Friday, March 9, 2012

Opportunity for Banks in PACE Lending

PACE programs are growing because they facilitate long-term financing at commercially-attractive rates for energy efficiency loans in the commercial property market. A PACE loan is secured by a lien on the owner’s property which is repaid via an assessment on the property tax bill. This financial structure allows the energy savings generated through energy efficiency investments to more than offset the additional charge on the monthly property tax bill. PACE loans represent a unique “win-win-win” scenario as the benefits flow to all the parties associated with the loan: the bank making the loan, the building owner who can upgrade the property and improve cash flow, and the community which enjoys a more competitive business climate, as well as local jobs associated with installation of the energy improvements.

Since the lien associated with a PACE loan occupies a priority position, the mortgage holder’s consent is required before PACE applications can be approved and the assessment placed. Much has been said in the development of these programs about potential bank resistance to the priority position of the PACE loan. In my view, there are a number of reasons why lenders should seriously consider the benefits that will accrue to the bank via participation in PACE lending programs.

1. With existing customers, who own property that can readily be made more energy efficient, it is an opportunity for banks to increase their business. Such customers will see particular value in the increased cash flow, increased building valuation and improved competitive position of the building in the market. For the bank, it is also an opportunity to identify and solicit new customers from other institutions that do not participate in PACE programs.
2. Much of the energy efficiency work will likely be associated with replacing energy-consuming systems that have exceeded their useful life and that has been delayed due to the recession. By providing loans to these customers, banks will be protecting their collateral and helping the property avoid obsolescence.
3. Non-acceleration clauses in typical PACE programs require only the low monthly payments be paid by the foreclosing bank, a fact that significantly reduces the financial impact of the PACE’s priority lien on the lender.
4. A secondary market (securitization) for PACE loans is already being discussed. The ability to package loans and sell them on the secondary market would be attractive to banks and add to the bank’s profitability.
5. Federal energy efficiency loan guarantees and/or state energy efficiency loan loss reserves (associated with the PACE program) may be available that will provide credit enhancement.
6. Emerging energy savings insurance which will guarantee the energy savings (from which the lender is recovering both capital and interest) will also provide a credit enhancement.
7. PACE programs support the bank’s commitment to sustainability, creating an opportunity for excellent PR in the community and within their customer base.

Does anyone have any other reasons?

Thursday, March 8, 2012

CBECS Funding Restored

In my September 27, 2011 blog, I stressed that the commercial real estate industry urgently needs the Commercial Buildings Energy Consumption Survey (CBECS) to be funded. If you recall, on April 28, 2011, DOE announced that due to budget cuts, work on the 2011 CBECS was suspended. They also announced that they would not be releasing the 2007 CBECS results. This meant that the industry had no choice but to rely on the last published survey in 2003, an information baseline that is almost ten years old. There is no question that much has happened with building energy use since the 2003 survey. To use data this old in benchmarking can only call into question any conclusions drawn. The industry not only needs CBECS, but needs it to be expanded to include many more buildings.

I am happy to report that in late December, Congress restored $10 million of the funds trimmed in April of last year from the Energy Information Administration (EIA), the analysis arm of the Department of Energy and responsible for the CBECS. The result was that in January, EIA resumed the CBECS program. EIA plans to sample more than 8,400 buildings in the next CBECS, more than double the number sampled in 2003. Although they are increasing the sample size, it is still well below the size needed to produce statistically sound data with the highest level of confidence for all types of buildings encountered in the commercial real estate industry. But at least it is a step in the right direction! EIA plans to publish the results in 2014. Unfortunately, until then, the industry must continue to rely on the outdated results published in 2003.

We as an industry need CBECS to continue and be expanded to include many more properties in each commercial real estate property type category. Too much is at stake in this highly competitive marketplace to rely on anything but absolutely unassailable data for benchmarking.

Friday, January 27, 2012

Latest Edition of IPMVP Released

The Efficiency Valuation Organization just announced release of its 2012 International Performance Measurement and Verification Protocol (IPMVP), updating the 2010 edition. The IPMVP provides a standardized framework for evaluating savings associated with energy efficiency improvements and is generally recognized as a best practice for M&V.

The update introduces two new concepts: "operational verification" and "monitoring and targeting." Both have been added as tasks to be performed as a part of the project M&V program. Four operational verification approaches are identified in the IPMVP guidance document: visual inspection; sample spot measurements; short-term performance testing; and data trending and control logic review. Operational verification can serve as a low-cost initial step for realizing energy savings potential and precedes energy savings verification activities. It also can be applied to support energy savings persistence after the the ECMs have been installed and performance verified. "Monitoring and targeting" also can follows M&V to achieve energy savings persistence. The end goal is to insure that energy savings resulting from the ECMs installed continue at the highest possible level long after measurement and verification.

