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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   May 2018

The Power of Green

Energy-efficient financing makes properties more profitable and climate-friendly

The Power of Green

Energy efficiency in buildings is one of the most powerful resources for achieving the world’s environmental goals. It also is an incredible economic opportunity for commercial real estate investors.

Residential and commercial buildings are responsible for about 40 percent of all U.S. energy consumption and, in order to make these buildings more energy efficient, investments of more than $279 billion are needed. Commercial mortgage brokers should know about green-building financing options so clients can stabilize or add value to their properties, or reduce risks associated with future refinancing opportunities.

It is estimated that green investments could result in more than $1 trillion in energy savings over a 10-year period. When looking at the types of projects in which energy efficiency presents opportunities, building retrofits stand out. Energy-efficient, building-scale retrofit projects — such as upgrades to heating, ventilation and air conditioning (HVAC) systems and lighting systems —could reduce greenhouse-gas emissions by more than 600 million metric tons of carbon dioxide per year.

There is a powerful trend emerging that shows commercial banks are now considering green buildings a better risk than conventional buildings because of the lower operating costs, higher rent prices, lower vacancy rates and increased values upon resale. The rising demand for green buildings is being fueled by an increased focus on corporate social responsibility and a demand from new generations of workers who prefer green spaces. As demand increases, lenders have followed and are now assigning lower valuations and higher risk premiums to conventional buildings that do not achieve Leadership in Energy and Environmental Design (LEED) or Energy Star certification.

Green investing also continues to drive change in the market. There are national programs to help increase investor and building-owner confidence in the environmental and financial savings of a retrofit project. These programs may have their own certification standards, which offer the commercial real estate sector a consistent and transparent process to ensure energy savings and greater investment returns.

ESCOs and ESAs

In 2011, Shaw Environmental and Infrastructure Inc. was subcontracted by the American Council for an Energy-Efficient Economy (ACEEE) to study the financial institutions involved in energy finance and outline the various green-financing models that were either available or being developed. They found that initiatives exist for nearly every type of residential and commercial building, and for every ownership structure.

State housing agencies are among the major sources of capital for energy-efficiency projects. 

The commercial banking sector’s main energy-efficiency financing offers are through contracts with large energy services companies (ESCOs), which most commonly work on projects with municipal governments, universities, school districts and hospitals. This structure is specifically for highly creditworthy organizations that have been evaluated by a major credit-rating agency, such as Standard & Poor’s, Moody’s or Fitch Ratings.

ESCO contracts require the energy company to provide a performance guarantee to the building owner, which means the borrower has to meet loan obligations even if the original energy-reduction targets are not met. An energy services agreement (ESA) is similar to the ESCO structure, except that energy savings are tied to loan repayment, meaning that repayment amounts are proportional to the savings that are generated.

Small-business options

For noninvestment-grade projects, commercial banks offer middle-market and small-business lending programs, including U.S. Small Business Administration (SBA) programs. The SBA’s 504 program is convenient for energy-efficient projects because it allows for longer-term, fixed-rate debt.

To accommodate small commercial facilities and privately owned multifamily buildings, large commercial banks offer financing to intermediary partners, such as community development financial institutions, or CDFIs. These entities encompass various private financial institutions, nonprofit loan funds and venture-capital funds. They are certified by the U.S. Department of the Treasury’s CDFI Fund. Commercial banks are one way that CDFIs secure funding for their loans, as well as from philanthropic foundations and government sources. CDFIs often have to pledge assets or provide guarantees in order to secure funding.

Utility companies have long provided energy-efficiency funds through on-bill financing and on-bill repayments. On-bill financing allows utility companies to recover the costs of a clean-energy upgrade, which is repaid by the property owner through the utility bill. An on-bill repayment means the property owner repays the investment through a charge on their monthly utility bill. These kinds of financing plans are increasingly becoming attached to state legislation that require utilities to offer a certain amount of financing for small commercial and residential projects.

Federal, state and local governments offer a variety of programs for energy-efficiency financing. On the federal level, energy financing is offered through the PowerSaver program at the U.S. Department of Housing and Urban Development (HUD) and the Energy Efficiency and Conservation Block Grant (EECBG) program at the U.S. Department of Energy. There also are various public-private partnerships that take advantage of subsidies, such as the Green and Healthy Homes Initiative, which was created through collaboration between the White House Office of Recovery and the Council on Foundations, a nonprofit organization.

More funding sources

State housing agencies are among the major sources of capital for energy-efficiency projects. They may require low-income housing-tax credit (LIHTC) allowances to be linked to such projects. State development-finance authorities also are a growing source of funding for the energy sector, typically requiring projects to provide back-up letters of credit from investment-grade companies in order to protect the state.

There is a demonstrated global availability of capital to invest in energy-efficiency projects. 

Private finance companies also are significant players in the energy-efficient lending space. Community development corporations (CDCs), which work with SBA’s 504 program, represent a portion of these private financiers. Through the 504 program, a commercial bank provides a loan for up to 50 percent of a project’s costs and a CDC provides up to 40 percent through a federally guaranteed debenture. Additional funds are available for projects meeting LEED standards.

Finally, private equity and venture-capital companies have long been focused on the energy-efficiency arena. These companies offer various financing options, one of which is funding of project costs for sponsors that do not have investment-grade credit ratings. An emerging trend within this sector is venture philanthropy, which is when high net worth individuals make large investments that mainly focus on social or environmental returns, but also have potential financial gains.

There is a demonstrated global availability of capital to invest in projects that are energy-efficient. Engaging these investment opportunities achieves the triple benefit of positive economic, social and environmental impacts. Even with this diversity of options, however, energy-efficiency financing is only reaching a fraction of its cost-effective potential in the market. A critical aspect of closing this investment gap is to provide energy-efficiency loans with a high degree of standardization and predictability.

Creating confidence

In the past, the energy-efficiency sector lacked a systematic process for performance assessment, resulting in a loss of investor confidence. An inability to predict accurate loan performance has hampered energy-efficiency investors of all kinds, including building owners, energy-service companies and insurance providers. Estimates vary widely, but energy-efficiency projects in the U.S. are valued between $60 billion and $115 billion, according to ACEEE. Many billions more are needed.

Today, a standardized assessment method — in the form of certification — is available to better serve investors and building owners. The Environmental Defense Fund and Clean Energy Finance Center, as well as a number of state- and local-level stakeholders, are partnering to provide large data sets regarding energy savings and loan performance for residential and commercial buildings.

To achieve certification, teams align their projects with established protocols, then follow procedural and documentation requirements to ensure quality project development, as well as their plans to maintain energy savings. The requirements include calculating baseline energy usage and potential savings; project design, construction and verification; property operations, monitoring and maintenance; and ongoing energy measurements and verification.

The goal of any certification program should be to increase confidence in savings and reduce transaction costs for investors, regardless of the public programs, incentives or underwriting programs they are utilizing. Commercial mortgage brokers also can help promote this knowledge with their clients and foster confidence, which is essential for increasing energy efficiency as a priority for all building projects.


 
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