PACE: A SMART WAY TO FINANCE RETROFITS FOR ENERGY EFFICIENCY AND WATER CONSERVATION
WRITTEN BY | STEPHEN M. BLOCK AND JAMES C. MORRISS III
uppose your company wishes to increase energy effi ciency and re- duce operating costs by retrofi t- ting its existing
properties. What if the retrofi t costs could be paid without diverting funds from the company’s capital budget, impairing growth capital, reducing cash reserves or drawing on traditional credit sources? What if these costs could be fi nanced through low-cost, long-term funding arrangements where the annual debt-service payments are less than the annual savings actually derived from the retrofi ts? It may sound too good to be true, but all of this is possible under PACE, the Property Assessed Clean Energy program. PACE is an innovative, common-sense
program that enables property owners to receive funding for energy-effi ciency retrofi ts and water-conservation improve- ments. PACE fi nancing is attractive because it enables property owners to avoid the high up-front cash outlays that are a common barrier to upgrades for energy effi ciency and water conservation. Because the payback period may range from fi ve to 20 years, conventional lenders often are reluctant or unable to make long-term loans to fi nance the upgrades. Several different models of PACE fi nanc-
ing have evolved, ranging from private- sector owner-arranged fi nancing to funding mechanisms utilizing government-issued bonds. In all cases, the key to PACE funding lies in the nature of the collateral: PACE fund- ing is secured by special-assessment liens voluntarily imposed on the property by its owner. In most cases, the liens are tanta- mount to, and have the same priority as, property-tax liens. For this reason, PACE loans
16 RETROFIT // January-February 2013
are exceptionally safe investments for lend- ers and other investors. PACE loans also tend to be attractively priced for the borrower on account of their low-risk profi le. Debt-service payments on PACE loans are collected by lo- cal taxing authorities as a separate line item on the property-tax bill and are then remit- ted to the holders of the PACE loans. PACE fi nancing transfers with any sale
of the property so future owners assume the payments while continuing to receive the benefi t of the positive cash fl ow derived from the energy cost savings. As a general rule, the consent of the holder of any fi rst mortgage lien on the property will be re- quired before applications for PACE fi nanc- ing are approved and assessments imposed on the property.
PACE PROGRAMS EXIST by virtue of special enabling legislation at the state level. The fi rst PACE program originated in California in 2007 and was successfully implemented, primarily with respect to residential property. In the summer of 2010, Fannie Mae, Freddie Mac and the Federal Housing Finance Agency (FHFA), Washington, D.C., moved to quash residential PACE programs. Specifi cally, FHFA, which was created in 2008 to regulate Fannie Mae and Freddie Mac, believes that PACE creates unacceptable risk for its regulated entities and has issued policies that prohibit Fannie and Freddie from underwriting mortgage loans on residential property with
PACE loans. FHFA’s actions with respect to residential PACE programs have been widely criticized and challenged in several ongoing judicial proceedings, and federal legislation has been introduced that would override FHFA’s policy position. A discussion of these challenges is beyond the scope of this article, but suffi ce it to say that FHFA’s opposition to residential PACE programs had a chilling effect on all PACE programs. However, as of this writing, almost 30
states and the District of Columbia have adopted some form of PACE legislation. But the statutory framework for structuring and administering PACE programs varies widely from state to state. A common thread in all PACE legislation involves authorization of special-assessment districts to be created at the local level for the purpose of fi nanc- ing energy-effi ciency improvements. The legislation generally provides that local governments may prescribe the types of energy-effi ciency improvements that qualify for PACE fi nancing, as well as underwriting standards for the fi nancing program.
ALTHOUGH PACE was initially con- ceived as a mechanism for fi nancing energy- effi ciency retrofi ts for residential property, there is a strong and growing business case for investments in commercial and industrial building retrofi ts. As a result, PACE programs for commercial and industrial properties are the current driving forces for the nationwide growth of PACE. Studies by several agencies, (continues on page 18)
imposed on the property by its owner.
PACE funding is secured by special- assessment liens voluntarily