Episode 1: David Schaefer

In this inaugural episode, Adam interviews David Schaefer, President of DSS Advisors and former COO and co-founder of Counterpointe Sustainable Real Estate, a national C-PACE Provider.

Transcript

Adam Lipkin: 0:00

Welcome to the C pace confidential, where you'll hear about the hottest happenings in the world of C pace, commercial real estate and beyond. We speak with the top players doing the most exciting projects and discover just how c pace has evolved into one of the most innovative financing options in the industry and how you can use C pace to be more successful in your business today. Now, here's your host, the C pace guy, Adam Lipkin. All right, all right. Hey, everybody, welcome to the CPACE confidential, I'm your host, Adam Lipkin, the CPACE guy, I'm just so excited for you to be able to join us for this kickoff episode, it's been something on my mind for a little bit and in the works for a while, had been involved with commercial real estate now for the last couple of decades. And in this world of CPAs for the last several years, and it's so exciting to see it grow and evolve. And oftentimes you're doing a lot of awareness and helping people learn about this product. And yet still, after several years, most people don't know about it, even fewer have done a transaction with it. So just after some some pressing, I realized that it was gonna be something meaningful to be able to share with folks in the commercial real estate industry a little bit more about this product, you know, maybe dispel some myths, I think anything worse than lack of information is a misinformation and thinking of something a certain way when it's maybe not reality that way. So excited about the show, cuz I have some guests, some folks that have done some awesome things, the world of CPAs, some of the folks that I go to for that extra insight and knowledge, we're going to be bringing on everybody from deal makers on the lender, broker borrower side, putting together awesome capital stacks, folks that have been in the industry helping to put together some of the legislation and structure some of the more complex deals. And we're gonna have this be something that ideally you walk away with or some new insights to be able to see how you can make something successful for your business. So with no further ado, we're kicking off this episode with your really my go to guy for the last several years when it comes to sea bass. Anytime you have that call a lender that's trying to figure out how to incorporate sea bass into their business, how to structure a deal with it, brokers, borrowers that are looking to push the envelope and figure out how to make CPS work for them. This is my guy, just really as smart as it gets when it comes to knowing the ins and outs of CPS how to get things done. So we got David Shaffer with us today. I'm going to bring him on. And it's going to be a really fun conversation we're going to have with David learn a little bit more about sea bass. David, thanks so much for joining today. Really, like I said, I'm just so happy to be able to kick off the show with you. You've been such a good personal friend for years now. And I really just find you're always my first call when it comes to just, you know, thinking about how we could do something with sea bass. And so really wonderful to have you on the show.

David Schaefer: 2:46

Well, thank you Adam, and good afternoon to everybody. I am David Schaefer. I'm the president of DSS advisors, a strategic consulting and advisory firm. A large part of our practice is in CPACE financing. We consult with governmental and non governmental entities, program administrators and investors and other other stakeholders. My background is as an attorney, it's where I started my career. I specialized in corporate securities and financing transactions. And on the financing side, my focus was on the securitization of esoteric assets. A little over 10 years ago, I was representing a client that was investing and financing and managing delinquent tax liens. It was that representation that introduced me to PACE financing, which is at its core financing secured by a tax lien. After my term as a as deputy chairman and managing partner of Loeb and Loeb, the firm where I was practicing an AM Law 100 firm. I co founded Counterpointe Sustainable Real Estate and served as its chief operating officer for a little over five years. During that period of time, I was responsible for strategic relationships, originating and managing those relationships, product development, legal legislative and Governmental Affairs, Program Administration servicing and a variety of other things that are part of the day to day responsibilities of our chief operating officer. I met Adam, when we were at counterpoint together and we've developed a great relationship and I'm delighted to be part of this kickoff. Yeah, pace confidential.

Adam Lipkin: 4:49

Now appreciate sharing that background. And just as I'm here and I'm just like, you pretty much have seen everything you know, you see so many sides from the regulatory side and compliance to the actual structuring and operation of what it looks like. To run a CPAs business, so really quite a quite a wide range of knowledge and really in depth, I think when it comes to your background and insights that you've gathered over these years. So let's just talk about where the interest is, is that today, I mean, the industry has grown tremendously, there's still a long way to go, in my opinion, though, I had seen it, I want to say was the summer of 2017. And I found that I said, wow, you know, in terms of financial products, this is one that comes along every so often that you just really know there's going to be a big future with it. And I kind of felt that over the next decade, this is just going to be growing tremendously, kind of almost thought of the comparison of cmbs in the late 90s, and how that grew. But like a lot of things, there's an adoption cycle. And so you know, everybody has the baseball analogy of what inning are we in with C pace, and I still feel like we're probably in like the second or third inning of that. But even with that there's been some some incredible growth in terms of volume annually, in terms of the size of deals. So tell me, what do you find right now is some of the most exciting things that you're seeing in the space industry? What are you seeing happening?

David Schaefer: 6:04

Well, I think perhaps one of the most noteworthy elements is the increasing number of participants in the sea pace industry, I think what we've, those of us in the industry, you have all been looking forward to, is actually having, you know, more people interested in NC pace. And that means, you know, investors and lenders, and people who, you know, prepared to establish programs. That's, you know, been relatively recent, I think, in the last in the last several years, you know, up until that it has been a little bit of a choppy and slow growth environment. So I don't I don't know what any women. But maybe I think the way to characterize it is that we are at the end of the beginning. And now we are ready to get into the next step of C PACE financing.

