Need to Pay for Earthquake Retrofit Work - Do it with Property Tax Assessments
Written by Peter Strauss of Iconic Investments
As we discussed in previous articles, the City of Los Angeles passed an ordinance mandating seismic retrofitting of apartment buildings built prior to 1978 that have soft, open, or weak wall lines. This article will discuss how property owners can pay for their earthquake retrofit work through property tax assessments.
PACE (Property Assessed Clean Energy) is a program that will allow apartment building owners to finance the entire cost of the earthquake retrofit work.
How does the program work?
Third-party companies have partnerships with local governments. These governments issue municipal bonds to fund your earthquake retrofit work. The financing of the earthquake retrofit work is then levied as a special assessment on your apartment buildings' property taxes. The payment is incorporated into your bi-annual property taxes. This financing tool can be used to pay for 100% of the costs of your earthquake retrofit work.
How do you get approved?
The approval process takes approx. 1.5-2 months. The property must have a minimum debt coverage ratio of 1.15, and the loan to value must not exceed 65%. The company that processes the application will require an appraisal to confirm the value of the property. No personal guarantee is required. The property tax assessment is on the property, not on the borrower. The company will require a credit application but will not receive a credit score. They are looking for previous bankruptcies as borrowers with previous bankruptcies will not qualify.
What are the terms of the assessment?
The borrower can decide the length of the property tax assessment. Terms can be from 5 to 30 years. Other typical terms are:
- Rates ranging from 5.25% for a 5-year term to 7.25% for a 30-year term
- Fully amortized loans (no balloon payment at the end of the loan term)
- Prepayment permitted but the borrower would be responsible for yield maintenance (prepayment penalty)
What if I sell during the term of the property tax assessment?
In the event of a sale, the assessment will be automatically transferred to the new buyer. The buyer will not need to undergo another approval process. The evaluation process only happens once, when the owner applies for the assessment. Since the buyer is assuming the property assessment, the buyer will take into consideration the additional expense as part of his/her underwriting process. If the buyer doesn’t want the assessment, the seller would be required to pay the yield maintenance (prepayment penalty) to pay off the assessment early or negotiate the deal point with the buyer.
At what point can/should I take the assessment?
The assessment can be taken at any point in the retrofit process. Most owners pay out of pocket for the initial architectural plans and City fees. The assessment will reimburse you for any out of pocket expenses.
How are payments made?
Once the owner is approved for the assessment, the total amount will be funded to an escrow account. As milestones are hit, escrow will release the funds to pay the expenses based upon the contract/agreement with the architect or contractor. Typical milestones are completion of: Demo, Foundation, Framing, and 100% Completion with City approval.
What are the fees?
The cost to issue the bond is $750. The third-party company that handles the entire process gets 5.25% of the assessment amount. This is added onto the assessment. For example if the actual amount of the work were $100,000, with the 5.25% fee it would be $105,250. The Title Recording Fee is $200.00. (FEES MAY VARY BY COMPANY).
For more information on PACE, check out the program's website at http://pacenation.us/.
For more information on the Earthquake Retrofit Ordinance read Iconic's article
UPDATES:
After posting this blog we received questions about the PACE Program. Please see below:
11/17/2017
QUESTION: Since the PACE Program is put on the buildings property taxes, how will the IRS treat the work - As an expense for the period of the PACE Loan or as a capital improvement that needs to depreciated over 27.5 years?
ANSWER: Here is the response Iconic received from a CPA who specializes in Real Estate.
It is an separate asset considered an improvement depreciated over 27.5 years, if residential property or 39 years if there is a commercial rental component. The work is considered a betterment, i.e., it improves the quality of or materially extends the life of the underlying property, notwithstanding that it is mandated by the government. The method of financing is immaterial to the accounting treatment of the asset.
PETER STRAUSS
Iconic Investments
16530 Ventura Blvd
Suite #409
Encino, CA 91436
T: 747-444-3303
E: peter@iconicinv.com
W: www.iconicinv.com