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Fund Invests $650M In Emerging Market for Green Retrofits of Aging Buildings

Commitment By Branson-Led Group Could Provide First Real Test of Market For Privately Funded PACE Energy Efficiency Loans
September 21, 2011
A business consortium has announced the largest single private-sector investment to date in commercial property energy retrofits and upgrades, providing new impetus to the promise of green technology to create jobs and help jump start the economy.

The announcement by the consortium formed by British billionaire entrepreneur Richard Branson that it will provide up to $650 million for retrofit projects in Miami-Dade County, FL, and Sacramento, CA, served as a sharp counterpoint to public skepticism over government-funded green technology and energy efficiency programs stemming from publicity over a failed solar panel manufacturer.

It also serves as a major endorsement by the private sector for efforts to build a nationwide financial foundation for commercial energy projects under Property Assessed Clean Energy (PACE). PACE legislation allows state and local agencies to set up programs for commercial landlords and other owners to obtain financing for such energy projects as solar installations, reflective roofs and lighting, window and HVAC upgrades, which borrowers can repay through lien-based special assessments on their property taxes over 15 to 20 years.

Editor's Note: Please see related CoStar coverage of PACE programs from June 2010.

This week’s announcement by the PACE Commercial Consortium -- created by the Carbon War Room, Branson’s nonprofit group and managed by Santa Rosa, CA-based Ygrene Energy Fund -- provides up to $550 million in contracts for city-led projects in Miami and surrounding communities, and $100 million for projects in Sacramento. The group said the investments could create a combined $2.3 billion in economic activity and 17,000 jobs in the two metros.

The consortium leverages the strengths of an impressive array of companies, from short-term loans provided by Barclays Capital to project management and engineering provided by Lockheed Martin. Hanover, MA-based Energi Insurance Services and global re-insurance giant Hannover RE will underwrite energy savings warranties and insure work by contractors.

The PACE consortium is the "missing piece in the jigsaw puzzle for cities looking to implement green plans," said Branson, founder of the Virgin groups of companies.

"The Carbon War Room has been working with its partners to solve this puzzle for over 18 months," Branson said in a statement, predicting that the investment will ultimately "unlock a trillion-dollar market for green retrofits, creating jobs and growth around the world."

Although 26 states have enacted PACE legislation, the tough economy and regulatory questions about who is held accountable if a borrower defaults on a mortgage have slowed the once-promising momentum for the programs, particularly on the residential side.

The Federal Housing Finance Agency (FHFA) brought residential PACE programs to a standstill in July 2010, determining they raise "significant safety and soundness concerns" for lenders, servicers and mortgage securities investors due to their long repayment terms and the first lien position held by retrofit lenders over existing mortgages.

The FHFA imposed restrictions on residential loans backed by Fannie Mae and Freddie Mac, prompting legal challenges by several states and local agencies, with PACE supporters winning a key ruling by a U.S. District Court judge in California earlier this month.

Although the setback caused collateral damage to efforts for commercial properties, municipalities and companies have regrouped to focus on launching commercial PACE programs. Momentum has picked up significantly this month, with major projects moving toward the starting line in Los Angeles County, San Francisco and Washington, D.C., among other metros, according to Derek Brown, managing director of San Rafael, CA-based Clean Fund, a specialty finance company which has been working on commercial PACE programs for two years.

"There's definitely a tide of momentum. This is a huge potential market and we're just at the tip of the iceberg," Brown said.

The economic case for PACE has become even more solid since an influential 2008 study co-authored by CoStar Group that found strong evidence of significant office rent premiums, faster absorption of space, lower cap rates and higher prices per square foot for buildings with either Energy Star or LEED certification. Landlords have historically been reluctant to invest in major upgrades due to uncertainty about the timeframe for recouping their costs. A retrofit program eliminating those upfront costs could potentially extend the green premiums to the larger pool of owners of existing properties.

The investments utilize 100% private capital with no government debt or cost, as noted by Energi CEO Brian McCarthy, and the programs enjoy broad political support from both deficit hawks and environmentalists.

"The markets can supply this financing because the economics are sound, engineering performance is insured, the security is strong, and clean energy capital assets are profitable," McCarthy said.

In what it describes as the first PACE project financed completely with private capital, Clean Fund arranged $1.6 million in funding for Codding Enterprises, developer of the mixed-use Sonoma Mountain Village in Rohnert Park, CA, through Sonoma County’s PACE program.

The funding will help pay for a second one-megawatt solar electric system that will allow the development and its 30 businesses and 800 employees in existing commercial space to fully cover its electric needs with renewable power generated on site.

While modest in size, the project demonstrates the power of private capital as a PACE financing source. While most PACE programs have relied on public agencies to fund the upfront costs of energy projects, Sonoma County, like most budget-strapped cities and counties, has limited tax revenues available for the programs. In March, the county board of supervisors voted to allow its PACE program to partner with private capital providers.

The structure, which pairs publicly administered PACE programs with owner-arranged private capital, is the basis for the projects being prepared for launch in Los Angeles County and San Francisco. In an era of deficits and budget cuts, the owner-arranged financing model is the only way to achieve nationwide adoption of PACE, according to Brown.

Clean Fund had planned to begin providing financing in fall of 2010, but ran into delays. Over the last year, the finance company has worked with mortgage lenders, owners and energy equipment providers to develop a range of PACE-based structures and now has several projects in the works.

"The programs in L.A. and San Francisco will be announced within weeks and will provide the first real test of the potential of PACE for commercial buildings," Brown said.

"Once property owners get their minds around how straightforward, long-term financing enables energy improvements to generate positive cash flows, they toss out their old [return on investment] benchmarks and do a very different economic analysis."
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