Adam Lipkin: 6:58

Yeah, I like the end of the beginning, right. And so, you know, I found that like, the, the overriding biggest gating issue has been lenders, and how they are looking at it. And I always find that, you know, there's an interesting framework when it comes to anything new. Initially, there's oftentimes a lack of understanding could lead to misunderstanding, oftentimes across the board in real estate outside of real estate. And so I saw early on that, you know, there's going to be some pushback with how lenders are receiving it. And I thought that, you know, the real, I would say, unlocking will be when the frame of CPS is something that evolves from an obstacle to an opportunity for lenders. And so let's talk about like, what are the common things we hear today with when lenders are looking at CPAs? What are some things you've heard? I mean, I know you've been involved in this industry for like, six plus years. What is the current conversation around CPAs? Behind closed doors? If you're a lender?

David Schaefer: 7:56

Well, you know, I think you're starting from the proposition that you have a lender that is actually willing to listen, I think the you alluded to this in the introduction, I think it's it's still true today, but it's getting it's improving. But in that, you know, probably the majority of lenders have either never heard of C pace, or pace, or they've, they've heard about it in passing. Sure. And that is the extent of their their knowledge, some of them that that, learn a little bit about it, summarily dismiss it for a variety of reasons. And, you know, we can we can sort of, you know, chat a chat about that, I think the but those who are beginning to, you know, take it seriously, are really looking to understand, really two things, I think, fundamentally. And when we're talking about lenders, we're talking because we've talked about lenders in two contexts, I think, what is lenders who have loans that are already outstanding, and the property owner wants to use see PACE financing to make a retrofit of some kind, and they need lead to consent, and so they're going to their lender to get that consent. Sort of the other more common scenario is that there is a construction or gut rehab or some other project where the capital stack is being developed. And the property owner would like or the developer would like C pace to be part of that capital stack. So it's, the conversations are similar, but they're a little bit different when they're, you know, the programs already the loan is already in place versus when you're when you're starting to go. I think I think you know, when you're when you're talking about the retrofit scenario, and again, assuming we have a lender that is willing to that is either educated or willing to be educated. It still comes down to A couple of things, I think, you know, what is, you know, how is a? How does c paced work? How is the lender underwriting the C PACE financing? And how did they get that to fit into their box of approving or consenting to PACE financing. And that last part is oftentimes where things become get delayed, or protracted. Because while lenders have consented to property owners putting debt or liens on their, on their properties, they've never had to confront something that's like PACE financing. And so it doesn't fit into their guidelines and their books. And most lenders, I think, with really a handful of exceptions, really haven't developed the policies as to how to deal with it. So it very frequently becomes a combination of a case of first impression, and also a process by which they try to work through to to satisfy the property owner and borrower and try to be helpful and get a give consent. So I think that's, you know, that's kind of what what happens. And, you know, it's again, education is a big is a big, big part of it.

Adam Lipkin: 11:19

Yeah, no, it's it's a good point. First of all I like that you did talk about there really is like a, you know, a bifurcated way that people are approaching phase one is for stabilize assets for property owners are looking to do these retrofits. And then it's really more of a going to a lender, that as a seasoned loan, and making that request the other to your point, the construction project that got rehab, where you're typically going to be going out to the market with a C pace plus a senior lender coordinated, you know, type of engagement. So it is really much that. So let's just talk about, you know, let's say you get over the hurdle, and you have, you know, a lender that's familiar with it, or maybe it's an early stage, but more importantly, they have a borrower that's a very strong borrower, very strong relationship. borrower approaches them says, Hey, we, we want to use the CPAs to be able to, you know, upgrade our building improve our asset, and the lender has to Now pay attention. I find that what's happened is, you know, there's, there's almost a mischaracterization of CPAs. And what I've heard, and I want to, you know, talk a little bit about this for a little bit and really dive into this is one topic, but I found that, that well, first of all, let's talk about the nature of CPAs. The structure is such that you're financing these eligible items that are going to typically be energy related utility related, in some case, there's going to be some safety measure that they're going to be able to solve for, like in California seismic work in Florida, you know, anything that could be for wind resistance, but for the most part, you're gonna be putting work into a building that's going to make it either you know, more energy efficient, or safer. And you're going and you're basically going to finance it. But the repayment is going to be something that's going to get added in the form of a tax assessment, a non ad valorem to the tax bill. And I found that because of it being as part of the tax bill, and we're going to into all the you know, lenders being able to structure to pay it off early and all sorts of stuff, but because it's added to the tax by found that there is a mischaracterization of it as a operating expense, and underwritten typically above the line. And so if somebody I'd like a stabilized and net operating income, what I've heard on a number of occasions, lenders underwriting to reduce that stabilized net operating income with the seat base amount, rather than characterizing it as a financing charge. And oftentimes, it really limited effectiveness. So what are your thoughts about that when it comes to how people were looking at CPS and characterizing it in some cases at an operating expense rather than a financing expense? Have you seen that?

