PACE Financing – Energy Efficiency Comes to Triple-Net Tenants

Posted by Dalkia Solutions on Sep 19, 2013 3:14:55 PM

This week I attended a USGBC hosted discussion on PACE financing held in downtown Boston.  Based just on Massachusetts Senator Brian Joyce’s opening remarks attendees got the clear impression that PACE is on a roll again…

Back in 2010 PACE also appeared to have momentum (16 states had already enacted legislation) only to have Fannie Mae and Freddie Mac suggest they wouldn’t “support” PACE, as it subordinated their mortgage loans.  While Fannie/Freddie had no legal means to stop it, even their expression of concern had the effect of changing market perception.  Just like that PACE looked to be stalled.

Surprise – three years later 31 states have now enacted legislations, with even conservative Texas having recently joined the ranks.

What’s kept it moving?  In my view, three things:

1.  Jobs.  PACE generates local jobs (no outsourcing local mechanical contractors to China) and politicians have latched onto this message.  In today’s economy there are very few jobs stories and energy efficiency finance is a feel-good, voter friendly message.

2.  Greed.  Bankers and Wall Street now support PACE as they see the chance to lend high quality, secured dollars and make money repackaging and reselling them.  Get ready, energy efficiency bonds are coming your way.

3.  Dropping Residential.  With the overhang of Fannie/Freddie’s concern, and the like hood of consumer lending scrutiny, successful PACE programs are quietly bypassing the residential market.  And in multi-family housing there are already a ton of existing financing programs, which means PACE stands to get lost in the weeds there as well.  The best initial programs are focusing on C&I as it is cleaner and easier.

If Brian Joyce has his way Massachusetts will become the 32nd PACE state next month.  His team is busy studying neighbor Connecticut, who also joined late (state #28) but whose C-PACE program has quickly implemented projects.   Meantime only six other states have live programs underway post-legislation.   With so many constituents needed to sign off (municipals, state agencies, bankers, etc.) the new program design and implementation process has proven to be challenging.

Unlike some others, CT has taken a single state approach (one program for the whole state) and has fast tracked the first projects using their own equity and debt capital. To do this, two years ago CT launched the nation’s first green bank, CEFIA, to provide the capital and use its bonding authority.  The proceeds from their RGGI auctions flow into this entity as well.  New England neighbor NY state will soon follow with their own green bank.

By priming the pump with their own capital C-PACE is now in a position to show demand and strong results, as opposed to living in hypotheticals.  Their lending rates for these initial projects have been 4.5 to 5% and they are now collecting sealed bids to sell off these first loans.

Genevieve Sherman, the manager behind the CT program, had some interesting early stats:   CT now reaches 65% of the state (59 towns have opted-in already), has $7 million of closed projects, another $13 million (100+ projects) in the funnel, Groom Energy is one of 300 contractors already trained and 14 capital providers are lined up. They had expected the average project sizes to be @ $300 to $500k, but projects are coming in higher.  All good news and impressive.

For those of us who have been cheerleaders in energy efficiency finance for the last several years, PACE now looks to have some ingredients which overcome obstacles faced by alternative financing approaches (ESCO, capital leasing, operating leasing & on-bill finance.)  In the past building owners have pointed to three reasons they haven’t already pursued energy efficiency upgrades for their buildings:

1.  Lack of capital

2.  The energy savings weren’t certain

3.  The owner-tenant split incentive problem

C-PACE solves # 1 using their own money to get started, replacing it with private third-party capital over time, #2 by having engaged a third-party engineering firm to confirm project savings projections and #3 by enabling the owner to recapture their increased tax costs from their tenants.

On #2 there was the expected question from the audience – “what happens if the savings don’t materialize?”  The answer?  The owner is still obligated to pay.  No guarantees.  No third party insurance.  As we’ve commented before on this topic, adding guarantees (or even the perception of a guarantee) is expensive.  And C-PACE is betting that a third party engineering review will suffice and preserve a light weight, low-cost administrative layer.  Unlike traditional utility rebate program’s technical review (which is a black box) the results of these engineering reviews will be made publicly available.  One building owner panelist even commented that  this is “a government program which is “non-offensive” and allows him to shift the performance risk to his tenant.”

Interestingly, CT appeased the bankers association by requiring that any PACE financing first gain a sign off from the bank owning the mortgage on the property.  While it seems like a no-brainer that the bank would not stand in the way of a cash flow positive building upgrade, CT has already seen cases where an owner shifted banks when their own bank hesitated to give the sign off.

But in the end it’s #3 that is most curious and potentially the biggest opportunity.

As a flow through tax to triple-net tenants an energy efficiency upgrade can finally be considered regardless of where the tenant is in their lease cycle, and with less landlord tension about who pays for the upgrade.  The tenant decides how to accrue the benefits, absorb costs over time, and, using up to 20 year PACE financing, how cash flow positive it is from day one.

Compared to yesterday’s announcement that the Federal Government is bringing back Cleantech Loan Guarantees, this sounds like a way more compelling loan program.


Topics: PACE