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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   July 2017

Accelerate Your Energy-Investment Game

Green banks tackle aging infrastructure and keep buildings financially stable

Accelerate Your Energy-Investment Game

Overhauling the United States’ aging commercial-building stock is an ever-present challenge for property owners and managers. Nearly half of all commercial buildings in the U.S. were built before 1980 and another 12 percent before 2002, according to the U.S. Energy Information Administration. 

Even in newer buildings, core mechanical equipment, lighting and other energy-related systems are nearing the end of their useful lives, or are well past that point. The result is inefficient buildings with higher operating costs that face major capital-investment needs. Commercial mortgage brokers should be aware of the upgrades that may be needed when they’re facilitating loans for older properties.

For commercial property owners, replacing outdated energy equipment means an expensive upfront capital expense that only yields operational savings — such as lower utility bills and maintenance costs — over time.

In an operating-expense budget of one to three years, most energy upgrades don’t pass financial muster, and property owners continue to put resources into patching inefficient, underperforming equipment. When the equipment ultimately fails, odds are it occurs outside of regular mortgage- or business-financing cycles, leaving owners scrambling to cover these costs with cash, equity or expensive credit options.

Green banks are public-private partnerships that have emerged in the past five years with the aim of tackling this challenge head on as an opportunity for capital markets, particularly conventional commercial banks. Connecticut Green Bank, the first green bank in the nation, was established by the Connecticut Legislature in 2011 with the directive to create new financing mechanisms for making buildings more energy efficient. Critically, it does so with limited public subsidies.

New financial products

While subsidies for clean energy — in the form of tax credits or utility rebates — have existed for decades, they only cover a portion of equipment upgrades, leaving the remainder on the shoulders of property owners. Meanwhile, financial institutions have not picked up on what the Rockefeller Foundation and Deutsch Bank Climate Change Advisors group estimated to be a $72 billion capital-investment opportunity in equipment replacement for commercial properties alone.

There are two key reasons for this. First, the vast majority of commercial-property ownership companies are unrated, posing a credit-underwriting challenge for financiers at scale. Second, conventional commercial banks are unfamiliar with clean-energy technologies, the construction timelines associated with their installation and the risks related to energy-savings projections.

Green banks are public agencies that seek to leverage private capital by developing financial products or underwriting procedures, thereby removing risks of clean-energy transactions for private lenders. Green banks do not compete with conventional banks. Rather, they fill a gap in capital markets, and create pathways for banks and private-lending institutions to become active in clean-energy lending.

Green banks’ contributions to the marketplace span from providing loan-loss reserves and interest rate buydowns, to creating structured-debt facilities. In the latter category, green banks provide standard-technology and financial-underwriting guidelines, and sit at the bottom of the capital stack as a credit enhancement.

Since the establishment of the Connecticut Green Bank, several others have been founded, including the NY Green Bank, the Rhode Island Infrastructure Bank and the New Jersey Energy Resilience Bank. The Coalition for Green Capital estimates that these green banks and others have spurred more than $2 billion of clean-energy investments in the U.S. in the past five years.

C-PACE support

One financing product that has been successfully supported by green banks is Commercial Property Assessed Clean Energy (C-PACE). In many ways, C-PACE is the ideal public-private partnership because it requires no deployment of green-bank capital and instead relies on the public-agency status of green banks, as well as local taxing authorities, to create a secure investment vehicle for private lenders.

C-PACE legislation, which has been adopted by more than 30 U.S. states, classifies energy-related upgrades to commercial buildings as a public benefit, similar to water lines or sewers. This means the financing for these upgrades can be secured in a similar manner, as a long-term special assessment on the property. As a special assessment, C-PACE payments are typically billed and collected as part of property-tax bills.

In some states, current or past-due C-PACE payments are senior to other property liens, including mortgages. Importantly, however, C-PACE financing does not accelerate and the payment obligation transfers to the new property owner after a sale or foreclosure. In the event of foreclosure, mortgage lenders are only subordinate to any current and past-due assessment payments, while the remaining C-PACE loan amount stays with the property.

The senior position of C-PACE loans and their repayment structure via taxing authorities has created a secure investment vehicle for lenders, who can underwrite clean-energy financing against a commercial building’s property taxes, as well as the collateral value of the building. Meanwhile, as energy upgrades reduce operating costs, these projects typically increase cash flow and boost the property’s value, an incentive for mortgage lenders to consent to C-PACE investments prior to placing an assessment on the property. This consent is a statutory requirement in most states.

As of this past December, more than 200 lending institutions have enabled C-PACE assessments on commercial buildings. Many mortgage lenders are using C-PACE to proactively retain customers between commercial mortgage resets when they learn their clients face large capital-improvement needs but cannot deepen their debt obligations to the lender.

Green banks support C-PACE programs on a state level as program administrators. They have accelerated the uptake of C-PACE through standardizing the project-approval process for investors, as well as centralizing the billing and collection functions among local taxing authorities. In addition to state-level support, local municipality buy-in is important as well. In the case of Connecticut Green Bank, standardizing its C-PACE program motivated nearly 80 percent of the state’s municipalities to adopt the program.

Seventeen states now have active C-PACE programs. The Rhode Island Infrastructure Bank has launched a C-PACE program, and its first projects were financed earlier this year. In states without green banks, third-party entities such as the Texas PACE Authority and the Maryland Clean Energy Center have worked to design standardized C-PACE programs that local taxing authorities can adopt and administer independently or with an outsourced statewide administrator.

State-by-state growth of C-PACE has spurred federal agencies active in the commercial mortgage market to develop their own guidelines, further streamlining the underwriting and approval process for financing. In the past year, the Federal Housing Administration (FHA) and the Small Business Administration (SBA) have issued guidance on C-PACE for multifamily or commercial properties. These guidelines are leading to improved C-PACE implementation and program design, while helping C-PACE investors and mortgage lenders that work in concert with federal agencies to remove the uncertainty surrounding the mortgage-lender consent process.

• • •

As adoption of C-PACE legislation grows and green banks continue to prove their abilities to support both economic development and environmental goals, the nascent industry is moving briskly toward accessing the securitization markets and more efficient financing. In fact, a report this past May said a C-PACE asset-backed securities deal is imminent. Such scenarios bode well for the continued growth of C-PACE, because the flow of private capital will be further facilitated by added liquidity for lenders.

If the trajectory for C-PACE continues as anticipated, it will serve as a model for creating viable public-private partnerships and government-sponsored enterprises (GSEs). That will be good for the nation’s business – including mortgage brokers seeking financing options for borrowers looking to make their commercial properties more energy efficient.


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