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U.S. PACE ABS 2023 Outlook

DBRS Morningstar expects the performance of both commercial property assessed clean energy (C-PACE) and residential PACE (R-PACE) securitizations to remain stable in 2023, with relatively low portfolio-level delinquencies and losses.

• Across C-PACE assessments, loan-to-value ratios remain relatively low, while most C-PACE originators continue to require lender’s consent. DBRS Morningstar views the lender’s consent requirement as a credit positive because it helps imbue borrower discipline.
• While demand for C-PACE financing is at an all-time high, executions will have to contend with the rising cost of debt and, in the case of new construction projects, increasing labor and material costs.
• Hotel and retail properties are likely to be the most severely affected by a recession, while office properties, especially suburban offices, could also face challenges as tenants re-evaluate office needs.
• The makeup of originations in pooled C-PACE is expected to shift toward retroactive C-PACE financings and away from new construction projects. C-PACE financing has become increasingly attractive to developers of completed or nearly completed commercial real estate projects as it offers a cheaper source of capital to replace more expensive mezzanine debt, cover cost overruns, and/or add incremental reserve funds.

“C-PACE momentum is expected to continue as additional states enact or expand PACE-enabling legislation to address climate and resiliency initiatives, while R-PACE origination volume will likely remain mixed, constrained by existing onerous consumer protection measures,” said Stephanie Mah, Senior Vice President, Structured Finance Research. Speaking on C-PACE specifically, Mah noted that “the sector will likely get some uplift from the passage of the Inflation Reduction Act of 2022 as property owners become even more focused on energy renewal, energy efficiency, and resiliency efforts.”