Last week I attended a discussion on Property-Assessed Clean Energy (PACE) financing in Boston, where I got the clear impression that the program is on a roll again.

Back in 2010, PACE had strong momentum as sixteen states enacted legislation enabling the program. But that momentum quickly stalled after Fannie Mae and Freddie Mac suggested they wouldn’t “support” PACE, as it subordinated their mortgage loans. While Fannie/Freddie had no legal means to stop it, even their expression of concern had the effect of changing market perception. And just like that, PACE looked to be stalled.

Or was it?

Three years later, 31 states have now enacted PACE legislation, with even conservative Texas joining the ranks.

What’s kept it moving? In my view, three things:

  1. Jobs. PACE generates local jobs (no outsourcing local mechanical contractors to China) and politicians have latched onto this message. In today’s economy, there are very few jobs stories, and energy efficiency finance is a feel-good, voter-friendly message.
  2. Greed. Bankers and Wall Street now support PACE as they see the program as a chance to lend high-quality, secured dollars and make money repackaging and reselling them. Get ready: energy efficiency bonds are coming your way.
  3. Dropping Residential. With the overhang of Fannie and Freddie’s concerns, as well as likely consumer lending scrutiny, most (but not all) successful PACE programs are quietly bypassing the residential market. And in multi-family housing, there are already a ton of existing financing programs, which means PACE stands to get lost in the weeds there as well. The best initial programs are focusing on C&I, as it is "cleaner" and easier.

If Mass. State Senator Brian Joyce has his way, Massachusetts will become the 32nd PACE state next month. His team is busy studying Connecticut, which also joined late (state #28), but whose C-PACE program has quickly implemented projects. In the meantime, only six other states have live programs underway after passing legislation. With so many constituents needed to sign off (municipals, state agencies, bankers, etc.), the new program design and implementation process has proven to be challenging.

Unlike some others, Connecticut has taken a single-state approach (one program for the whole state) and has fast-tracked the first projects using their own equity and debt capital. To do this, two years ago, Connecticut launched the nation’s first green bank, CEFIA, to provide the capital and use its bonding authority. The proceeds from RGGI auctions flow into this entity as well. New England neighbor New York state will soon follow with its own green bank.

By priming the pump with its own capital, Connecticut's C-PACE program is now in a position to show demand and strong results, as opposed to living in hypotheticals. Its lending rates for these initial projects have been 4.5 percent to 5 percent, and the state is now collecting sealed bids to sell off these first loans.

Genevieve Sherman, manager of the C-PACE program, had some interesting early stats: Connecticut now reaches 65 percent of the state (59 towns have opted in already), has $7 million of closed projects, and another $13 million (100+ projects) in the funnel. (My company, Groom Energy, is one of 300 participating contractors.) They had expected the average project sizes to be between $300,000 to $500,000, but projects are coming in higher. All good news and very impressive.

For those of us who have been cheerleaders in energy efficiency finance for the last several years, PACE now looks to have some ingredients that overcome obstacles faced by alternative financing approaches like ESCOs, capital leasing, operating leasing and on-bill finance. In the past, building owners have pointed to three reasons why they haven’t already pursued energy efficiency upgrades for their buildings:

  1. Lack of capital
  2. The energy savings aren't certain
  3. The owner-tenant split-incentive problem

C-PACE solves number one using its own money to get started, replacing it with private third-party capital over time; it solves number two by having engaged a third-party engineering firm to confirm project savings projections; and also addresses number three by enabling the owner to recapture their increased tax costs from their tenants.

So what happens if the savings don't materialize? The owner is still obligated to pay. No guarantees, no third-party insurance. As we’ve commented before on this topic, adding guarantees (or even the perception of a guarantee) is expensive. And C-PACE is betting that a third-party engineering review will suffice and preserve a lightweight, low-cost administrative layer.

Unlike traditional technical reviews under utility rebate programs (which are a black box), the results of these engineering reviews will be made publicly available. One building owner panelist at last week's discussion even commented that this is a "non-offensive" government program and allows him to shift the performance risk to his tenant.

Interestingly, Connecticut appeased the bankers' association by requiring that any PACE financing first gain a signoff from the bank owning the mortgage on the property. While it seems like a no-brainer that the bank would not stand in the way of a cash-flow-positive building upgrade, Connecticut has already seen cases where an owner shifted banks when their own bank hesitated to give the sign off.

But in the end, it’s number three that is most curious and potentially the biggest opportunity.

As a flow-through tax to triple-net tenants, an energy efficiency upgrade can finally be considered, regardless of where the tenant is in their lease cycle and with less landlord tension about who pays for the upgrade. The tenant decides how to accrue the benefits, absorb costs over time, and, using up to twenty-year PACE financing, understands how cash-flow-positive it is from day one.

Compared to the recent announcement that the federal government is bringing back cleantech loan guarantees, this sounds like a much more compelling loan program.

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Jon Guerster is the CEO of Groom Energy Solutions. This piece was originally published on Groom's blog and was reprinted with permission.

Tags: energy efficiency retrofit, energy management, groom energy, pace