Power Plays: Public, Private Sectors Target New Ways to Finance Energy Upgrades

Cutting energy consumption and operating costs through retrofits is an established best practice among forward-thinking owners. But as the economy comes back only by fits and starts, financing the upfront costs of upgrades remains the biggest single hurdle for owners.

Cutting energy consumption and operating costs through retrofits is an established best practice among forward-thinking owners. But as the economy comes back only by fits and starts, financing the upfront costs of upgrades remains the biggest single hurdle for owners. “There’s been very little improvement financing that’s gone into buildings,” noted Ken Hubbard, a New York City-based executive vice president for Hines. “It really needs to come into the capital stack as equity.”

The challenge of financing energy-related property upgrades is all the more vexing in light of the staggering potential. In an often-cited analysis, McKinsey & Co. projected that energy efficiency measures couId save the economy $1.2 trillion over the period 2009 to 2020. By then, improved energy efficiency could save the economy $130 billion annually. McKinsey put the cost of the upfront investment at $523 billion—a hefty sum, to be sure, but one that would yield a 130 percent return.

As compelling as those figures are, they also hint at a Catch-22 familiar to property owners and lenders alike. The efficiencies and cost savings added by energy-related retrofits can enhance the long-term value of a property by increasing its value to tenants and investors. But that added value takes several years to accrue, while energy efficiency measures are gradually paying for themselves. With lenders unlikely to finance projects based on anticipated future value, financing upgrades can be problematical at best.

“Those things showing up in the valuation of the building take time,” said Charles Leitner, CEO of the Greenprint Foundation, a new commercial real estate organization dedicated to promoting sustainable practices. “You can do a return-on-cost calculation based on similar properties’ energy savings. But how does it show up in terms of cash flow?” added Leitner, who was previously global head of RREEF and is still its chairman.

Well intentioned and often effective as they are, the array of incentives offered by federal, state and local agencies have so far fallen short of meeting the need for financing. But some recent initiatives may change the picture dramatically. The most far-reaching could be a proposal outlined by the White House last month. On Feb. 3, the White House unveiled a package of proposals dubbed the Better Buildings Initiative, which calls for the nation’s commercial building stock to improve energy efficiency 20 percent by 2020. Drawing extensively on suggestions from commercial real estate organizations, the initiative would significantly ramp up federal support for financing sustainable energy retrofits in the commercial property sector.

A centerpiece of the plan would eliminate the current federal tax deduction for upgrading energy systems in commercial properties and replace it with larger tax credits. Among other advantages, the approach would reach a wider range of owners, especially those whose businesses are running in the red during a given year.

The Better Buildings Initiative would add to the federal commitment beyond the American Recovery and Reinvestment Act of 2009, which authorized $20 billion for green energy measures overall. About one quarter of that—$5.5 billion—is earmarked for the General Services Administration to incorporate energy-efficient features into existing buildings and new construction.

Another major provision of the Better Buildings Initiative is a new federal loan guarantee program designed to make financing energy improvements more attractive to lenders. A pilot program offered by the Power Plays Public, Private Sectors Target New Ways to Finance Energy Upgrades By Paul Rosta Sustainability To promote the potential of energy efficiency measures, President Obama visited Orion Energy Systems, a manufacturer of high-performance fluorescent lighting and other products. A week later, the White House unveiled its Better Buildings Initiative, which the administration estimates could save commercial and residential property owners $40 billion in energy costs annually. U.S. Department of Energy would guarantee loans for energy retrofits in commercial buildings, schools and hospitals.

Another source of stepped-up financing will be newly increased limits on the size of energy retrofit loans offered by the U.S. Small Business Administration. That action can be handled through an administrative change and does not require Congressional approval, sources pointed out. Moreover, the Obama plan would establish competitive grants to state and local governments that streamline codes and regulations in a way that promotes sustainability upgrades and draws investment from the private sector.

Other measures are designed to enhance training and reward CEOs and university presidents who foster a series of best practices in energy efficiency. All told, the Obama Administration estimates that its plan would save single-family homeowners and the commercial sector $40 billion in energy costs annually.

Picking up the PACE

Though it is impossible to predict how the proposal will fare in the budget battle, influential industry organizations like what they see at first glance. Industry observers especially praise measures that are intended to make energy upgrades significantly easier to pencil out.

“The President’s aggressive approach to providing incentives for commercial building retrofits and new construction projects, as well as a new proposed competitive grant program, will be important factors in building owners’ ability to retrofit and improve their properties,” commented NAIOP president & CEO Thomas Bisacquino in a prepared statement. Bryan Howard, manager of federal advocacy for the U.S. Green Building Council, suggested that the Better Buildings Initiative could provide a watershed of sorts. “We think there’s a real target-rich environment and an opportunity to take advantage of extra savings and opportunities to do projects quickly,” he said. “The scale … in terms of energy reduction, as well as reduced costs, is amazing.”

The White House proposal may also provide an alternative to a promising financing mechanism that has run aground, at least temporarily. Dubbed Property Assessed Clean Energy, orPACE, the model allows government agencies, usually at the municipal level, to reimburse property owners for the cost of installing energy-efficiency measures and other green steps. Owners then pay back the funds incrementally through increased property taxes.

Between 2007 and 2010, legislatures in more than 20 states and Washington, D.C., authorized programs based on the PACE model. Initially targeted for single-family and small multi-family properties, PACE financing was widely considered to have potential for expansion to the commercial sector. But last July, the popular program ran into a wall in the form of a decision from the Federal Housing Finance Agency, which regulates Fannie Mae, Freddie Mac and the 12 Federal Home Loan banks. By making loans on participating properties ineligible for repurchase by Fannie Mae or Freddie Mac, the FHFA effectively ended the program. “First liens for such loans represent a key alteration of traditional mortgage lending practice,” the agency contended in a letter explaining its decision. “They present significant risk to lenders and secondary-market entities, may alter valuations for mortgage-backed securities and are not essential for successful programs to spur energy conservation.”

The FHFA’s move drew wide criticism. Before his election to the governorship last fall, then-California Attorney General Jerry Brown sued the federal government to reinstate the program.

While the PACE model remains in limbo for now, the Better Buildings Initiative may offer an alternative mechanism. “My guess is that the loan guarantees are a way to deal with PACE issues,” said Dana Schneider, vice president of Jones Lang LaSalle Inc.’s energy and sustainability services group.

Innovative efforts to boost sustainable energy retrofits are also springing up on the local level. In Los Angeles, a coalition of leaders from city government and local businesses are backing CLEAN LA, a proposal to provide multiple levels of financial incentives for commercial and residential business owners. When fully in place, say the plan’s supporters, CLEAN LA would be the most extensive program of its kind in North America to use a strategy called feed-in tariff, or FIT, financing. The basic mechanism involves allowing commercial and residential owners to install solar panels and sell excess capacity to a local utility. The city’s proposal originated with the Los Angeles Business Council, a group focused on education, research and policy. In 2009, the coalition asked the UCLA Luskin Center for Innovation to come up with recommendations for implementing the financing.

If approved by the city council, as expected, CLEAN LA would enable building owners to sell electricity generated at their properties to the Los Angeles Department of Water and Power. It is unclear how much the White House’s Better Buildings Initiative would affect the Los Angeles program, but the federal tax credits available for solar installation would provide an estimated $300 million for commercial and residential owners. CLEAN LA’s backers believe the program could generate 150 megawatts annually through 2016 and scale up to 600 megawatts by 2020.

Bring on the Private Sector

Though much of today’s discussion focuses on the role of public policy, private-sector solutions are also multiplying. Solar energy is a regular source of attractive financial structures for commercial property owners. A case in point is the record-setting installation under way at Jersey Gardens, a 1.3 million-square-foot regional mall owned by Glimcher Realty Trust in Elizabeth, N.J. Covering some 325,000 square feet of rooftop area, the panels will comprise what project officials say will be the largest installation of its kind in North America.

Besides its record-setting scale, the Jersey Gardens project provides an elegant solution to financing issues. Glimcher has no upfront capital costs. Instead, Sunnyvale, Calif.-based Clean Focus Corp. will finance the installation and own the panels. All told, the panels should generate 4.8 megawatts annually, about 11 percent of Jersey Gardens’ annual power consumption. Like many other solar projects at commercial properties today, it relies on a simple but elegant model. The property owner provides space for the panels and agrees to buy a certain amount of the power produced at the site. In exchange, the outside provider foots the bill for installing and maintaining the installation.

Charlie Kretzer, Glimcher’s director of operations, said that it is difficult to estimate how the enhanced role of renewable energy at Jersey Gardens will translate into savings. But the service contract itself may carry a distinct advantage: By locking in long-term rates for electricity, the contract with Clean Focus will provide a hedge against the unpredictability of oil prices. The 20-year operating contract with Clean Focus gives Glimcher buyout options at specified milestones. And although the sheer size of the Jersey Gardens roof makes the property an ideal candidate for hosting solar panels, Kretzer said, “I don’t think the size should limit your commitment.”

The most effective mechanisms for financing sustainable energy retrofits will remain works in progress for some years to come. Political agendas, as well as the trial-and-error process, will move financing ahead only by fits and starts.

Given the consensus that green energy is an urgent economic and environmental priority, some senior executives expect the new models to emerge from market forces no less than from public policy. As Hines’ Hubbard explained: “We think over time the marketplace is going to factor out the buildings that are at the top of the performance scale, as opposed to those that are at the bottom of the performance scale.”