The effort to bring energy efficiency investment to scale accelerated in 2013, with some significant events that drove the pace.
PACE programs across the country expanded and used a simple policy measure to overcome obstacles that prevent commercial building owners from investing in energy efficiency improvements.
And the innovative transaction structure MEETS re-imagined the energy efficiency project completely, squaring the circle by selling "negawatts" back to utilities through a power purchase agreement.
All of these developments have strengthened momentum. But, in the end, it may be the tried-and-true mortgage that could do the most to spur energy efficiency investment.
Speaking recently at the Center for the Sustainable Built Environment at the NYU Schack Institute of Real Estate, Susan Leeds, CEO of the New York City Energy Efficiency Corporation (NYCEEC) gave an overview of progress since she began with NYCEEC in 2011.
NYCEEC was launched with ARRA funding in 2009 as part of Mayor Bloomberg’s Greener, Greater Buildings Plan, and has supported projects with technical guidance, credit enhancements, and direct lending through mortgages, energy services agreements (ESAs), and equipment finance. All of these programs have been implemented successfully. But, as Leeds underscores, the potential for energy-efficient mortgages to drive the market is vast.
“We offer multiple instruments, because no one product will work for every project,” said Leeds. “But our work to enable energy-efficient mortgages might go the furthest in making the built environment more sustainable. Just incorporating energy efficiency considerations into mortgage underwriting standards goes much further to improve energy performance in our building stock, and it’s more familiar to real estate practitioners, it’s quicker to execute, and it’s more replicable.”
NYCEEC has supported two separate energy-efficient mortgage programs thus far: the Multifamily Property Improvements to Reduce Energy program (M-PIRE) and the Program for Energy Retrofit Loans (PERL), the latter in cooperation with the New York City Housing and Development Corporation. The two programs are similar in concept, but they function somewhat differently, with a key difference surrounding the inclusion of energy savings in the underwriting process.
M-PIRE uses Fannie Mae’s typical desk lending process for multifamily properties. But the Property Needs Assessment, the standard assessment of capital improvements needed for a property, is amended to include an ASHRAE Level 2 energy audit. The audit provides a list of potential energy conservation measures to be implemented as part of the capital plan, and the cost of those measures is added to the loan principal.
The program allows for increasing the loan-to-value ratio from the standard max of 80 percent up to 85 percent, relaxes the minimum debt service coverage ratio from a minimum of 1.25 down to 1.20, and allows for up to 50 percent of the projected energy savings to be included in the property cash flow underwriting.
The portion of the mortgage dedicated to underwritten energy efficiency measures is capped at 10 percent of the total loan amount, but any portion of loan proceeds can be used for additional energy efficiency measures that are not included in the underwriting. For properties with existing Fannie Mae loans, M-PIRE allows for a second supplemental loan that exclusively finances energy efficiency upgrades, as long as the combined loans satisfy the same covenants applied to a single loan.
HDC’s PERL program uses a standalone ASHRAE Level 2 audit in addition to the standard PNA to identify energy savings opportunities. PERL loans were originally capped at $2 million, but a recent decision will allow for greater loan sizes on a case-by-case basis.
The projected energy savings from implemented efficiency measures must be 15 percent or greater, but those savings are not considered in the underwriting of the total loan package, so there is no proscribed benefit to the borrower from the additional loan proceeds. However, the underwriting criteria for the whole loan package are relaxed and the interest rate on the PERL component is considerably lower than the rest of the mortgage. And, since HDC lends to low-, moderate-, and middle-income borrowers, building owners are typically cash-strapped and unable to invest in energy upgrades, despite recognizing the bottom line benefits of such projects.
The inclusion of the energy audit suddenly brings energy efficiency consideration into the process and makes available additional funds dedicated exclusively to energy improvements that owners could not otherwise afford.
NYCEEC’s role in both of these programs is to serve as a technical advisor to both sides of the transaction, as well as to provide first-loss position credit enhancements. It’s worth noting that despite so much coverage about the huge interest in making energy efficiency a stand-alone asset class, nothing about these two programs is directly enabling direct investment in cash flows derived exclusively from energy efficiency.
M-PIRE loans are bundled into a single mortgage, and PERL loans aren’t tied specifically to energy performance. NYCEEC isn’t earning a competitive rate of return deploying its capital in credit enhancements, either, and credit enhancement is not a model that can be replicated by private lenders. As Leeds sees it, though, that’s okay for now.
“It’s not our job to manufacture a market for third-party investment in energy efficiency. It’s our job to deploy our resources to establish a more sustainable built environment, whatever the investment instrument is. People are very excited about ESAs and MESAs and the like," said Leeds. "These are important niche products, but they have a long lead time and limited applicability. Multifamily mortgage transactions happen every day, and the impact from just including energy performance in the lending process will be enormous.”
And, of interest to the investment community, M-PIRE mortgages are already tagged and sold as Green MBS, similar to Fannie’s Green Refinance Plus program. The bonds HDC issues to raise capital could also eventually include a “green” or “energy efficient” designation.
As Christopher Diamond, NYCEEC’s Director of Engineering and Technical Analysis, explained: “In both cases, these are not necessarily a separate asset class, but they definitely are energy-efficiency-specific sub-classes. These tags on common, accepted assets are expected to eventually command a premium once sufficient data has been established on their performance.”
Furthermore, energy-efficient mortgages for multifamily assets will also be overwhelmingly beneficial for the intelligent efficiency industry. The increase in demand for energy efficiency projects will expand the customer base for products and services exponentially.
Familiarizing the mortgage lending community with the language and tools of energy efficiency underwriting has obvious benefits as well, and the performance data generated through these programs will further strengthen the case for the reliability of energy efficiency investments and spur even more demand.
This isn’t the silver bullet we’re all hoping for, but it’s a major step toward unlocking market potential.
Nick Lombardi is the Program Manager for New York City at Conservation Services Group, and Chairman of the Advisory Board for the Center for the Sustainable Environment (SBE) at the Schack Institute of Real Estate at New York University. His Twitter handle is @eefficionado.