Will lenders allow PACE/HERO loans to encumber the property when the lender has a first trust deed? Dan J. Harkey

Here’s a breakdown of the key considerations:

🔑 1. Lien Priority and Risk

C-PACE loans (commercial PACE) are structured as super-priority liens, like property taxes
This means they take precedence over existing mortgages or deeds of trust, including first trust deeds.
Because of this, commercial lenders are highly cautious. Super-priority status can impair the lender’s collateral position in the event of default or foreclosure.

📝 2. Lender Consent Is Typically Required

Most commercial loan documents prohibit additional encumbrances without lender approval. Therefore, borrowers must obtain written consent from the senior lender before placing a C-PACE loan on the property
Lenders may require:

An intercreditor agreement with the C-PACE lender.
Escrows or reserves for C-PACE payments.
An energy audit and cost-benefit analysis to ensure the improvements justify the added debt

🧾 3. Underwriting and Structuring Considerations

Lenders will evaluate:

The impact of C-PACE assessments on the borrower’s ability to service existing debt.
Whether the improvements increase property value or reduce operating costs.
The terms of the C-PACE loan, including non-acceleration clauses and repayment structure

✅ 4. When C-PACE May Be Allowed

If the C-PACE loan is already in place at origination, lenders may underwrite around it and require reserves.
If added later, explicit lender approval is mandatory.
Some lenders are becoming more open to C-PACE as it can enhance collateral value and reduce operating expenses. However, this is only possible with proper structuring and risk mitigation, which should be a top priority for all parties involved.

Here are the key risks commercial lenders consider when a borrower proposes placing a PACE (or HERO) loan on a property with an existing first trust deed:

🔺 5. Lien Priority Risk

PACE loans are senior to the first trust deed because they are collected as property tax assessments.
In a foreclosure, the PACE lien gets paid before the lender, which subordinates the lender’s position and increases loss severity.

💸 6. Impairment of Collateral Value

If the property is sold or foreclosed, the outstanding PACE balance may reduce the net proceeds available to the lender.
Some buyers may be unwilling to assume the PACE obligation, which can lower marketability.

📉 7. Cash Flow Risk

PACE assessments increase the borrower’s annual property tax burden, which can:

Reduce net operating income (NOI).
Effect on debt service coverage ratios (DSCR).
Leads to payment stress if not properly underwritten.

⚖️ Legal and Documentation Risk

Many loan agreements prohibit senior liens or require lender consent for additional encumbrances.
If a borrower adds a PACE loan without consent, it may trigger a default under the loan documents.

🧾 7. Underwriting Complexity

Lenders must evaluate:

The use of funds (e.g., energy efficiency, seismic retrofits).
Whether the improvements add value or reduce operating costs.
The terms of the PACE loan, including repayment structure and non-acceleration clauses.

🏦 8. Servicing and Escrow Challenges

PACE assessments are paid via property taxes, which may require:

Escrow adjustments.
Reserve accounts to ensure timely payment.
Monitoring of tax delinquencies.

🧠 9. Market Perception and Regulatory Uncertainty

Some lenders and investors view PACE as unpredictable or politically volatile.
Regulatory changes could affect lien enforceability or repayment terms.

Here’s a Lender Risk Checklist for evaluating whether to approve a PACE (or HERO) loan on a property with an existing first trust deed.

✅ 10. PACE Loan Lender Risk Checklist

🔐 1. Lien Priority & Security

Does the PACE loan create a super-priority lien ahead of the first trust deed?
Is there a waiver of acceleration in the PACE agreement?
Has the borrower obtained written lender consent?

💰 2. Financial Impact

What is the annual PACE assessment amount?
How does it affect the debt service coverage ratio (DSCR)?
Will the borrower’s cash flow support both mortgage and PACE payments?

🏢 3 . Property Value & Use of Funds

Are the improvements capital-enhancing (e.g., HVAC, solar, seismic)?
Has a cost-benefit analysis or energy audit been provided?
Will the improvements increase NOI or property value?

📄 4. Documentation & Legal Review

Does the loan agreement prohibit senior liens?
Has legal counsel reviewed the PACE documentation?
Is an intercreditor agreement required or available?

🧾 5. Tax & Escrow Considerations

Will the PACE assessment be escrowed?
Are reserves required to cover future PACE payments?
Is the PACE loan current on payments?

🧠 11.. Borrower & Market Risk

Is the borrower financially sophisticated and aware of obligations?
Could the PACE lien impair future refinancing or sale?
Are there jurisdictional or regulatory uncertainties?

Here’s an expanded PACE Loan Lender Risk Checklist with additional financial metrics to support underwriting and risk assessment:

✅ PACE Loan Lender Risk Checklist (Expanded)

🔐 1. Lien Priority & Security

Does the PACE loan create a super-priority lien?
Is there a non-acceleration clause in the PACE agreement?
Has the borrower obtained written lender consent?

💰 2. Financial Impact & Metrics

Annual PACE Assessment: $__________
Remaining PACE Balance: $__________
Loan-to-Value (LTV) including PACE: _______%
Debt Service Coverage Ratio (DSCR) post-PACE: _______
Net Operating Income (NOI) impact: $__________
Operating Expense Ratio (OpEx ÷ Gross Income): _______%
Break-even Occupancy Rate post-PACE: _______%
Cash-on-Cash Return post-PACE: _______%
Internal Rate of Return (IRR) impact (if modeled): _______%
Cap Rate sensitivity with and without PACE: _______%
Debt Yield (NOI ÷ Loan Amount): _______%

🏢 3. Property Value & Use of Funds

Are improvements capital-enhancing or maintenance-related?
Has a third-party energy audit or cost-benefit analysis been provided?
Do improvements reduce OpEx or increase NOI?