Hotel Lawyer: PACE Financing – Now an accepted tool for hotel lenders and borrowers | By David Sudeck

Hotel finance lawyer: PACE Financing is now mainstream

About five years ago, my partner David Sudeck, a senior member of JMBM’s Global Hospitality Group®, spoke at a hotel industry conference about the attractive features of PACE financing as an innovative financing technique. David has extensive experience with virtually all kinds of real estate financing from senior debt to joint ventures. At the time, he had just finished working on a hotel financing that included components of a senior construction loan from a private lender, Mello Roos community facilities district financing, EB-5 financing, and PACE Financing. Few people in the audience at the conference had heard about PACE financing, and there were a lot of questions about its characteristics.

Over the past five years, PACE financing has gained wider acceptance, and moved from a novel or creative technique to a widely-accepted practical solution to financings. It has gained traction with both lenders and borrowers. But its gradual increasing use was accelerated by the COVID pandemic and resulting lockdowns, and near collapse in many segments of the hospitality industry. The accompanying deficiency of construction and other financing since March 2020, supercharged the importance and use of PACE Financing. Over the past few months alone, David Sudeck and his team have worked, on the lender and borrower-side of transactions, on more than a dozen PACE financing transactions. The largest that we have worked on, more than $40 million of PACE financing, closed just a few weeks ago.

At this point, most owners and developers are considering PACE financing as part of their capital stack for development, for renovation, and for rescue capital (more on this below). And more and more lenders have been approving PACE as a part of the capital stack. Why, you ask?

Why PACE financing can be attractive:

PACE financing takes the form of a voluntary tax assessment on real property, having the same features and priority as an ad valorem real property tax (typically paid only twice per year, when real property taxes are paid). Here are some of the features that may be negotiated which can make it attractive financing:

  • Meaningfully lower rates than traditional mezzanine debt and equity
  • Terms up to 30 years with fixed-rate financing
  • No personal recourse guaranty (though a completion guaranty is often required)
  • Ideal for renovation/”PIP” financing
  • Capitalized interest component allows years without any payment due
  • Interest-only period
  • A growing number of cities, counties and states have active PACE financing programs
  • Fully assumable financing (no due-on-sale component)
  • Prepayable (often with a declining prepayment fee)
  • Meaningful portion of the capital stack (often 20%+ of the building’s value)
  • Fast and efficient process (PACE financing documents are less complex than typical real property-secured loan documents, and the due diligence process is usually meaningfully faster and less exhaustive)
  • Limited default triggers (the most material being failure to complete the development and failure to make a payment – no financial covenants or tests applicable)
  • No acceleration on default – if the property owner misses a payment or payments, the default can be cured by the property owner or the lender with the late payment or payments that include penalties and interest; the entire amount of the PACE financing does not become due as a result of a default

PACE financing has generally been thought of as a type of construction financing, but it can also be available for certain completed or operating properties. This is called “retroactive financing” which can provide the ability to refinance qualified improvements such as the costs of HVAC, electrical and water efficiency systems, building envelopes, seismic foundations and upgrades, and related soft costs. The retroactive financing calculation can include costs relating to improvements completed as much as 36 months earlier than the closing, in certain jurisdictions.

The PACE proceeds from such retroactive financing can be used for working capital, paydown or payoff of existing loan obligations, or payment for PIPs or improvement.

Why has PACE Financing Become so Popular?

During this COVID-induced downturn, despite the abundance of capital sitting on the sidelines, traditional capital sources have pulled back significantly. Some believe the hospitality industry is too volatile and want to see how long the downturn lasts. Some have tougher underwriting requirements or have reduced funding as a result of lower values derived from lower comps from distressed sales, reduced NOI, lower loan-to-value requirements and/or higher pricing for more conservative financing.

Yet many hotels need a capital infusion in the current market to avoid a loan default and foreclosure. PACE financing has emerged as a popular solution to provide capital to fund senior loan debt service, pay down senior loan principal balances, fund renovations and brand conversions, and in some circumstances, where the property owner has substantial equity, to fund new construction. A number of senior lenders did not previously accept PACE in the capital stack, because of the super-senior nature of PACE financing. However, recently, many such lenders have determined that PACE financing is a good — and possibly the only — financing source available, absent additional funding by the senior lender, to stabilize their collateral property.

How we can help with PACE financing

PACE lending has become an important and fast-growing sub-specialty in our hotel finance capabilities. We work with PACE providers/lenders and borrowers. In fact, we have been fortunate enough to work with one of the leading providers of PACE financing as they expand their national platform.

We welcome inquires to see if we can help you evaluate potential PACE financing opportunities.

For PACE financing and other hotel finance-related inquiries, contact David Sudeck, at 310.201.3518.

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