David Schaefer: 13:55

Well, yes, I think you're pointing out one of the biggest issues and perhaps to some extent, there was, you know, part of the maybe lack of true understanding of what PACE financing is is all about is you know, particularly in the in the early years, so I'll say from 2010, which is probably the beginning of when sea PACE financing was done, and it was the minimis amount, but probably Those were the first, the first ones for probably the next, you know, five, six years. Most of the property owners and many of the sea pace providers approached lenders with the notion that we're going to make these renewable energy, energy efficiency, water conservation, the whole you know, panoply of things that are green that are going to reduce, you know my utility costs. And because the financing is fixed rate And it's over the term of the useful life of those assets, I'm going to be cashflow positive or neutral worst case in the first year, so that they spoke to lenders like it was an operating expense. In other words, I'm going to reduce my utility bill. And I'm going to be placed that with this tax assessment, and it's either going to be a wash, or we're going to come out a little bit ahead. And so the focus was, even though it's, it's really not an operating expense, it is a financing. People talked about that way. And that, of course, got, you know, people's in this very difficult scenario where you had to not take it on faith, because there was always lots of engineering reports and other things, but you needed to get people to really believe that you were going to save the utility costs in an amount sufficient to completely offset the debt service. Yeah, now, in probably the vast majority of cases, it does have a very dramatic effect on your net operating income. But it's not necessarily guaranteed to be cash flow, breakeven or better, because it's virtually impossible to have those assurances over a period of 1015 or 20 years. So I think in the early years, people collectively got off on the wrong foot, when it was trying to be sold as something that, you know, is going to be beneficial. Don't worry about it, just consent, no problem when everyone's good.

Adam Lipkin: 16:38

You know, it's so funny to you know, it's almost like a mis framing, right? And so it's the CPAs providers, right, that are going out to the market back in 10. And 11, say, Hey, listen, this is no brainer, we're going to finance the cost of this, and you know, the savings is gonna weigh more than offsetting these charges, it's a no brainer, right? But right, right didn't account for this evolution, where now there's a huge opportunity for construction projects, where you're really just keeping the budget the same, you're not doing anything different. And now you go back to those same groups and say, well, we still want you to do this, but we're not doing any additional work. So you can really see, you know, a challenge with having to walk back that narrative, and maybe early on in just the very, very kind of, to your point 1011. A lot of folks probably don't even realize this is that long, you know, around but you know, when these, you know, folks are maybe adding 200, Grand 300 grand type of improvements to 1020 $30 million assets, it was kind of like very easy to present it that way, but didn't really account for this evolution of where it's now at today. They're very, very, very good perspective.

David Schaefer: 17:39

Which is not to say that they're those attributes are non existent. Yep. They just are not quite as, you know, full as was suggested. And of course, there are other benefits to see PACE financing to property owners. Yeah. And oftentimes the you know, the lenders are not are sometimes also being a little too extreme and how they view, you know, some of the negative attributes, but yes, so those, those are the issues. And and, you know, they're not, they're not as easily understood, unless you're prepared to really take the time to understand them, essentially.

Adam Lipkin: 18:15

Yeah. And not only that, it also really limits where you can use it, right? If that has to be the criteria where you absolutely have to have this, you know, greater than one savings to investment ratio, it's just much smaller of a universe of projects that fit right. So it's a it becomes a narrow box. So So now let's say it's evolved. I mean, there's a lot of interesting things I had gotten involved with, I remember I first found out about it in summer of 17. And I remember going to like an industry event and just kind of checking around I knew there's, there's some big players that are already used it some of the major mall operators and you know, other big industrial users. And so I was like, okay, folks that are really the movers and shakers in the industry are already doing this, what just kind of hear if other people I know are familiar with it. And I remember not a single person. I've heard of this when I went to this one conference in August of 17. And I said, it's either just really early and you know, just planting the seeds now, or this is maybe just not as big of a thing. But I've continued to see it evolve tremendously. The volume is growing exponentially still came from I mean, let's talk about where it was it was maybe doing like 20 30 million a year back in 16. If that typical transactions were under a million. We obviously saw this year some some pretty big milestones some records set with, I think we saw that $90 million New York City deal for 111 wall, you're just seeing the size of CPS going into transactions dramatically increasing now you're even seen nine figure CPS deals that are in the works for these massive transactions. So that's continued. You continue to see more players to your point coming industry putting downward pressure on pricing. Let's talk a little bit about how it's evolved. right you know In the last several years, so you talked about in 11 and 12, it was initially just, you know, simple small retrofits for existing real estate, somebody wanted to do new h HVAC, new lighting, whatever would be small projects, and then probably around 1617, you started to see folks using it for new construction. And that really attracted me to it, I thought that Wow, now that's something that could become incredible to start being able to use CPAs to reduce maybe more expensive capital, reduce the amount of equity needed. So let's talk about maybe some of the transactions you had been involved with on the construction side, you know, maybe 17 1819. And and how you saw that come together? I don't know if there's one that comes to mind. But maybe we could pick a construction project and talk a little bit about, you know, how that actually went through with the lender? And, you know, kind of like, what was that conversation? Like? What were some of the hot buttons that you know, got lenders comfortable? And maybe we'll talk a little bit about what you saw in housing, and how it evolve with construction?

David Schaefer: 20:58

Well, sure, I mean, you're right, I think probably the, and that of these things is not is a little imperfect, but probably the first uses of PACE financing for construction, I think started in about 20, in 2017. And so it it, you know, going to the my URL, my earlier point, so here's an opportunity where the, the property owner and the developer go through the somewhat, you know, typical gymnastics, they reach a point where they have a sense of the maximum leverage the senior lender, you know, is prepared, and now they have some some amount of equity that they are prepared to put in to get the returns their investors that they're lucky to have, and then there's the gap. And the gap can ebb and flow a little bit, depending upon the marketplace is anybody in the industry knows, you know, the amount of leverage that senior lenders are prepared to do is not a static situation. And so, you know, typically, it's preferred equity and mezzanine. And for the, you know, for the pace industry, once once there became, I think, more sophisticated commercial, real estate finance professionals joining the see pace industry, that's when the exploration of using C pays for construction and cut rehab began and, you know, they knew who the players were, they were able to sit down and say, you know, here is an opportunity to, you know, reduce the overall cost of capital, you know, for the property owner, this is going to improve, you know, cash flow, this is going to enable the developer or the property owner to maybe not do so much Value Engineering, create a greener, you know, better building, which should drive, you know, a higher a higher rent roll. And when you're sitting down around the same table as everybody else, and you're working through the projections, and the numbers and the cost and all of that, you know, you're able to bring all the stakeholders, you know, to the same conclusion and get them comfortable with the fact that, you know, this is a pretty good element of the capital stack. Now, you know, many think it is intended to be, you know, a completely substitute for mezzanine financing, or preferred equity, and maybe even reducing the amount of equity. And I think that's unnecessarily aggressive to position it that way. Could it do all of those things? Of course, it could. But that doesn't necessarily mean it has to and, you know, there's plenty of opportunity that to use PACE financing for those things, and in some sense, it does act as a de facto reduction in the amount of equity in a project because PACE financing is essentially a 100% of the rillette costs of whatever the projects that are being you know, improved. Yep, so it does it does have that effect, but it doesn't necessarily have to be the driver there and you know, that's you know, part of what will define you know, you know, the, the underwriting criteria of the senior lenders and if there is mezzanine financing the mezzanine lenders as to how they are going to view the fact that this slice of financing doesn't require us a slug of equity to be part of it. It's just part of the overall capital stack. Yeah, so those conversations generally you know, we're we're very constructive No, nope, no pun intended, and deals were able to get done and and the larger the deals, in some sense, the more attractive pays finance thing becomes, for a variety of reasons, you know, property owners and developers have, who like this a lot, you know, have a lot more influence over the other participants in the capital stack, to get them to sit at the table and understand it rather than to summarily dismiss it, or to give it short shrift as part as part of the as part of the program. And I think, you know, we're seeing the benefit of that, because it is, you know, one of these situations where, once you've gone through the experience, and you've been educated, and you now understand how to view PACE financing, in terms of who the who's providing it, and their underwriting criteria, and how it applies to yours, and you've done it once, it gets easier to do a second time, and now you begin to look for the opportunities, because that enables you to do more deals.

Adam Lipkin: 25:59

Yeah, no, it's there's a few things I wanted to build on with that. So you know, when it comes to construction financing, that's oftentimes what the conversation looks like folks that are looking to see where could capital become available, that could maybe reduce the amount of equity, I need to raise through third party equity, raise LP money, maybe even reduce the overall blended cost of capital. So case comes in the conversation, let's just take an example. Because we were involved with quite a bit of this and you I'm just picturing like, a typical apartment development, let's let's call it $100 million, just round numbers keep it easy for me, somebody comes in, they say, Hey, you know, 100 million dollars, you know, that there's like a traditional execution that might be a bank, maybe in the 60 65% leverage range. And, you know, there's gonna be a, you know, already 35% ish type of need, you know, this is something that's a significant, I'm sorry, 35 40% need 35 $40 million of equity to come up with, oftentimes, as you get to these larger size projects, 50 100 or more, you start looking at what are the alternatives, and oftentimes to go to had been at least over the last 10 years was measure pref, you know, to go from maybe that 60 65%, let's say, 7580, probably 85%. You know, I mean, it's great, you know, while these days, you know, every everybody's just dying to, you know, put money for good well located multifamily projects with right sponsor, so you'll probably 80% is very achievable, not even 85. But it's expensive, you know, and so that money is also in the, you know, low teens, mid teens. And so oftentimes pace gets into the conversation. And oftentimes you have a borrower that would say, or broker is, you know, taking this out the market and wants to see that gap, be something that pace could replace, and then the asked to the lender, is it Hey, you know, we see that we have$20 million of paste that could be available for this project, we'd like to be able to use that. And the feedback, oftentimes from a number of lenders, and I'd say it's probably more on the bank side, then we'll call it the private lender side, is this pace is in front of me, you know, this pace is at a tax position, it pushes up my last dollar from whatever 60% or 65, to now, what effectively is 80 or 85. And oftentimes, you hear anything from lenders that might just say, we're not going to do that. Or they might say, well, maybe we'll allow, but we're gonna take it down dollar for dollar, which doesn't help anybody out, right? In a construction project like that. Where do you think somebody could come from to maybe see, because we're I would come from is, you know, I get the aggressive, like, replace it with, you know, equity, you know, that's another level. But I do find that the folks that we've done transaction with are looking like a combined leverage comfort level. In some cases, you still want to pay attention to what's most important, which who's the sponsor? What's the business plan? But if there's meaningful equity going into the project, let's call it 15 or 20 20%, you know, somebody who's going to be putting in 15 $20 million? I would argue, why would it be any different to allow mezzanine or preferred equity to 80 to 85? Compared to pace at the end of the day? What what are your thoughts on that?

David Schaefer: 29:09

Yeah, so I mean, I think that the, the, the the issue, the obstacle that needed to be overcome, and is beginning to have to happen is that the the lenders look at the, let's see, whatever, whatever the we're at the 20 to $25 million of PACE financing, as a senior to the bank, as well as priming priming their loan to the extent of the 20 to 25 million. And so they look at this, the way they look at that type of financing is saying, Okay, well, here's a problem. I'm behind $25 million. And the answer to that the short answer to that is no, they're not Because PACE financing is not callable, if you you know, it's typically billed on an annual or semiannual basis in installments, if there's a failure to pay, the the the PACE financing does not accelerate, you know, you miss a payment, year one, year two, year three, whatever year you missed it in, you're just missing that installment. And if you're missing that installment, you may also be missing your property taxes from being paid as well, because there is that that lien on it. And typically, the senior lender is going to step in, and cover those taxes and figure out what's the problem? How do we how do we write the ship? Sure. And so, you know, arguably, in a disaster scenario, I suppose you would look at this as being well, maybe there's one or two or three years of installments ahead of me, that need to be satisfied, but it's not 20 years and $25 million worth Yeah. Now, I'm not suggesting to lenders that they don't look at the you know, possibility of that happening. But that is a really, really extreme type of scenario, and not what is going to happen and 99% of the cases, so so that, you know, there is a bank out there. And that will remain nameless for these purposes, I'm not authorized to talk about what they do, but you know, my conversations with with them, because we've I've participated in selling pace assets to them, both residential and commercial, is, you know, if if a lender is is worried that a pace having a PACE financing is going to create a problem for them, that that there's just wrong, the problems will be much deeper than what the PACE financing is doing the PACE financing is not going to tank, a borrower or project, it's going to be something something else. So you know, there is there is a different approach that you know, should be, should be taken, and the lenders that have gotten comfortable with this, you know, realize that yes, is not going to be a foreclosure, and $25 million of financing is going to come ahead of me. Yeah, that is just that is just not not the scenario. There's a lot of details and stuff that go into how these analyses are done. Maybe we'll do another show on that at another time. But but that, conceptually, has been the biggest obstacle on both lended consent, and, and even on the construction financing side for getting the banks to do that. And, you know, this is not intended as a criticism, you know, banks had been providing consent to, you know, subordinated mortgages and other types of financing for decades and decades and decades, so that they know how to do it. They just don't know how to do it with pace, because it's novel. And it is no playbook on this. And, you know, I think some of them are developing the playbook, ya know, it's

Adam Lipkin: 33:05

it's such a, it's such a dead on point that because it's new, there really hasn't been a program to say, here's how we're going to run this play. I will bring up though that there's, you know, there's not like an infinite amount of innovative financial products, probably a handful right now that are in the market and attention. Space is one for sure. The other is the new modern Groundlings. And you've seen a handful of really big players be in that space in a big way. It's just growing. But it's interesting, right? How some lenders will look at a ground lease, maybe more favorably than si pays, when in some ways I might say a ground lease could be much more stress. But you know, I find it overall, the reason why I like the idea of having these conversations is that my belief is at best execution comes when you have a number of options at your disposal, and you go to the market, maybe a traditional financing, maybe more like a you know, higher leverage, you know, private lender scenario, and then also looking to see where you can incorporate either a CPA structure a grantee structure, and see what's going to be optimal, there's gonna be a number of considerations, you know, both from the borrower side, some lenders are going to be more favorable. And so with regards to that, I find it it's something that you need to do more and more than education. What I found when it comes to successfully executing with CPS on construction, it's the lenders that really do pay attention to the combined leverage between their loan and the CPS knowing that pretty much every see based lender today structure is very easy exits, I see exit ease nowadays that could be zero to one or two points after two or three years. And so with that in mind, if I'm a lender and I know that this see pace can be paid off, you know, zero or 1%. I would like to just solve for Where could I exit this in the stabilize market and not really be as concerned with well what happens if the, you know, agencies won't allow it or if cmbs won't allow it. It's more of the same plan that you would think about if it was mezzanine or preferred equity, it's going to be just paid off once the project is complete and stabilized. And so I've found that lenders that are successfully execute with CPAs, are essentially paying attention to what already matters, leverage and coverage. And they're saying, What's the combined leverage that I'm comfortable with that it's going to get me still able to get taken out of this, and I find for multifamily, it's very simple, you would run it to a agency exit scenario, really feel good about your stabilized income, probably, you know, undercut that, that loan that you would be able to achieve with it, you know, maybe you take it off 510 percent, and say, that's my combined leverage comfort level. So whether that's getting to 75 80% 85 loan to cause you're going to probably be a little bit more focused on the exit the loan to value. And it seems like that's the right way to look at it. And I'm seeing more and more lenders that are seeing that as something that makes sense. What are your thoughts on that?

David Schaefer: 35:56

Well, I do think that's the right. The right factor, I don't I again, I sort of, I still come back to the idea that, you know, in a, in a default scenario, even in a bankruptcy scenario, right, that's your sort of, arguably worst case scenario, you know, the C PACE financing doesn't accelerate, it's, it's just there, you have to bring it currently, at some point when you come out of bankruptcy, but it's just, it's just there. Whereas in other it with mezzanine or something else, or if you wanted to, you know, cause a prepayment and buy it out, well, okay, fine, then, then you're, you're in a sense, making it you know, part of the deal, and that's okay, I think all the capital providers that I'm you know, familiar with, and this is certainly true counterpoint, are always prepared to have that discussion, on on what the, you know, on what the prepayment, you know, fees are, and, you know, from an from an economic point of view, from an investor's point of view, it's, it's a yield issue. You know, if you need more favorable terms on prepayment, then maybe the interest rate will be a little higher or absolutely, well, let's talk about what the lockout period is going to be and, you know, and so on and so forth. Those, you know, by the time if you're having if you if you by the time you're having that discussion, there's a deal to be had. But you got to get to that point. That's that's, that's that's the issue. You have to mentally, the lender has the has to get that that priming issue sort of out of their out of the out of their mind. Yeah, they're not being primed by by$20 million. It's just really not the case.

