C-PACE provides 100% financing which helps many commercial building owners retain and attract new tenants while preserving precious liquidity. It’s become quite clear that tenants demand a safe comfortable working environment and now is the time for owners to reconsider the HVAC upgrade/lighting retrofit they’ve been putting off the last few years.
By making this investment, the owner’s building will be much more attractive to tenants when trying to renew leases and fill vacant space. However, it requires capital which is precious to owners enduring a substantial decline in rental income from tenant departures and rental concessions required for renewals and to fill vacant space. This is where C-PACE financing can provide an important tool to help building as described below.
This article answers these three questions.
- Split Incentives: do they still exist?
- Tenant Investment Economics: can an efficiency investment pay for itself?
- Funding: how does C-PACE provide attractive funding for efficiency investments?
1) Split Incentives – Do they still exist?
For years owners have been loathed to invest in efficiency projects because tenants receive all/most of the direct benefits of avoided repairs and lower utility costs. However, all else equal, tenants demand space with a safe comfortable working environment without incurring high unexpected repair costs.
Happy tenants = rental income and that why the phrase “efficiency investments” is more accurately characterized as “tenant investments.”
Back to our question above – do split incentives still exist? I would say no, especially in today’s market and likely well into the future.
Yes, tenants still benefit directly from the reduction in repairs and utility costs. However, owners clearly do as well and in some markets, a tenant investment will clearly differentiate their building versus competing space. While in other markets, it’s a necessary investment to keep up with the competition.
Important note: the split incentive problem arises primarily when owners sign tenants to triple net leases. However, owners using modified gross lease or traditional gross leases similarly benefit from tenant investments.
Now that we’ve tackled the split incentives question, let’s look at the economics.
2) Economics of Tenant Investments
Owners using any of the most common commercial property leases, benefit in two ways.
1) Additional rental income from filling vacant space and/or renewals.
- Vacant Space – if the enhanced space causes vacancies to be filled earlier by say ~ three or four months, it accelerates the collection of incremental rental income by hundreds of thousands of dollars (depending on building size and rental rates).
- Renewals and Extensions – if an HVAC upgrade/lighting retrofit was long overdue, existing tenants have likely been frustrated by high operating costs in an uncomfortable working environment. A tenant investment could play a huge role in causing tenants to stay allowing the owner to avoid a lengthy vacancy while searching for another tenant.
2) Reduction in Financial Concessions
- Many owners are enduring tenant concessions in the form of rental forbearance, build out allowances, etc. when trying to retain and attract new tenants. Although difficult to quantify, it’s reasonable to assume tenants could demand lower concessions for higher quality space.
Important note: in addition to the benefits above, owners using modified gross or gross leases receive another substantial benefit.
To the extent owners pay for repairs and/or utilities, their operating costs should decline substantially.
Although this all sounds good, the biggest questions remains – how do owners pay for a tenant investment when liquidity is needed to simply keep the doors open.
3) Funding from C-PACE
If the owner uses C-PACE, 100% of the tenant investment can be funded with annual payments delayed for up to 1 to 2 years in many cases.
In other words, with no $$$ out of pocket for at least a year, owners can enhance their ability to attract tenants which boosts their staying power while waiting for the market to normalize!
In addition to the above, C-PACE provides numerous other benefits to building owners:
- low annual payments from 20+ year financing,
- freedom to sell the building – lender can’t block the sale and the obligation is assumed by the buyer, and
- no total debt acceleration, owner guarantee, financial/operating covenants, or quarterly reporting.
The discussion of C-PACE is purposefully narrow to fit the scope of this article. However, C-PACE also helps building owners derive liquidity from past building improvements and provides construction financing as a great long term alternative to mezzanine funding as shown in the Addendum below.
- The age-old split incentives problem should be considered a thing of the past.
- Owners benefit from “tenant investments” in three ways:
1) tenants value space which is safe and comfortable with low operating expenses,
2) financial concessions could be lowered, and
3) operating expenses decline for most owners with modified gross/gross leases.
- C-PACE provides 100% financing allowing owners to reap the benefits above.
Please feel free to comment or ask questions. The views of others are always appreciated.
Questions? Feel free to reach out to Larry Derrett, founder, and CEO of EnFlux Building Solutions.
About the author: Larry Derrett is the founder and CEO of EnFlux Building Solutions which provides: 1) an ongoing program to help service based contractors and ESCOs overcome the challenge of selling to the C-suite, and 2) funding solutions to building owners. Having sat on both sides of the desk as a banker and CFO, he brings a unique perspective to why businesses often fail to invest in efficiency projects.
It’s important to note that C-PACE is not available everywhere in the US as shown in both of the articles reference below.
C-PACE provides two other substantial benefits to building owners in both the owner occupied and tenant occupied segments as shown below:
1) recapitalization financing which provides owners with much needed liquidity by borrowing against a long list of building improvements made over the last 1 – 3 years as shown in the article below:
2) construction financing: which provides a great alternative to mezzanine debt as described in the article below: