Per the aspirational title of this piece, it is a challenge to get both of those critical “building elements” from a single source. Let’s begin by discussing what each does.
Construction Financing
This is short term, high risk money. The lender is borrowing on faith, because there is nothing built. The lender faces myriad of circumstances by which the project could not be completed. Scenarios include the contractor/developer having issues like technical or financing impasses; there could be supply problems; there could be accidents; there could be relationship issues between various parties. CleanFi has encountered all of these and the history of project financing disasters causes consternation.
In “ground-up”, or new building construction financing, lenders have a significant asset they can go after…The land (and whatever part of the construction is completed. But in retroactive project financing, or in component financing in a new construction (i.e., the solar system that is being finance separately from the building), in the extreme majority of cases there is no security until the project is done. Thus the rule “high risk = high cost” applies.
Typically in construction financing, the capital interest accumulates with no progress payments from the borrower, until the agreed upon completion date for the project, at which point the principal and the interest are due together in one lump payment. So the next question is: where do you get the money to pay for that? In new construction, the same bank that provides the eventual mortgage often provides the construction loan, so the entire amount is rolled into a long-term commercial mortgage, with the underlying building as the security. But when building a component that is separate from the building, that distinction rarely exist, except in situations further in this article.
Project Financing
Once a project in completed, the risk shifts to whether the borrower can make payments, or whether some issue with the equipment financed will cause the borrower to create problems for the lender. But now there is something to “lien” (see this related article in our Knowledge Base). Project financing is a vast universe that covers terms from one year to 30 years or longer. The applications can be from paying for the installation of a new HVAC on a church, which can be done within a few days, to creating an electrical micro-grid on a college campus, which may require over a year. So over time, different financing instruments have evolved to accommodate these different circumstances, and to address the full range of project costs.
What Project Financing Mechanisms Have Inherent Construction Financing Options:
C-PACE – There are two main reasons this is a great mechanism for a combo construction/project loan.
1-Per the article referenced above on how lenders lien (or secure their risk) Commercial Property-Assessed Clean Energy loans are secured by the senior-most security possible…the property taxation process. In effect, the debt stays attached to the property until it is paid off, no matter who owns the property or how many times it changes hands. So this gives the lender full confidence that the debt will be paid, even if the improvement is never finished (note: every lender in the industry will do everything they can to avoid this situation, including making careful progress payments during construction, and interjecting themselves into the process if something goes awry).
2- The debt financing schedule (the schedule of dates when the borrower needs to make their payments back to the lender) is generally annual, as opposed to monthly. This is because often the payments are made along with, or on the same date as the property taxes are due. So, before the very first payment is due, there can be months of interest that have accumulated; all of the time that has passed between when the money was placed in service and when the first payment on the debt is made. That money is subject to interest, but there is no payment on the interest. So it is “Capitalized”, or added to the entire amount that the borrower is financing. For that reason, a C-PACE funder is most likely amenable to extending that no payment period by an extra year, or even two, so long as the capitalized interest is added to the principal amount when the repayment begins. It’s like a larger loan, secured by the property tax assessment.
Third-Party Owned financing – The best known of those are Power Purchase Agreements (PPA’s), but they can also be Operating Leases, Energy as a Service agreements, Capacity Sales Agreements, etc. These agreements are usually undertaken by investors who are very familiar with the technology that they are investing in, and they trust both the process and the materials. So their greatest concern is who will be handling the construction of the improvement and whether the off-taker will be able to make the payments for the duration of the agreed Term. But if they like the project, they will finance its construction. You might say “Well, if it’s 3rd-party owned, then that’s not really financing, is it?” True, if the off-taker carries the PPA to Term. But most PPA’s today provide a buy-out agreement after the tax benefits have been exhausted (year 6 for solar, storage, thermal, hydrogen), and the owner can, at that time take full possession of the improvement. That can be financed via a remortgaging, or in some cases even C-PACE.
Exceptions – CleanFi does everything it can to provide creative solutions for project financing, inclusive of cajoling lenders and funders to adopt creative features to their products that we believe would help our users and the marketplace in general. For that reason, we now have a few Capital Leases and standard Loans that offer construction period options. In all cases, they will capitalize the interest, just as C-PACE lenders do, so the principal amount borrowed will go up, along with any applicable points and fees. To find those funding products, read the Notes carefully. They hide some gems.
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