to be applied retroactively to previously completed projects. Owners work with C-Pace lenders to determine project eligibility. Retroactive C-PACE loans can thus help property owners address challenges with interest rate management, liquidity, and budget overruns. For example, they can provide capital to pay down maturing mortgage debt or provide additional liquidity at attractive rates due to their position in the capital structure.
According to analysis from NAIOP[1], the average C-PACE loan is now between $15 and $17 million, providing a much-needed relief valve given the increase in construction costs.
Ground Lease Financing
Ground Lease Financing can also be an effective nonrecourse financing option for real estate owners. Through the Ground Lease structure, the land underneath the building is sold to a lender, who then leases the land back to the real estate operator on a long-term (between 50 and 99 years) basis.
The owner can receive a lump sum payment between 30-35% of the as-stablized value, providing funds for construction, renovation, or asset repositioning. These funds can also offer a solution for distressed properties by allowing owners to use them to pay off the senior loan and capitalize the lease payments for up to 36 months. This presents a viable alternative to foreclosure for real estate owners.
Many lenders offering ground lease financing also give owners the option to buy the land back after a few years at a predetermined price, providing owners the peace of mind that they can repurchase the land as capital becomes available.
Preferred Equity
A more common form of rescue capital, especially in recent years, has been preferred equity.
Unlike mezzanine financing, preferred equity brings in parties as equity partners via joint ventures or limited partnerships. Further, unlike mezzanine financing, preferred equity is not secured by the property itself, but is collateralized by the owner’s common equity position. The debt is subordinate to mortgage loans and mezzanine loans, but is senior to common equity.
Preferred equity deals are often complex and have several trade-offs, including giving the preferred equity investor priority in profit distribution and tax benefits. Despite the complexity, developers often will accept these terms to salvage or jumpstart stalled projects.
The dynamic nature of commercial real estate presents ongoing challenges for property owners, ranging from project delays to financial uncertainties. However, the market also offers innovative rescue financing solutions.
C-PACE loans provide a pathway for green building upgrades with long-term, low-cost financing supported by state-level policies. Ground lease financing offers property owners financial flexibility while maintaining operational control. Additionally, preferred equity has become a lifeline for owners amidst market fluctuations, offering investors priority in profit distribution.
These innovative financing options highlight the variety plethora of solutions property owners can deploy when experiencing distress in the real estate market.
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[1] National Association for Industrial and Office Parks