Thursday, January 2, 2014

Pace is the Trick* - C-PACE and Financing Energy Upgrades for New Hampshire Commercial Buildings

I work hard in my writing to present facts and not opinions about energy matters. For that reason , I tend not to take a strong position on popular energy topics as I see my role chiefly as an educator. As I have said more than once about energy (and believe me, my students in the Franklin Pierce University MBA in Energy and Sustainability Studies program hear it often enough) - there is no free lunch when it comes to energy matters. Every energy-related decision we make has costs and consequences for ourselves and for others.  The very best we can hope for when making energy related decisions is to understand these costs and seek to reduce their consequences for present and future generations. My students have described me as an “energy agnostic” as I weigh, in my teaching, equally the value of fossil fuels, nuclear energy and renewable energy sources.

However, when it comes to energy savings I am anything but agnostic. I believe we can accomplish far more for our energy futures and the planet through energy savings than we can by arguing about energy sources, renewable energy, deregulation or climate change. When it comes to energy savings, I can be that crazy, wild-eyed, bushy-bearded zealot who corners you at the Christmas party and who simply does not shut up. So when I come across a program that will promote energy efficiency and savings, I tend to become very enthusiastic.

In this post, I want to tell you about an important issue that will come up for a vote in the New Hampshire legislature early in January 2014 that relates to financing energy efficiency improvements in NH commercial buildings. The legislation deals with a financing tool called PACE which is a mechanism whereby payments for energy efficiency investments are done through property tax like assessments. The program provides a great way to get sorely needed energy efficiency investments made in NH’s building stock. I think it is a good idea and I hope you will too and that you will go ahead and encourage your representative to vote for House Bill 532. However, I openly admit to a bias on this issue so be sure to read my disclaimer at the end of this post.

If we look at energy consumption in NH using data provided by the Energy Information Agency (EIA), we see that most of the energy used in the State is consumed by transportation, homes, commercial buildings and industrial operations.



Omitting the transportation component, if we total up the residential and commercial slices plus 50% of the industrial slice (which is my estimate of the portion of industrial operations that is associated with the heating, cooling, and lighting of buildings), we determine that almost 60% of NH energy consumption is associated with buildings. So if we want to reduce energy usage in NH, clearly the focus should be on reducing energy use in buildings. In fact, it has been estimated that we could achieve savings of 23% on residential, commercial and industrial energy consumption just by implementing building related energy efficiency projects with a positive financial return.

I highlight positive financial return as the remarkable feature of many of these building-related energy efficiency (EE) investments (- such as new heating systems, air sealing and insulation and making sure the systems actually function as specified) because they do pay for themselves over time through lower energy costs. In spite of this, one of the biggest challenges in upgrading a building, whether it be a home, a factory or a store, is finding the upfront money to do so.

There are a lot of programs, including government subsidies, utility rebate programs, etc., out there to partly fund these sorts of investments but moving forward is often stymied by two barriers, the most important of which is that we don’t have the money to retrofit our homes or buildings. Even though we know that the investment will pay for itself over the longer term, we simply do not have the cash on hand to make the investment.

The other barrier to implementation is that we tend to have a short term view of these projects. Most business and homeowners look for paybacks of capital investments in three years or less, but many comprehensive EE projects have longer paybacks. Some might say looking for rapid paybacks on energy related investments is shortsighted, but as a previous CEO and business owner, I do understand these pressures. Intellectually, we believe in long term returns but the reality is that if you own or run a business – three years out is indeed long term planning. And when it comes to homes, the long term horizon is not that much longer because the average length of time for ownership of a home in the US is five years.

Many of us, when looking to make a major investment in our homes such as an updated kitchen or bathroom, justify our investment by the aesthetic and functional value we get out of it and also by convincing ourselves that those investments will be recouped via the increased value of our home that a future buyer will recognize. The problem with energy related investments is that the value of the investment are not obvious. There are no gleaming granite countertops, or Jacuzzi bathtubs that demonstrate your investment. Instead, there is hidden insulation, airtight windows, a higher efficiency furnace; the way these investments manifest themselves is in lower utility bills. These investments, once paid off, do indeed put money into the pockets of home or building owners, but, unfortunately, this is often overlooked by the potential new owner and by the appraiser. In the few houses I have sold, I don’t recall once being asked by the purchaser for a copy of my utility bills. Nor, I am embarrassed to admit, did I look carefully at the utility bills for the homes I purchased.

So the dilemma is this: The savings are real, but they require a substantial upfront investment. If you have to sell or move in the short term, you cannot recover your investment and, as a consequence, many of us don’t make the investment.

Well, there is a program that takes care of these investment recovery concerns. In 2010, the NH Legislature adopted House Bill 1554, an Act which allowed municipalities to establish energy efficiency and clean energy districts. The key aspect of this bill was that it permitted municipalities to set up programs to fund energy improvements in buildings and then it allowed repayment of the investments through  property tax like assessments.

