A lending platform designed to fund investments in renewable energy and energy-efficient improvements, commercial PACE lending has helped hotel owners and developers in need of capital during the COVID-19 pandemic.

PACE financing, which stands for property assessed clean energy, originated in the late 2000s, said Jim Butler, partner at Jeffer Mangels Butler & Mitchell and chairman of the law firm’s global hospitality group. This type of lending has has taken a while to fully catch on with developers because state legislatures have to pass laws to enable it. Often county and local municipal governments must pass their own legislation, as well.

Currently, 36 states and Washington, D.C., have authorized commercial PACE lending, and of those, 24 states and D.C. have active lending occurring.

PACE financing has the potential to reach into the billions and trillions of dollars, and part of that potential comes from the hotel industry, Butler said.

The pandemic has devastated U.S. hotels, forcing some to close temporarily or permanently. Hotel owners are dealing with the revenue declines of 2020 while also facing property improvement plan requirements over the next few years.

“They’ve been saving every penny and going to the bare minimum, but they’re going to have to do property improvement plans and rehire people ... train them and do marketing,” Butler said. “They’re facing a lot of costs in getting back into business.”

One of the things that makes PACE financing so appealing to borrowers is it’s a self-assessment, similar to a tax improvement district, except the owner voluntarily imposes a long-term tax agreement on the property for up to 30 years, Butler said. It’s a non-recourse loan, and interest rates are typically low at about 5% to 6% because of its high security. Rather than the owner holding the debt, the loan remains with the property even following a transaction.

PACE lending is tied to energy efficiency expenditures during new construction and renovations, and the improvements can help save on utility costs, he said. Borrowers can use PACE lending on things like HVAC systems, insulation, water systems, geothermal heat recovery, lighting and solar energy.

In some states, such as California, owners can take advantage of what’s called “retroactive PACE,” Butler said. What that means is owners can receive PACE funding for qualifying capital expenditures made in the recent past. California has a 36-month window.

“You can include all the expenditures which have already been made and are eligible for the PACE financing,” he said.

That means owners can look at what they spent on eligible improvements within the allotted time period and recover that cost through PACE, he said.

“You don’t have to spend it on those things,” he said. “You just must have spent it on them. If that’s the case, your funding is available for anything you choose. Pay down senior debt, operating expenses, expansion.”

About 70% of Stonehill’s PACE financing deals are for hotels, said Jared Schlosser, vice president of business development at Stonehill. The company has closed on about $200 million in PACE deals over the past year, making it one of the larger PACE lending groups currently. It closed the country’s second largest PACE deal for the CitizenM Downtown Los Angeles at $42 million, in the middle of the pandemic while the property was in the middle of construction, he said.

Stonehill has 10 deals signed currently and more than $600 million in term sheets, he said. It also has more than 100 opportunities it’s looking at across the country.

“We do this on construction, as well, as we do a lot of retroactive PACE, which is really where you’ve seen the explosion of PACE in the hospitality sector,” he said.

The challenge for PACE has always been getting senior lender consent with the new capital stack structure, as PACE loans take the senior lender’s position, Schlosser said. One of the benefits of the retroactive PACE deals is that they make senior lenders more comfortable because those proceeds will help the hotel owner and improve the property’s performance.

“It's a win-win for everybody involved, and that's why I think you're seeing a lot of adoption,” he said.

PACE financing has been a critical tool during the pandemic for hotels that are mid-construction, need to boost liquidity and have eaten through start-up reserves because of cost overruns stemming from longer construction times, said Ethan Elser, executive vice president at PACE Equity. As markets reopen and people start traveling again, there will be more ground-up and major renovation projects going forward.

PACE Equity funded construction of the new JW Marriott hotel in Dallas, which he said was a good project before and during the pandemic, and will remain so when it opens in about two years.

“From our standpoint, the quality of projects that are getting done are stronger than pre-COVID,” he said.

Eventually all 50 states will have PACE legislation, Elser said. It usually takes multiple tries for state legislatures to pass the necessary bill and a local champion, usually an investor/developer or clean energy non-profit, to make the connections and put the dollars behind lobbying efforts.

It’s debatable whether PACE lending could be part of every hotel deal, given the lower cost of capital in institutional-quality deals, but it will be available for most projects, he said.

“The question that we are now posing much more often is how do we add more value than just funding,” he said, likening it to historic tax credits or new market tax credits.

“We see the future of PACE funding as a way to open the door to being able to leverage much more benefits than just a funding experience,” he said.

PACE lending is attractive to any hotel owner, especially given the lack of liquidity in the space, Schlosser said. Over the next few years, he expects a majority of hotel deals will have some PACE components.

PACE is a cost-effective way to lower the cost of capital compared to the alternatives of mezzanine and preferred equity, he said. The average PACE yield is about 5.5% or 6%, compared to 12% to 20% in the other types.

“Until that gap narrows, I think you’re going to see a huge demand for PACE from owners getting it in their capital stack,” he said.