In early January, we provided a synopsis on the guidance issued by HUD on January 11th, 2017, which allows for PACE Equity financing on project which has a HUD mortgage or guarantee. Currently, PACE is active in 18 states including the District of Columbia. Each of those states have different PACE guidelines & requirements that can impact the HUD guidance discussed below.
In reviewing the HUD guidance, much of the process includes standard HUD project procedures as it relates to approval, reporting and waivers. Therefore, we have outlined the strengths and challenges associated with the guidance issued by HUD when utilizing the PACE program.
Positive Attributes of Guidance Issued By HUD For PACE Programs
The strengths are captured in the twelve HUD programs included in the guidelines that reflects a clear path to approval for any borrower utilizing HUD and PACE. Within the approval processes are built in waivers that address some of the challenges that might arise with Debt Service Coverage Ratio (DSCR) and positive operating profits or net income disclosed on the annual financial statements.
The DSCR requirement is a 1.10 which is less than that of most lenders and investors allowing for less challenge during the underwriting phase.
The approval process and conditions are within the standard HUD financing or program commitments allowing for the HUD financing and PACE financing to run in conjunction without interrupting the closing timeline. HUD views the PACE financing as debt service and maintains their Loan To Value (LTV) limits of 83% to 90% for various programs and financing, inclusive of PACE. The amount of financing will be impacted by the amount of utility savings and energy efficiency that result from an energy audit. PACE Equity can complete the required energy engineering and add value during the building’s design process, to drive additional savings to increase the PACE sizing, while adding only incremental construction cost.
Green Fee: Get the Best Return
To realize the strongest return for the developer, it is most effective to structure the project with owner paid utilities or a “green fee”. If the borrower wishes to pass savings onto the tenant then a Ratio Utility Billing System (RUBS) maybe used while still capturing a portion of the savings beyond the common area utilities. For market rate, mixed income, and age restricted multifamily projects, a green fee may be added for the borrower to mitigate a portion or all of the debt service payment included in the capital stack through PACE Equity, so the tenant is capturing both the savings and part of the cost.
Challenges In HUD Guidance
Inversely, there are a few challenges present in the guidance as it stands. The Rental Assistance Demonstration (RAD) program is not included which in practice would benefit the most from allowing PACE Equity as a funding source. RAD projects are existing HUD owned projects in need of moderate to substantial rehab and refinancing that come with a Project Rental Assistance Contract and are meant to be owned by Public Housing Agencies (PHA). This rental subsidy would make it advantages for developers and PHA’s to add value but also retrofit the project for significant energy efficiency. Additionally, the HUD 223f program that is very successful among multifamily which does not allow for the inclusion of PACE in the capital stack.
HUD has a requirement that the Attorney General of the state writes a legal opinion, which confirms the attributes of the PACE law in that state. Thus far, only one state has successfully obtained this opinion. PACE Equity views this as a large challenge, as it may not be possible or may take too long to be practical.
Finally, as referenced above, the HUD guidance also references the energy savings which are required for each project. The requirement is that the utility savings (with a 25% discount) exceed the payment in year 2. There are several benefits included in this calculation but this can or cannot be a barrier.
PACE Equity and HUD Guidance Standards
PACE Equity worked with HUD on the guidance and has successfully obtained consent from HUD. We are working on multiple projects with HUD backing and thus, are the leading experts in utilizing PACE financing with HUD projects, also having created innovative ways to include a green fee. Contact your local Market Leader to discuss your HUD project and how it can work for your project.