The specific language in the bill that relates to these assessments is as follows:

VII. [A municipality may] Enter into agreements with property owners in which the property owners consent to make energy conservation and efficiency improvements or clean energy improvements to their property and to have the municipality include a special assessment to pay for such improvements on their property tax bills, their bills for water or sewer service or another municipal service, or separate bills, provided that such agreements shall not affect the tax liability or municipal services charges of other participating or nonparticipating property owners in the district.” 

This program is known as PACE: which stands for Property Assessed Clean Energy. The fundamental feature of the program is that it permits an energy related building investment to be repaid through a property tax like assessment and that the investment is associated with the property and not with the property owner. If a property owner invests in energy efficiency in a building, the money can be borrowed from a municipal fund and, if the property owner then decides to sell the property before the loan is paid off, the property owner does not have to find the  money to repay the loan - instead the increased property taxes just move onto to the next owner.  The obligation for repayment continues with the new owner who will continue to benefit from those EE investments. This is very similar to how major municipal projects such as sewers, sidewalks or schools are funded;  property tax assessments remain associated with property rather than specific property owners.

Paying for investment through property taxes allows more affordable and longer term paybacks. It also removes the disconnect between long-term financing and the fact that the average length of ownership for a home is only five years.  Moreover, these property tax liabilities are primary lien assessments, meaning property taxes get paid before everyone else, including the bank holding the mortgage, in the case of a foreclosure. This primary lien position makes these very safe investments and, as a result, low interest rates are applied.

This was a great program and appeared to have great promise for funding EE investments but it was limited to $35,000 for residential projects and $60,000 for commercial buildings. Comprehensive energy-efficiency projects called Deep Energy Retrofits can cost significantly more than this. Regardless, it was a start. But then in 2010, the Federal Housing Finance Authority (FHFA) got their knickers in a knot.

FHFA oversees much of home mortgage market in the US and they became concerned that additional first lien assessments through the PACE assessments on homes would leave less collateral for mortgage lenders to recover in the case of foreclosures.  If we consider that the average outstanding mortgage amount in the US is of the order of $150,000, one can see that an additional $30,000 to $50,000 of primary  lien PACE assessments for EE investments seriously compromises the collateral available to a mortgage lender. This also occurred at a time when property prices were on the decline and many home mortgages were underwater which  further eroded the mortgage collateral position. As a result, FHFA called for a reconsideration of the PACE program for private homeowners - which essentially brought the rollout of the program to a grinding halt.

However, the FHFA does not have jurisdiction over the commercial property lending sector, so implementation of commercial PACE programs – known as C-PACE – is underway throughout the US. The HB 532 bill that goes to the NH House of Representatives for a vote on January 8, 2014 is looking to put New Hampshire’s C-PACE on a firm footing. The bill extends the original PACE bill and looks to accomplish the following:
  • The program only deals with the financing of EE investment projects for commercial buildings, not residential buildings.
  • The bill addresses lien position concerns by requiring agreements between building owner, municipality, the mortgage note holder and C-PACE lender.
  • It allows financing sources to include municipal or clean energy related government bonds as well as financing from banks, financial institutions or even private investors.
  • The $60,000 limit available for PACE programs has been removed . Now the building owner, lender and municipality can come to an agreement regarding the appropriate amount to finance.
  • The length of time for financing has been increased from 20 to 30 years.
  •  The original PACE legislation required the project to be cash positive even in the first year. In other words, the annual savings from the EE projects had to be greater than the increased annual municipal assessment from the funding of the EE investments. Because the length of time for financing this project has been lifted, the requirement is now that the project needs to be cash positive over the length of the C-PACE assessment.

The C-PACE program was rolled out in Connecticut this year and is a good model to follow. The program is administered by Connecticut’s  “Green Bank”, the Clean Energy Finance and Investment Authority (CEFIA).  Since the start of the Connecticut program,  almost $20 million has been invested in EE investments.  In documentation prepared by the CEFIA team, the advantages of the C-PACE program are listed as follows:

·         “Many owners lack capital to do energy improvements. C-PACE provides 100% upfront, long-term financing to property owners for qualified energy upgrades. That means no money down. Audits, construction costs and M&V can be wrapped into C-PACE financing.
·         “Owners often want to sell the building before an energy upgrade loan is repaid. The C-PACE tax obligation is attached to the property and transfers to the new owner. Payments do not accelerate in case of default.
·         “Many owners feel energy improvements don’t yield an adequate return on investment. The C-PACE program requires projects to be cash flow-positive; financing is structured so that energy savings more than offset the additional property tax assessment. Deeper energy upgrades and savings are possible because the assessment is up to 20 years.
·         “Other owners are uncertain that energy savings will perform as advertised. C-PACE has employed a third party administrator to review all projects to verify that projected energy savings pay for the investment over the term of the assessment. C-PACE also tracks owners’ savings on an open-source data management platform.
·         “Owners need tenants to share in the costs of energy upgrades. As a benefit assessment repaid through the property tax bill, under typical leases C-PACE payments – as well as energy savings – can be passed along to tenants.
·         “Auditors and Contractors: The biggest barrier to converting leads to deals for energy upgrades is the lack of access to upfront financing. C-PACE solves this. By allowing a property owner to access 100% upfront financing for up to 20 years, deeper energy efficiency and clean energy improvements are now affordable.
·         “For Municipalities: C-PACE is an economic development tool for municipalities. Energy upgrades create a more competitive environment for retaining and attracting new businesses by lowering energy costs. Energy upgrades also create jobs and reduce greenhouse gases and other pollutants.
·         “For Lenders: C-PACE has created a very secure, clean energy product for lenders. The security comes from its position as a tax lien on a property. The tax lien, like all public benefit assessments, sits in a senior position. The repayment is also tied to property taxes, which are a very secure stream of payment.
·         “For Mortgage Holders: the structure of C-PACE allows participating buildings to pay for improvements to their property out of the savings the project creates. C-PACE approved projects are required to have a “Savings to Investment Ratio” greater than 1, meaning that projected lifetime savings from the energy measures must exceed the total investment over the full term of the C-PACE assessment. The building sees increased net operating income, an immediate return on investment, and becomes more attractive to current and potential tenants and future buyers.”

