2023

Weighing the cost of capital for commercial development projects

by Bali Kumar

At a time where sponsors and developers are facing a seemingly endless array of increasing economic challenges — including inflation, rising interest rates and deepening supply-chain issues, to name just a few — any tool that eases the burden must be considered. Commercial Real Estate Developers are looking for new ways to reduce the capital costs associated with construction and development. Many are turning to C-PACE (Commercial Property Assessed Clean Energy) financing, which reduces their cost of capital while providing energy efficiencies for their projects.

A confluence of increasing construction costs, high financing costs, supply-chain issues has many sponsors and developers are worried of the economic uncertainty that can follow even after a project is completed. These factors are coming together in a wave of metrics that no longer pencil with traditional financing.

Since the beginning of the year, the 10-year Treasury has increased by 425 basis points, and SOFR and Prime are right behind it. In a typical capital stack, C-PACE comes in and decreases the weighted cost of capital by 100 to 200 basis points. C-PACE sizes down more expensive construction loans, mezz debt, third-party equity or other gap fillers. C-PACE was always thought to shrink the dependence on double-digit interest-rate gap financing, and that’s certainly true. But as of January, C-PACE is even priced inside of debt fund mortgage and even some banks. Because of that many projects include this more competitive form of capital in a construction project’s capital stack.

In light of these market conditions, C-PACE should be considered as a cost-cutting tool as a part of every developer’s budget. C-PACE has been a compelling financing component for many reasons. One, the interest rate is low, and it’s fixed from project development to term, so developers don’t need to place expensive hedges or interest rate caps. Two, C-PACE can automatically transfer to a property’s next owner upon sale, or the current owner can choose to pay off C-PACE before the sale, or refinance, negating worries of post-completion economic uncertainty.

With experts predicting the Federal Reserve will increase rates by another 50-75 basis points in 2023, having long term, fixed rate debt priced at 6% to 8% , nonrecourse with no financial covenants, and assumption restrictions, makes C-PACE a no-brainer. And there’s the added bonus that installing energy efficiencies is very likely going to boost the property value on sale.