New Approaches to Financing Energy Efficiency Investments

The often high initial cost of energy efficiency improvements remains a challenge for many customers, despite their many advantages. Financing projects conventionally can be difficult for both commercial and residential property owners, due to a number of factors including substandard underwriting practices by lenders, inappropriate payback calculations, and uncertainty about how to quantify cost-savings. This report discusses a financing program designed to overcome these hurdles and broaden access to financing for energy improvement measures.

Property Assessed Clean Energy (PACE)

“PACE financing is a loan alternative that incentivizes renewable energy system installation and energy efficiency improvement by avoiding the high up-front energy equipment and installation costs associated with each,” according to PACENow, a nonprofit advocacy group that seeks to broaden adoption of PACE programs. [1] PACE is available to commercial and residential property owners to finance renewable energy projects, energy efficiency upgrades, and water conservation measures that achieve cost savings and are permanently affixed to the property. PACE does not reduce the total cost of energy improvements; it restructures the financing to smooth costs over a multi-year period.

PACE is a national initiative, but programs are locally based, tailored to the local market, and locally funded through municipal bonds. In most states, the legislature authorizes municipal governments to issue PACE financing by creating special assessment districts. Following an energy audit, property owners within the assessment district may borrow dedicated funds through bonds issued by a local government to cover 100% of eligible project costs. Generally, a property owner may finance no more than the equity that they have in the property. The loan is then repaid with interest over a period of no more than twenty years by a surtax that is assessed on the property. The surtax functions as a lien that legally transfers with the property, if sold prior to full repayment. Since it can take years to recapture the costs of energy improvements, tying the cost of the upgrade to the property itself, and not the individual, removes a significant deterrent for property owners who are averse to long-term investment. In addition, the security of the tax lien enables commercial building owners, even those who do not meet investment-grade credit standards, to obtain attractive rates. According to an article assessing a PACE program in Connecticut: “This [security] allows owners to undertake deeper, more capital intensive retrofits with greater energy savings and longer payback periods.” [2]

Applying a surtax to repay a publicly funded loan is a financing mechanism that has been used nationwide for decades to create access to low-cost, long-term capital for improvements to private property that meet a public purpose. [3] Using the mechanism to finance energy improvements, however, was not pioneered until 2008. The pilot program, in Berkeley, CA, was called Berkeley FIRST; its success spurred California to pass AB 811, a law that authorized all cities and counties in the state to designate PACE assessment districts. [4]

Implementing PACE

In order for a local government to offer PACE financing, statewide PACE-enabling legislation must first be introduced. PACE legislation enables the creation of both residential and commercial programs, and the language must typically address the following issues [5]:

• Statement of public purpose – PACE enables the jurisdiction to achieve an identified public good, such as energy security, job creation, increased property value, or reduced air pollution.
• Definition of qualifying improvements – this typically includes water conservation, energy efficiency, and renewable energy installations permanently affixed to property.
• Assessment district – legislation must define a geographical area within which a voluntary assessment or charge may be placed in return for a financing benefit.
• Credit history standards must be applied to determine owner eligibility, such as:
  • Current on mortgage payments
  • Current on property taxes
  • No current lien on property
  • No history of bankruptcy
• Funding source – type of municipal bond of the sponsoring municipality or other government.
• Program basics – minimum and maximum borrowing amounts, acceptable loan-to-value ratios, maximum repayment period, and other guidelines.

Opportunities and Progress

Buildings consume over 40 percent of the energy used in the United States, and roughly 75 percent of all electricity, owing largely to energy inefficiency. A 2012 report by the Rockefeller Foundation and DB Climate Change Advisors reported a potential nationwide market for commercial and residential PACE of “nearly $280 billion over the next ten years that would translate to over $1 trillion in energy savings, over 3 million jobs, and 600 million fewer metric tons of carbon emissions per year.” [1] Clearly, PACE programs represent an enormous opportunity to cut energy use, and progress toward realizing this opportunity is underway, though it varies considerably between commercial and residential programs.

As of October 2013, thirty-one states and the District of Columbia have PACE-enabling legislation, which means that 80% of the U.S. population lives in a state that permits local governments to offer PACE programs. [3] Of these, local governments in only eleven states (California, Colorado, Connecticut, Florida, Maine, Michigan, Minnesota, Missouri, New York, Vermont, and Wisconsin) and the District of Columbia have actually established PACE programs. [7] Efforts to implement PACE programs are underway in an additional twelve states (Utah, New Mexico, Hawaii, Louisiana, Arkansas, Illinois, Ohio, Georgia, Virginia, Maryland, New Jersey, and Rhode Island).

PACE is a rare example of a program that enjoys bi-partisan support at the federal, state, and local levels. [3] With this broad support, PACE-enabling legislation spread rapidly between 2008 and 2010 – this quickly stalled, however, following a July 2010 statement issued by the Federal Housing Finance Agency (FHFA) that challenged the legality of residential PACE. In short, the FHFA questioned the legality of the programs’ prioritization of the PACE lien (making them the “senior” lien) over the mortgage and advised Fanny Mae and Freddie Mac to cease buying mortgages with PACE liens (for more information on this dispute, see sidebar).

PACE Financing Endures

The legal challenges have severely stalled, though not entirely stopped, residential PACE financing; commercial PACE programs are not regulated by the FHFA and remain unaffected by these legal challenges. While most residential PACE programs have suspended activity indefinitely, some have restarted and are navigating around the strict FHFA guidelines. [10] According to an article published by the Clean Energy Finance Center, a nonprofit advocacy group that seeks to expand the energy efficiency and renewable energy markets, “Some municipal and county programs keep PACE as a senior lien, providing disclaimers for homeowners enrolling in the programs. In California, Western Riverside Council of Governments has taken this approach with the HERO Program.” [11] Other states, including Maine, Vermont, Rhode Island, and Oklahoma, have decided to subordinate the status of residential PACE liens. However, this approach is not as attractive to investors, since junior liens are less secure.