Once C-PACE is implemented, the challenge then becomes one of rolling the program out. The program in New Hampshire is voluntary and, unlike Connecticut, there will be no State money to kick off the program so some districts or municipalities might elect not to establish energy-efficiency districts due to lack of resources or expertise. Some municipalities might be concerned about loan defaults. In such cases, the C-PACE assessment would be treated just like a property tax default and the municipality would use the lien to seize the property. The C-PACE lender would then not receive any payments from the municipality until such time that the owner makes whole on the back payments or a new owner takes control of the property and starts paying the assessments.

Some districts might not want to issue energy efficiency bonds themselves to provide financing for EE improvements. However one of the most important aspects of the C-PACE program is that it permits outside investors to provide funds for these EE upgrades. Unlike Connecticut, the program in NH will be driven almost exclusively by private investment and interests. This presents both challenges and opportunities that will need to be worked through to get the program up and running after its legislative approval. However, if the NH bill passes, the opportunity is there, and, over time, I believe many districts will welcome the ability to involve private investments to improve the commercial building stock in their area.

Another question regularly asked about the C-PACE program is the lien position of the C-PACE assessment. In Connecticut  C-PACE liens are, by law, senior to those of the mortgage but they do require the consent of the mortgage lender for the placement of the lien. Their experience has been that lenders view EE investment projects financed through C-PACE to be beneficial because the energy savings increase the cash flow from the property which reduces the mortgage repayment risk and increases the value of the building.

If I were an investor in a C-PACE program I would be very pleased that I would be able to collect money for EE  projects via property tax assessments, but I would also want the following considerations taken into account:

  • An energy audit should first be carried out to ensure the correct investments are being made. For example, it might not be the best investment to install a shiny new furnace in a poorly insulated building. A better investment might be better to insulate the building and then carry out the furnace upgrade.
  • I would want the EE investment projects performed, or at least monitored, by approved installers. The stories are legion of EE upgrades not providing the benefits that building owners anticipated because of poor installation practices or unscrupulous contractors looking to cut corners.
  • The energy savings should be cash positive over the life of the investment, i.e., the energy savings should be greater the increased property tax assessments. I would want this confirmed by post- installation monitoring and verification of the energy savings.

Overall I think the C-PACE legislation is the trick* that could do a great deal to promote privately funded investments in EE projects in commercial buildings in New Hampshire. I encourage you to support it. At least that way you will be able to avoid the crazy, wild-eyed, bushy-bearded energy efficiency zealot from cornering you at the next party you attend. Follow this link if you would like to learn more about the NH C-PACE legislation.

Until next time, remember to turn off the lights when you leave the room.

Mike Mooiman
Franklin Pierce University
mooimanm@franklinpierce.edu
Disclosure: I am biased on this issue as I am a Member of the Board of The Jordan Institute which is a NH non-profit focused on reducing energy use in commercial buildings. The Jordan Institute is actively monitoring the C-PACE legislation in NH. I am also President of RBG (Resilient Buildings Group), the for-profit subsidiary of The Jordan Institute. RBG works in the area of energy efficiency upgrades to buildings in New England and might benefit financially from the implementation of the C-PACE program in NH.


(*Pace is the Trick - A track by Interpol which is another one of my post-punk indie groups, this time out of NYC. The Strokes are my clear favorite from this place and time but Interpol was a close second. They had a number of critically acclaimed albums during the last decade and are reportedly back in the studio. Pace is the Trick is from their third album released in 2007. As you will hear Interpol and The Strokes were clearly drinking from the same influence pool.)

1 comment:

  1. I think that the intentions of the C-PACE program are good. However, I think that this situation could become easily gamed by organizations and leaving the bill on the tax-payers (Title Companies will have to develop a defense against these tax obligations). I would be curious to see how technology and its evolution are quantified in these scenarios. LEED is the best example of technological energy failure; insofar as, what energy a system is "projected" to use as opposed to what that building is "actually" using. Either way, fascinating article. I am an "Energy in New Hampshire" groupie.

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