Adam Lipkin: 37:36

Yeah, yeah. No, I and I find that where there's been some pretty good success today has been with the private lenders. And I think it's just also maybe like a very simple way of just saying, look, we're very basis driven. If I'm a private lender, making a construction loan, and I know that I feel good it 80% leverage, and my rates seven or eight or 9%. And the ask is just could you replace some of my dollars with the CPS in like the we'll call it five ish range. And you don't have to go higher and stepped up leverage. It seems like that's becoming more and more well received. I've certainly seen that over the last couple years. You know, we're not talking about it, somebody asked me for nosebleed leverage 95% combined, where it's just like you're crazy, we're talking about maybe 80% 85, where there's still meaningful equity going in deal, you still have all the carve outs, completion guarantees, everything that is going to get you comfortable that the project should get built, and then it comes down to is this a comfortable basis where I would exit. And so I like that that seems to be more and more something for folks to focus on today, that if you have a project, and you feel that there's going to be a need to go for a little bit of a higher leverage execution, you're going to go out to the market with private lenders, it's at least worth exploring these products like C pays, like ground lease financing, to be able to see how much more favorable terms you could get on the overall financing cost. So I I think that's actually something that's very doable today. Have you seen like over the last two, three years, like more reception in the private lender space? Have you heard conversations and I'm kind of curious what you've been seeing.

David Schaefer: 39:18

Yeah, I mean, I would say on balance. The, you know, investors are more, you know, private equity or hedge funds rather than commercial banks, although there are some commercial banks that are investing in this some couple on a national basis. And an increasing number are doing this locally, who you know, will give a supportive of their community interested in the retrofit transactions as well as you know, new new construction and taking the time to understand pace and to work with their that There local people. I think the other point I just wanted to make as well is that, you know, one of the, you know, benefits of having, you know, CPAs in, especially if it's going to, for example, the place, you know, mezzanine financing is the, you know, the see pace, you know, financier is a is a silent partner, once the deal is constructed. You know, for all intents and purposes, there are no covenant defaults. There's no acceleration, you know, if there's a problem, you know, it's, you know, work it out with working out with the property owner. You know, it's so there's nobody pounding the table saying, Well, you know, well, I only have to stand still for 120 days. And then after that, I'm going to do this, and I'm going to do that. And, you know, you know, I'm going to kidnap your grandmother, and you know, there's none of that stuff. We just just pay us every year. And you know, we'll send you off or pays off, it's all good, you know, just we're just hanging around. So

Adam Lipkin: 41:03

yeah, no, it's it's a good point, I find that there's such a passive investment with it. I mean, there's just really no rights, I think that's a it's a really good point to bring up that it's a lot less stress when things go a little sideways or not according to plan. So but let's talk about also like, you know, a lot of times people say like, it's mez or Pacer prep or pays, it could be both, right. So especially as you do these larger transactions, hundreds of millions of dollars, right, you know, it's oftentimes you might need both and think about it, you know, I talked to a lot of folks that are in that space, where they're providing, you know, either that mezzanine loan, or they're providing a preferred equity. And I say, Listen, this is going to, you need to make a certain return, you know, you need to make your mid teens return, maybe the way you get there is look at pace as your friend and it's not replacing you, you're just going to take a little bit off, instead of maybe putting out you know, 50 70 million a mess, maybe you're putting out 30 to 50. And by you doing that the deal pencils, and it helps everybody out. And so I like that mindset, too, that it's maybe just reducing the amount of mess, especially for these large deals that you just kind of see that continue to play out in the city where these big retrofits and major gut rehab projects that involve multiple capital providers, and I find that that's a way to make it work, you know, if you maybe take a little bit of that higher octane capital off, still have some and still works for everybody. But I think the idea of having both is also something that I find is a is a good mindset, rather than replacing it, maybe just reducing it, you know, have everybody everybody had a seat at the table? Vanessa?

David Schaefer: 42:33

Yeah, well, you know, I think they're, they're, they're both what I would call internal and external factors, you know, contributing to that, you know, externally, you know, they are, I would say, the following that, you know, pace is a creature of state law. And, you know, some state laws are more restrictive than other and we'll we'll cap, the amount of PACE financing that can be made available to a particular project, it could be 20%, it could be 25%, it could be other mechanisms that apply. Like in California, there's, there's a, there's a ratio that applies there. So you know, you have that you have that limitation, you also have the limitation that PACE financing can only be used for projects which are eligible under state law. And again, it's it's, you know, renewable energy, energy conservation, water conservation and other resiliency and sustainability. And although, my think may be one of the things that might often surprise a variety of people, is, you know, how much of a of a, of a new construction or or got rehab, you know, falls within those eligibility requirements, but but you're going to be limited by that. And then, you know, there's internal underwriting criteria of how much you know, you're willing to finance as a percentage of, of cost. And in the really large deals, I think, and every, you know, every lender Investor or Financial Institution, you know, has diversity requirements, you know, I'm only prepared to put, you know, so many eggs in this particular basket, even if it's under all of my percentage guidelines. So, you know, that I think that is another reason why you're seeing pace and mezzanine coexist on larger deals, you know, you and I have been involved in, you know, deals, you know, 20 million and up where, you know, those factors, you know, have come into play. Yeah, yeah,

Adam Lipkin: 44:41

it's such a good point that it's not a one size fits all for how lenders look at it. I think when you're going out to market with an execution, you know, back to what we're saying earlier is have options have a few different scenarios. different lenders will look at things in all sorts of ways and they have different criteria that is more going to be a hot button item that others might just offer. Almost not even really consider anywhere near at that level. So I think best execution is having options. Having somebody that knows how to do things with pace, steer things away from pace towards alternatives when needed. So where do you think things are going to move? Let's go to one last thing that I have a couple questions that came in, and we could answer some of those. But now let's talk about, you know, where do you see pace going over the next 12 months? And maybe even specifically, New York City? I feel like that's on a lot of people's minds, you know, obviously was big news. But what do you think is gonna play out? You think we're gonna see this? Uh, you know, going like gangbusters? I think it's gonna be a little slower than people think. What are your thoughts?

David Schaefer: 45:37

Well, you know, having been hanging around this industry now for the better part of eight or nine years. It's always it's, it's always gonna take longer, longer, longer than I think it's still it's still a no brainer. I just, we just haven't convinced enough people to do that.

Adam Lipkin: 46:01

And that's what we're hearing over here. David?

David Schaefer: 46:03

Yeah, come on. It is it is a no brainer. So but you know, I think I think that where pace is really hitting its stride. Now is, is in is in the new construction, got rehabs, retroactive financing. And to some extent, you know, rescue capital, you know, I, you know, I'm familiar with some situations, and, and it would be an appropriate dimension, specifically, where, you know, between the time you started the transaction and the time, you got to some ways in the middle, you know, markets turned in different directions, and you either needed more capital to complete the project than you thought, or senior lenders or mezzanine lenders got a little skittish, or there was some covenant, you know, related issues, and they needed more capital, and, you know, pace pace fits in very nicely into those, all of those situations. I think the rehab, the the, you know, the retrofit market, will continue to be, you know, very challenged. And I think the small, balanced commercial market will continue to be very challenged, even though that that is probably the market that attracted most of the players to see pace in the first instance, certainly the ones that were around at the beginning, so I, I think you're going to see in 2020, yeah, remainder of 2021 2022, maybe 2023, more of the same, you know, the the sort of unknown that might might impact that is, you know, where do we, you know, where do we come out on mandates that either the federal or the state level, some of that may be driven by the, you know, the the big social infrastructure climate change bill that the Biden his administration is working on. But, you know, you're also beginning to see, as in New York City, now recently, Chicago and other jurisdictions where, you know, mandates are being put into place that are creating, you know, financing opportunities, where pastes, you know, would be a natural if if that necessarily for all of it, but but again, for part of it, and so, that that could change the direction that I just described, but I think I think the jury's gonna be out on that short run.

Adam Lipkin: 48:35

Yeah, it's it's so interesting to see how some of these things play out we have all our theories, right? And speculating on on how it actually goes, and it usually always is different. But no, that's great. Well, I'm gonna do is I'm gonna I'm gonna open up some of the questions. We have a few good ones that came in, I think we could jump into it. So why don't we you know, post a couple right here. And, you know, this is from Samir if you see it just talking about you know house pace viewed at the time of reversion you buyers discount the price because pace is in place in reality owner not going to come up with additional capital to pay off the PACE loan prior to sale. I have some thoughts on it. I'm curious, you know, what are your thoughts on that?

David Schaefer: 49:12

Yeah, I don't see I don't see property owners paying off the pace prior to sale. I mean, if if that becomes part of the deal, then that's what you know, the sale proceeds will be used to pay it off just like you would any other, you know, subordinate type of financing. But so yeah, so that's that's an obviously it's a it's a negotiating point, you know, there. I find, at least in my experience, it's I certainly don't want to put words in anybody's mouth. Usually the driver for prepaying the PACE financing is not the the new owner. It's it's usually the senior lender, that the new owner has financed not is not paid. He's friendly, if you will, and is insisting that the paste financing be prepaid?

Adam Lipkin: 50:06

Yeah, I agree. And I found that it's usually the way you look at other financing, whether it be mezzanine or preferred equity, somebody would probably just pay it off and and it just affects the net sale proceeds not the value. It's just right how much you're netting, you know, you're paying off the senior, you're paying off the pace. That's usually what I find happening, although the question does come up quite a bit. And I find that it's interesting. A lot of folks ask about how does it affect valuation, and I say it doesn't, this isn't like some kind of recurring operating expense, it's a financing charge that typically can be paid off pretty easily. So no different than mezzanine financing shouldn't affect your valuation of ability, mezzanine, preferred equity, you name it, but it does come up quite a bit. I do have people asked that. So I did want to address

David Schaefer: 50:49

what it looks and it's also, you know, some lenders I've spoken with, it's as simple as, hey, this is a great property, it's got, you know, sufficient, you know, equity. I want, I want all the financing I can get, I gotta put out as much money as I can. It's a good deal. property, I'm giving the property owner a good rate. Yeah, maybe it's a little more economically favorable for that person to keep the PACE financing. But they're willing to do this because they like they like what they like what I'm offering.

Adam Lipkin: 51:17

Nice, nice. I'm gonna put up this with you from William, he's asking, are we speaking about the accounting treatment, I know, this is always an interesting thing. But the accounting treatment as an operating expense, paying taxes, assessment versus debt service, I've always taken the attitude of talk to your accountant, which nobody likes that at all. But it's kind of one of these things that does come up quite a bit. I hear it here often where somebody says, Well, if this pace thing is part of your tax bill, how do we really need to account for it, even though it's technically a financing charge? You're not you're not gonna play the role of accountant and provide accounting advice. But what's your take on it?

David Schaefer: 51:57

Well, there's not a whole lot of very little in the way of pronouncements from the accounting industry on this yet. Yeah, I've I've seen PACE financing accounted for in a variety of different ways. And I think, because there aren't any real, you know, official pronouncements here. And I don't think, by the way, I don't think anyone's doing anything, you know, any funny account thing. I mean, there's been a couple of public companies that have done this. And to the extent the PACE financing was material, it usually winds up, you know, being, you know, disclosed, possibly in footnotes. You know, I've seen people treat the the PACE financing as as it as a type of off balance sheet. financing, because it's an assessment, it's not alone. That callable, you know, it does it is it is a recurring expense. So usually it shows it shows show up as a financing cost. I've seen it show up as an operating costs, don't usually see it on the balance sheet, usually see it in the footnotes. Yeah, I'm not an accountant, go talk to your accountant. But those are, those are the things I've seen.

Adam Lipkin: 53:08

Yeah, exactly. I mean, that's just one of those things, where it is a little bit a range of how people look at it. But um, no, this is great. There's so many areas to cover with you, I really did want to dive into, you know, some of the lender treatment, because that's usually the questions that come up. And I feel like you're really creating alignment, that's one of the things that I'm so focused on right now is, you know, when it comes to taking projects out the market, really finding that alignment as we're building the capital stack, making sure that folks do get this, that at the end of the day, you know, you find good sponsors that have good business plans. And then there's a little bit of an education around structure. I mean, I'd much rather be that lender that's going to take a little time to understand structure than the, you know, somehow in and chase to find product go down quality in business plan. This, to me seems like worth a worthwhile pursuit to say we spend a little bit more time just learning the structure that seems to be getting more and more attention. There's not like, an infinite amount of them. There's this and I mentioned, Groundlings, financee, which I think we're gonna have to kind of table that for a follow up conversation. Sure. As we're kind of wrapping up the hour, it's kind of put it on you like to see is there any else specifically things that you want to talk about what you're focused on today? And what we'll call it a wrap? What's, uh, what's kind of some closing comments?

David Schaefer: 54:20

Well, you know, thank you for that. Like I said, I think I think we're at the end of the beginning. You know, one of the, one of the headwinds for pace over the last decade, you know, roughly speaking, is that, you know, it's it's people often use the chairman, you know, it's a public private partnership, of financing and there's a lot there's a lot more to the public part, then weapon meets the eye. You need states to enact paste legislation. They don't always get it right the first time and needs to be fixed. And then once you have state legislation, paste needs to be approved. You On a county by county basis, but sometimes also on city basis, in order for it to go on, you know, be part of the property tax collection process. And, you know, and and because it was a new product, some program administrators, you know, had, you know, had a couple of issues that they had to work through before they can get the program's actually, you know, up up and running. And so it wasn't like pace became a tool that was available nationwide in 2010. And How come nobody is using it? Right? Case in point, New York's program didn't go live until this year. You know, it took it took the state of New Jersey, more than two years to adopt its current, you know, pace legislation. You know, some states have had to amend the legislation two or three times before, it was, you know, considered, you know, marketable in terms of not just pace lenders, but also, you know, other capital providers. So, you know, all of that work, and it is an enormous for those people involved in the space, it is certainly beyond anything they would have imagined when they signed up for it. But the vast majority of that is now all behind us. Yeah. And so it pays is about is pretty much a national product at this point. And I think that's part of the reason why I'm very bullish on seeing it, seeing it grow. And particularly, you know, New York City, I think will turn out to be the tipping point. Because the deals will be bigger, the players will be bigger. And that reverberates throughout the industry. It's not, you know, Chicago, and Dallas and San Francisco and Miami are not big places. But you know, that the hub, the hub of the wheel is New York City. Yeah. And I think that will trigger the demand for people who want to be in real estate financing to become better educated, come up with their programs, find out which pace lenders they like the pace providers they like to work with, and set up their programs.

Adam Lipkin: 57:12

I love that it Sorry, I gotta go one one into that New York City, because you just triggered me because this has come up a lot recently, talking about talking about amending, you know, some of the, you know, gaps is New York City ready for retroactive and yeah, any update on that? Are we still pending?

David Schaefer: 57:28

No, I think I think New York City is is is ready for retroactive, I think I think they have final rules. Don't quote me on this. But you know, the preliminary rules did have retroactive financing. And I expect that to to be there.

Adam Lipkin: 57:46

Good. Good. Yeah. At the end of the day, I mean, I find this is such a niche product, you got to find experts like yourself, I think that everybody would be well served to be able to reach out. somebody that's actually executed in the business, I would say is key. Find out what they've done recently, and how much of it but get a couple resources in this area. So you really get accurate information. It's so critical. There's, there's way too much theoretical. There's a lot of misinformation. So find folks that have executed a can show a track record and really get you properly set up to be able to use this, you know, in your own business. So that's great. David, thank you so much. It was such a pleasure. Thank you. I really I really enjoyed it quite a bit. Thank you,

David Schaefer: 58:27

sir. Thanks for having me.

Adam Lipkin: 58:29

All right. We'll see you on the next show.

Unknown: 58:31

Thank you for joining us on another episode of the C pace confidential. Give this episode a like and subscribe so you don't miss any of the fast coming opportunities in the world of CPAs. Got a question? message us on LinkedIn. Adam Harris Lipkin. See you next time for another edition of the see pace confidential.