In September 2013, to address the FHFA’s concerns over “undue risk” resulting from senior residential PACE liens, California Governor Jerry Brown proposed a statewide reserve fund to insure FHFA against the risk of residential default or foreclosure on PACE properties. In a letter to the FHFA Acting Director, Governor Brown stated that the reserve fund would “make Fannie Mae and Freddie Mac whole” in the event of “any foreclosure, for any losses… resulting from the payment of any PACE assessment paid while in possession of the property,” as well as in the event of “any forced sale for unpaid taxes or special assessments, for any losses… that result from PACE assessments being paid before the outstanding mortgage.” [12] The next step is for an existing California Authority, which will create the reserve fund, to issue draft regulations for public comment.

To date, the FHFA’s concern that senior residential PACE liens will create undue risk to mortgage lenders has not been supported by market activity. In fact, housing data from Sonoma County, California, tell the opposite story. “In [the] 2009-10 and 2010-11 fiscal year[s], Total Secured tax delinquencies in Sonoma County were 3.3% and 2.3%, respectively, [whereas] PACE assessment delinquencies were 1.2% and 1.8%, respectively,” according to a letter submitted to the FHFA by Renovate America, Inc., a for-profit enterprise that partners with local governments to develop PACE financing programs. [13] The letter then cites a review of 1,459 PACE properties by the Sonoma County government from 2009 – 2011 in which “only 16 properties showed recorded documents demonstrating mortgage defaults, an average of 1.1%… [while] the average mortgage delinquency in Sonoma County varied from 8% to over 10%.” [13]

Looking Forward

In the wake of FHFA challenges to residential PACE, many local governments have diverted resources away from residential PACE programs toward establishing commercial PACE programs. In 2011, only four commercial PACE programs operated in just two states; by November 2013, this number had expanded to twenty-six active commercial PACE programs in nine states and DC, with roughly 200 commercial projects funded at a total of $51.4 million. [14] In addition, the pipeline of pending commercial financing applications exceeds $133 million. [14] Projects vary in size, ranging from $10,000 to over $3 million, but have generally been small in scale. [1] From a sample of 136 commercial PACE-funded projects approved as of November 2013, 50% of projects cost less than $50,000, 12% of projects cost $50,000 – $100,000, and 16% of projects cost $100,000 – $200,000. Only 22% of projects cost more than $200,000. [14]

PACE project activity remains low as a share of the total market opportunity, but momentum in commercial programs has accelerated by every measure and states are showing creativity in addressing the legal challenges to residential programs. Five years after its inception, the program has not yet achieved the numbers nationwide that some had envisioned, but the states that passed PACE-enabling legislation and established programs early are seeing strong signs of success. Above all, PACE has demonstrated an ability to broaden the market for cost-saving energy upgrades while minimizing risk to property owners and investors across the country.

References:

1. “What is PACE?” PACENow, from http://pacenow.org/wp-content/uploads/2013/10/What-is-PACE.pdf
2. Buonicore, Anthony J., Bailey, Jessica, and O’Neill, Kerry E. (2011). “Underwriting Energy Efficiency Financing in the Innovative Connecticut PACE Program.” BEPAnews, from http://www.bepanews.com/images/pdf/Whitepaper_CT_PACE_Final_01-14-13.pdf
3. “About PACE.” PACENow, from www.pacenow.org/about-pace/
4. California Assembly Bill No. 811 (2010), from http://www.energy.ca.gov/recovery/documents/ab_811_bill_20080721_chaptered.pdf
5. “Make PACE Happen.” PACENow, from http://pacenow.org/act-now/make-pace-happen/
6. “Commercial Property Assessed Clean Energy (PACE) Primer.” U.S. Department of Energy, from http://www1.eere.energy.gov/wip/pdfs/commercial_pace_primer_revised.pdf
7. “PACE Programs.” PACENow, from http://pacenow.org/pace-programs/
8. “Annual Report” (2013). PACENow, from http://pacenow.org/annual-report/
9. “PACE Programs and Legislation at a Glance.” PACENow, from http://pacenow.org/wp-content/uploads/2013/07/7.24.2013-PACE-Programs-and-Legislation-at-a-glance.pdf
10. “FHFA Statement on Certain Energy Retrofit Loan Programs.” Federal Housing Finance Agency (2010), from http://www.ase.org/sites/default/files/nodes/2200/FHFA_PACE.pdf
11. Friedrich, Kat (2013). “Residential PACE Energy Programs Pursue Innovative Approaches.” Energy Efficiency Markets, from http://www.energyefficiencymarkets.com/2013/08/25/residential-pace-energy-programs-pursue-innovative-approaches/
12. Brown, Jerry 9/23/2013 TS. “PACE Program in California; Resolution of Fannie Mae and Freddie Mac Issues”, from http://pacenow.org/wp-content/uploads/2013/09/PACE-Letter-9.23.13.pdf
13. Renovate America, Inc. 3/26/2012. Letter to FHFA. TS. From http://www.fhfa.gov/webfiles/23785/353_Renovate_America_Inc.pdf
14. “Commercial PACE Dashboard”, PACENow. 11/12/2013. From http://pacenow.org/wp-content/uploads/2013/11/11.12.2013-PACENowdashboard.pdf

Further Reading

PACE Financing for Energy Efficiency: Success Stories, from http://www4.eere.energy.gov/challenge/sites/default/files/uploaded-files/pace-financing-for-energy-efficiency-success-stories.pdf