The update includes a number of additional changes and can be downloaded at no cost on EVO's web site (

Friday, January 20, 2012

Challenges Associated With Incorporating Future Energy Savings into Traditional Loan Underwriting

Direct borrowing of capital from private lenders is an option for funding energy efficiency investments. While banks generally agree that more energy efficient buildings are ultimately a good investment, it is crucial that banks develop the ability to fully recognize the benefits in their loan underwriting process. To accomplish this, however, banks need to develop a much stronger energy efficiency performance database and then build scalable financing models. Unfortunately today, rarely is future energy savings considered in loan underwriting.

Traditionally, banks have rated the borrower’s ability to repay the loan (the borrower’s “creditworthiness”) at the highest end of the spectrum in the loan decision-making process. Moreover, for most commercial businesses, operational savings associated with energy retrofit projects are often too small a percentage of total expenses to impact in any significant way the borrower’s ability to pay down debt. Factors such as location that affect occupancy rates and rents are much easier for banks to analyze.

The existing mortgage on commercial properties can also present a challenge to borrowing for energy efficiency improvements in that loan covenants may restrict the addition of further debt. At a minimum, there typically are strict rules about incurring debt, particularly for commercial mortgages that have been securitized.

Another challenge that banks face is associated with understanding how a building’s energy performance can impact its value. The fact is that to-date there is insufficient data on how building valuation is impacted by energy efficiency improvements. Appraisers are not focused on a property’s energy efficiency and therefore it is not reflected in their valuation. This void creates uncertainty and adds to the potential risk associated with energy efficiency investment.

Interestingly, lenders have had a difficult time getting their hands around energy savings because energy savings cannot be measured directly. Energy savings must be based upon what is not going to happen in the future, rather than what will happen. Moreover, cash flow from future energy savings is not a familiar form of revenue or collateral to back traditional lending. There also is a general lack of confidence in energy savings projections because of the embedded bias to present projects as compelling investment opportunities.

Notwithstanding, banks are beginning to recognize that energy efficiency loans can help preserve the value of a building by avoiding obsolescence. In fact, the obsolescence issue, directly related to the value of the collateral, may even be a more important consideration today than operational savings.

Fortunately, today standardized measurement and performance protocols have emerged and are now being deployed with success to identify energy savings at a high degree of confidence. By building these protocols into the loan documentation and underwriting process, banks will eventually become more comfortable with the way energy savings and risks are quantified. Moreover, the advent of “energy savings” insurance and loan guarantees by the government will further reduce the risk and uncertainty. In the final analysis, this should enable energy efficiency financing to become a mainstream financial asset class with a high degree of standardization, predictability and scale. It should also go a long way toward moving the commercial real estate industry toward large scale adoption of energy efficiency investment.

Wednesday, January 18, 2012

Incorporating Energy Savings into Underwriting for Energy Efficiency Loans in Multifamily Properties

Earlier this week, Deutsche Bank released a study, Recognizing the Benefits of Energy Efficiency in Multifamily Underwriting, suggesting an approach to underwriting against fuel savings projections that balances the need for simplicity with that for accuracy. The study is impressive and worth the read if you are a lender looking to make energy efficiency loans.

The study and approach is based upon analysis of 231 buildings in New York City including 21,022 residential units that had undergone energy efficiency retrofits. There were a number of interesting findings. One was that improvements associated with fuel measures (such as replacing atmospheric boilers with sealed combustion units or installing a cogeneration system or switching from oil to gas) saved considerably more than improvements associated with electricity measures (such as lighting retrofits). Another was that actual energy savings were strongly correlated with pre-retrofit fuel use intensity (in kBtu per square foot normalized for weather). Higher pre-retrofit fuel use intensity translated into greater savings potential. Furthermore, heating system and building age were found to be good proxies for fuel use intensity. The study also examined the energy audits associated with these retrofits and evaluated how well the projected energy savings matched the actual energy savings (the study used the term “realization rate” to mean actual savings divided by projected savings). Across all projects, the fuel realization rate was 61% with a 90% confidence interval of +/- 14%.

The study proposes a methodology by which lenders can mitigate the risk of “over-projected” savings by limiting an energy auditor’s projected savings to a conservative threshold of expected savings as defined by the statistical correlation between pre-retrofit fuel use intensity and fuel savings. For example, if a multifamily building that uses 140 kBtu/SF pre-retrofit was projected to save 60 kBtu/SF, the capping methodology proposed in the study would suggest that this be reduced to the threshold of 40 kBtu/SF. If that same building was projected to save 25 kBtu/SF, which is below the threshold for a multifamily building of that pre-retrofit fuel use intensity, then the audit projection could be regarded as conservative for the basis of underwriting. It may sound complex, but if you obtain the study and review it, you will find that the approach does make sense.

The primary causes of under-realization of energy savings identified in the study included an inappropriate or inadequate retrofit scope of work (generally involving a lack of understanding), improper execution of the retrofit scope and unexpected post-retrofit operations and maintenance or tenant behavior.

