Financing and Benefiting from Implementing ESG in Real Estate

In this Solutions InSight presentation, we identify financing options and incentives available to real estate companies to help them manage the initial cost of implementing environmental, social, and corporate governance (ESG) initiatives. We also discuss how implementing these initiatives can improve a real estate company’s long-term financial and portfolio position. Featuring special guest, Bali Kumar, the Chief Operating Officer of Pace Loan Group, we highlight how PACE Loans can be used as a financing tool to make real estate property more sustainable, and how this can benefit a company overall.

The commercial real estate industry is responsible for 39% of total global greenhouse gas emissions. As a result, there have been increased calls for ESG and sustainability targets for the industry, such as net-zero targets set for new buildings by 2030, retrofitting pre-existing buildings by 2050 and the SEC’s proposed climate-related disclosure requirements, which would mandate public real estate companies to disclose information about their climate-related risks, governance and management processes.  

Improving your real estate company’s financial and portfolio position with ESG  

Real estate companies can improve their bottom line and portfolio position by implementing ESG and sustainability initiatives. We’re seeing that:   

• ESG is shaping and influencing real estate valuation. When investors see ESG and sustainability in a real estate company's portfolio, they believe the investment is safer because they think the company is more attentive, proactive and responsive in mitigating its risks. This often results in a lower overall cost of borrowing. 
• Implementing ESG and sustainability initiatives can help decrease the amount spent on insurance premiums and expenses relating to repairs and maintenance due to severe weather-related events, as well as repairs and maintenance. 
• Real estate companies can comply with local ordinances regarding decarbonization, thus avoiding large fines and penalties. 
• By meeting these carbon and energy reduction targets, companies can improve their asset value and overall position. By implementing these ESG and sustainability initiatives, real estate companies can immediately increase reasonable value and mitigate against potential decreases in their fair market value associated with failure to comply and meet these new net-zero laws.  

What is a PACE Loan? 

Although ESG and sustainability efforts are essential, implementation is often viewed as daunting and as placing an unwarranted strain on real estate companies' finances and operations. Real estate companies can finance these initiatives by means including conventional loans, capital contributions, green bonds or crowdfunding, but another option is a PACE loan.  

PACE is a method of financing commercial real estate that companies can use to retrofit and renovate existing buildings.   

Depending on the state, owners and managers can also use PACE to retroactively reimburse themselves for previous work done in the last 12, 24 or even 36 months. Reimbursement, retroactive PACE and rescue capital are interchangeable terms that mean people can "reward" themselves for their previous work.  

Types of PACE Loans 

There are two types of PACE loans: residential and commercial. However, residential PACE is rare and only exists in three states. Commercial PACE has active programs in almost 30 states, with legislation passed in nearly 40 states.   

Commercial PACE loans are fixed and not floating, so the interest rate will fix at a close, and the fixed interest rate in the term can go up to 30 years.   

Since rates often fluctuate over time, property owners and developers are particularly interested in PACE since the interest rate is long-term fixed. PACE capitalizes interest through the construction period so that people are not making out-of-pocket payments until after the building is up, running and earning income.  

PACE is a non-recourse voluntary special assessment, not a mortgage. It runs with the land, and if someone is buying a property intending to sell, they can walk away from the PACE loan and the buyer automatically assumes the PACE loan because it is on the property tax rolls. It is important to note that a PACE loan cannot be accelerated.  

Energy Efficient Tax Incentives 

Tax incentives include the 179D commercial building energy-efficiency tax deduction and the 45L energy-efficient home tax credit. So, for instance, the 179D is a federal deduction applied to ground-up energy-efficient construction projects and energy-efficient retrofitting of pre-existing buildings. So this 179D applies to all types of energy-efficient commercial buildings and residential rental buildings at least four stories tall. The 45L tax credit is a one-time federal tax credit promoting the construction of energy-efficient residential homes. This credit is available to builders, developers and others who build houses for sale or lease. 

Real estate companies can utilize cost segregation studies to generate these additional tax savings, accelerate the income tax depreciation deductions and maximize their real properties' financial returns by generating significant cash flow savings.