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Financing Green Part I: Funding Energy Efficient Retrofits and Overcoming Uncertainty

An In-Depth Look at Financing Options and Obstacles for Green Improvements in the CRE Industry
May 18, 2012
It has become increasingly evident to those in the commercial real estate industry that improving building energy performance and making other sustainable and green improvements can impact property values and balance sheets. To some degree, building owners find themselves caught in a 'Catch 22' situation. On one hand, buildings that are slow to adopt these changes and implement green retrofits and more efficient operations are seen as being at a competitive disadvantage in the market. On the other hand, lenders willing to finance such green improvements are few and far between.

How do stakeholders in this profit-driven industry go about financing these building improvements in an uncertain economy?

Energy Efficiency Retrofit Financing Options

A recent report issued by Anthony J. Buonicore, PE, BCEE, QEP, managing director at Buonicore Partners LLC, entitled, Energy Efficiency Retrofit Financing Options for the Commercial Real Estate Market, cites the lack of commercially-attractive funding as a major impediment to energy efficiency investment in the CRE market. A recent McGraw-Hill survey confirmed that building owners seeking to pay for energy retrofits for their properties often are forced to rely on resources from the internal balance sheet rather than outside funding.

Buonicore reiterates what owners have been saying to lenders for years, "To really move this market, there is a clear need to make energy efficiency financing a mainstream financial asset class with a high degree of standardization, predictability and scale."

"Ideally," said Buonicore, "such funding should come without any capital expense, without adding debt to the property, will cover the entire cost of the project, contain favorable tax deductions for the expense, and present favorable terms with low rates and extended repayment periods." Does everyone have their magic wands ready?

Despite the dearth of mainstream financing, Buonicore surveys the financing options that have sprung up for retrofits and finds a surprising number are able to meet many of the ideal criteria outlined above, no magic needed.

In addition to internal and debt financing, these mechanisms include lease/lease purchase agreements, ESCO (energy service company) financing, energy service agreements, government loan programs, PACE (property assessed clean energy) programs, and on-bill utility financing.

In identifying the advantages and drawbacks associated with each and with several energy efficiency underwriting options, it’s clear that Buonicore’s main contention that making energy efficiency financing a 'mainstream financial asset class' remains an elusive goal.

Editor's Note: Financing Green is a three-part series taking a look at energy efficient retrofit financing options, the role of data in overcoming the uncertainty of financing green improvements, and real-world examples of funding green improvements for the tenant or end-user.

Financing Building Energy Efficiency, Overcoming Uncertainty

At the Second Annual Conference on Sustainable Real Estate hosted by NYU Schack Institute of Real Estate, a panel confirmed the scarcity of financing available for green building improvements.

The discussion was led by moderator Susan Leeds, CEO of New York City Energy Efficiency Corp. The panelists included: Caroline Blakely, vice president multifamily risk with Fannie Mae; Greg Hale, senior financial policy specialist with the Natural Resources Defense Council; Sean Neil, managing director of Transcend Equity; and Arah Schuur, director of the energy efficiency building retrofit program with the Clinton Climate Initiative.

CRE lenders and banks understand commercial real estate and the risks involved - after all they’ve been making loans collateralized by commercial property for years. But for many lenders, green is a new thing, one that doesn’t fit neatly into underwriting programs that often require years of data for evaluating risk and assessing the long-term financial impact from investments.

In addition to looking for the costs versus the savings of implementing green improvements, lenders also are looking for more historical data documenting the increased rent income or increased property values that can be expected from such investments. Numerous studies have shown that Energy Star and LEED-certified buildings can attract higher rents and generate increased demand from tenants, which can lead to higher income and sale prices. However, lenders want to see more actual data instead of projected results, panelists noted. Policy data and market performance are also important assessments for lenders to consider in evaluating a specific project.

As a means for side-stepping the issue until more definitive data to satisfy lenders is available, panelists cited one option that may work in the current lending environment, and that is for building owners to roll the cost of green improvements into an ongoing building retrofit or repositioning. That way, panelists said, owners may overcome lenders’ reluctance to consider green improvements as a stand-alone investment.

The panelists noted that financing for green improvements should become more available as more historical performance information is standardized and analyzed. They acknowledged that vast amounts of data are currently being collected on countless green improvements for commercial real estate buildings, such as the energy savings of light sensors or LED lighting, or the cost savings of using low-flow fixtures in restrooms, and even the environmental and employee health impact of clean air technology.

However, they also cited several challenges associated with the data being collected. One problem they identified is that different entities are collecting the information using different criteria and methodologies, which make it difficult to make valid comparisons between data sources.

Another issue is that the collected data can quickly become obsolete as newer and more advanced technologies are released into the marketplace. Often these newer technologies do not have the testing or data available that banks and lenders would like to see in order to make proper assessments on the risk versus the reward of implementing such improvements. For example, 10 years of performance data doesn’t exist for a brand new solar panel or light sensor.

The panelists cited the importance of collecting data, and aggregating and presenting it coherently as critical to getting money flowing for green improvements. Only then will lenders, building owners and related parties be able to review the available options, analyze the execution process, and then look for optimal financing options.

In his keynote address, Richard L. Kauffman, senior advisor to the secretary, Department of Energy, introduced several themes that would be repeated in the panels to follow that day, including that big banks are unlikely to, and perhaps should not, provide financing for green improvements, which are too small and risky. Instead, owners should be looking to capital market investors, state bonds, local banks and government incentives to pull together the necessary capital for individual green improvements to their existing commercial buildings. He also cited points often brought up between lenders and stakeholders in the green improvement industry, namely the need for more metrics, empirical data on risks, and actual cost vs. performance data, not just promises of what a new technology can be expected to deliver.

In Part II of Financing Green, available here... Following the conference, CoStar News speaks with Dr. Constantine Kontokosta, PE, clinical associate professor and director of the Center for Sustainable Built Environment at NYU Schack Institute of Real Estate, to discuss financing and the role of data collection in green retrofits for existing buildings.
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