In the final analysis, the study is a first effort to compile an historical database of actual building energy performance resulting from improvements, a database that is sorely needed by the lending industry in order to accelerate energy efficiency lending.

Monday, December 12, 2011

EPA Boiler Rules Create Significant Opportunity for Building Energy Assessments!

On Friday, December 2, 2011, the Environmental Protection Agency (EPA) released for public comment its rules for industrial boilers under the Clean Air Act. The rules require, among other things, that all buildings with oil-fired boilers equal to or greater than 10 million Btu/hr will need to conduct an energy assessment. Tens of thousands of buildings across the country will be impacted.

EPA divides all boilers in the country into one of two categories: “major sources” of toxic air pollutants (defined as emitting 10 tons or more per year of any single air toxic such as sulfur dioxide, nitrogen dioxide, mercury, lead, etc. or 25 tons per year or more of any combination of air toxics), and everything else (referred to as “area sources”). Approximately 187,000 boilers would be covered under the “area source” boiler rule, 98% of which would be required to implement work practice standards, including maintenance and tune-ups. The majority of area source boilers are located at commercial and institutional facilities, such as office building, retail establishments, hotels, medical centers, schools, universities, churches, municipal buildings, apartment buildings, warehouses, restaurants, nursing homes, etc.

If you own a boiler other than a gas-fired boiler, EPA’s boiler rule will impact you! The extent of the impact will depend on whether or not your boiler(s) has a heat input capacity less than, or equal to or greater than 10 million Btu/hr. From our "building energy performance assessment" viewpoint, facilities with oil-fired boilers having a heat input capacity equal to or greater than 10 million Btu/hr will be required to perform an energy assessment consisting of:

1. A visual inspection of the boiler system.
2. An evaluation of operating characteristics of the facility, specifications of
energy using systems, and operating and maintenance procedures.
3. Inventory of major systems consuming energy from the affected boiler(s).
4. A review of available architectural and engineering plans, facility operation
and maintenance procedures and logs, and fuel usage.
5. A list of major energy conservation measures (ECMs).
6. A list of the energy savings potential of the ECMs identified.
7. A comprehensive report detailing the ways to improve efficiency, the cost of
specific improvements, benefits, and the time frame for recouping those

The energy assessment would need to be completed no later than March 21, 2014.

How many area source oil-fired boilers would be impacted by this energy assessment requirement? I was astounded to find out that it would impact more than 26,000, located all across the country, but with the heaviest concentration, of course, in the Northeast and Mid-Atlantic. This is a huge number of buildings, and all will have to be assessed over the next two years!

The opportunity for energy professionals is significant. Moreover, the up-sell opportunity to conduct a full building energy audit is even more appealing. While an energy assessment as defined by EPA in the rule is not a full energy audit (since it only covers energy use systems that use the energy generated by the boiler), it would seem logical to me that a building owner would be remiss if he or she did not take advantage of this opportunity to include a full energy audit to identify all possible ECMs and their ROIs. In this way, a much more-informed decision could be made about any potential capital investment.

EPA is taking comment on the proposed rules for 60 days from the publication of the rule in the Federal Register this month, with the final rules to be published by April 2012.

Monday, October 24, 2011

A Big Win for Energy Savings Insurance

A few weeks ago a business consortium including Lockheed Martin and Barclays Capital announced the largest single private-sector investment to-date for commercial property energy efficiency retrofits. The business consortium, referred to as the PACE Commercial Consortium, was created by the Carbon War Room, a Washington, D.C based non-profit group set up by British entrepreneur Richard Branson. The consortium will provide up to $550 million in financing for city-led PACE projects in Miami and $100 million for projects in Sacramento. The consortium is led by Ygrene Energy Fund of Santa Rosa, California. Loans will be provided by Barclays Capital and Lockheed Martin will provide project management and engineering services. Energy savings guarantees will be insured by Energi Insurance Services of Peabody, MA with paper backed by global re-insurance giant Hannover Re.

Energy savings insurance was first offered approximately 15 years ago, but failed to make much headway in the emerging energy efficiency marketplace principally because most of the work was being performed in the public market by large energy service companies (ESCOs) who could back their guarantees with strong balance sheets. However, with energy efficiency now moving firmly into the hugh commercial market, hundreds of energy service companies are now playing in the game, many without the financial strength of the large ESCOs. Energy savings insurance can provide a backstop to the performance guarantees made by these smaller ESCOs.

It is good to see the insurance industry, beginning with Energi and Hannover Re, coming back to the market. There is definitely a need for the product. I believe it can do much to remove the uncertainty asssociated with energy savings projections and thereby avoid disputes between building owners and ESCOs. It should also reduce the risk associated with energy efficiency lending and lower the cost of financing. As in many other areas in our industry, insurance can once again act as the grease to make the deals move forward.