Is Your Lease Keeping Up? Retail Lease Considerations

Simon Property Group, Inc. recently needed a new roof for its Sonoma, California shopping center. Simon decided to install a new roof that would reflect sunlight and heat off the building, improving energy efficiency. Instead of making payments directly to the lender to finance the project, a special assessment would appear on the shopping center’s property tax bills over the ten-year term of the loan. This unique payment structure is the result of Simon’s participation in one of a growing number of Property rated for clean energy (“RATE“) programs across the country.

This article discusses areas of commercial leases where the use of PACE financing by a landlord could have unforeseen consequences for the landlord or tenant.

What is the PACE programme?
The PACE program offers property owners financing for energy efficiency and renewable energy projects. PACE loans are unique because of the following features:

• Payments via property tax or assessment—Instead of the owner paying the lender directly, the government sponsor of the PACE program places a payment obligation on the property owner’s property tax account in the form of a special levy or assessment.

• Fees continue to be charged after the PACE property is sold—Obligations Related to a PACE Loan Originated on the Property. Any subsequent owner of the property that includes the PACE loan will continue to have a special assessment in effect on their tax bill for the duration of the loan.

• The term related to the period of use of improvements—The PACE loan term is typically longer because it is based on the expected useful life of the improvements. This approach allows the project to become cash flow positive more quickly.

These unique features address the financial barriers that make adopting energy-efficient improvements difficult for many property owners, such as providing a 100% financing solution and a longer-than-usual repayment schedule that can make projects immediately cash-flow positive. To date, 13 states have active PACE programs. (In 2010, only California and Colorado had active PACE programs.)¹

How does a PACE loan affect a commercial lease?
Participating in a PACE program may require some lease enhancements to balance the rights and responsibilities of the landlord and tenant. Here are some things to consider when PACE financing is involved:

• Responsibility for a special assignment—The special levy is expected to be passed on to tenants on a pro rata basis. A lease that states that each tenant will pay their share of the property tax bill but excludes any special assessments or fees may prevent the landlord from passing on the special levy to tenants as planned. Assuming the tenant is responsible for utilities, a lease modification may be desirable to balance the benefits of energy efficiency with payment obligations.

• Obligation to maintain target systems—PACE loan-financed improvements, such as energy-efficient heating and air conditioning systems, can be addressed in a variety of ways within a lease. However, only property owners are typically eligible to participate in PACE programs, not tenants. Adjustments to existing lease terms may be necessary if they require the tenant to install and maintain systems that could be retrofitted to increase energy efficiency.

• Sufficient space and access to the roof—Depending on the nature of the project, lease terms may provide existing tenants with too much roof space to support some projects. As part of the project assessment, the owner must ensure that they have the ability to adequately control access to the roof and space under the existing (or revised) lease terms.

• Sufficiency of power representation—The lease agreement may include statements related to the supply of electricity. Updates to such statements may be needed to address issues that may arise with new technology.

Jurisdictions across the country continue to create PACE programs. Building owners across the country continue to seek to make energy efficiency and renewable energy improvements. As more projects take advantage of this new financing option, the need for leases that incorporate the unique features of PACE financing will become more imperative.