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Nancy Anderson, Ph.D.Torchlight

Paving The Way

By: Nancy Anderson, Ph.D.

January 29, 2010

To amend the old adage, the road to hell is paved with good intentions that can't be financed. What does this have to do with making energy efficient building New York's "new normal"? Since the City's greener greater building legislation does not directly require building owners to undertake energy-efficiency upgrades beyond lighting systems, skeptics have said not much will change. Even optimists like me, who point to the new requirements for alteration work to comply with the energy efficiency code, have to admit that the Building Department's enforcement resources will be limited. But I'm still an optimist — grim real estate market and the great loan drought aside — because of the potential game-changing power of building benchmarking and PACE financing.

As Torchlight readers know, I believe that collecting and disclosing data on a property's resource consumption and comparing that data to that of similar buildings will prove to be useful knowledge for owners, renters, buyers, underwriters and financial backers. Oh yes, and government policy makers too. Consuming more energy than is needed, overlooking tax benefits, favorable financing opportunities or failing to capitalize on demand for more environmentally friendly building are proxies for management that's not making the most of its assets. But I admit that readers shouldn't just take my word for it so I've spoken with TIAA-CREF's Nicholas Stolatis, Director of Strategic Initiative Assets Management.

TIAA-CREF manages the retirement investments for many in the academic, medical, cultural and research fields and is one of America's largest institutional real estate investors. Its portfolio includes some 200 office buildings. Since launching its benchmarking effort in 2007, Mr. Stolatis has used Energy Star Portfolio Manager software to measure and compare the energy consumption of the retirement funds' holdings and he gives this software high marks. TIAA-CREF tackled its commercial buildings first and, starting with the rollout of updated software last year, it is benchmarking the 12,000 units in its multifamily property portfolio too. On average, benchmarking updates in office buildings take just fifteen minutes, although setting up the initial effort does take more time.

For Mr. Stolatis, benchmarking is not a one-shot deal. Building data is regularly updated in order to track progress and identify opportunities for doing better. Finding opportunities to do better include the installation of new ice-thermal storage equipment in TIAA-CREF's Manhattan headquarters, which initially received a low Energy Star rating. More typically, however, non-capital expense opportunities like improving operations and educating tenants are the preferred paths. Overall, the TIAA-CREF portfolio has cut its energy use by 7.5% since 2007 and avoided $8 million in energy bills. As a fiduciary institution, TIAA-CREF is always mindful of the bottom line. While professional appraisers have yet to say whether there is direct and quantifiable value for energy efficient commercial and residential real estate, Mr. Stolatis is confident in saying the reduced operating expenses mean higher building value. For him, energy efficiency and benchmarking are part of a "holistic" and prudent way to manage buildings.

Let's look at what public policy is doing to help other, typically smaller property owners pay for energy improvements. A March 2009 Snapshot by Mayor Tom Bates spelled out the Berkeley FIRST initiative. Berkeley, California through its own financing authority raised a pool of $80 million to provide up-front financing of as much as $37,500 to a property owner who wants to install solar power roof panels. The loan is repaid over twenty years through an add-on to property tax payments at zero percent interest (with a one percent charge to cover administrative costs). The loan goes with the property, which means if the building is sold, the obligation to repay goes to the new owner. The town of Babylon, NY offers a similar program to encourage energy efficiency upgrades that will cut CO2 emissions from existing buildings. The orientation of both these programs is toward residential owners who have twenty-to-thirty year mortgages and these long repayment times are congruent with a home or multifamily mortgage time frame.

Expanding on this model, eighteen states now authorize PACE (that's Property Assessed Clean Energy) bonds or taxes. New York is the latest state to join in and there's good reason to believe that the New York City Council will be considering PACE bond legislation in the near future. [ After this Torchlight went to press, Council Speaker Christine Quinn announced her support for PACE bond type legislation in her State of the City Address. ] Before that happens, however, the State law may need some tweaks. New York's statute, as written, requires municipalities that issue PACE bonds to be recipients of federal stimulus funds. Although New York City has applied for block grants from the US Department of Energy, it won't learn whether it will receive funding until Spring 2010; amended legislation would allow municipalities to move forward without federal stimulus funds in hand.

The Natural Resources Defense Council, a well-known green advocacy organization, champions PACE bonds as one of several innovative instruments to finance energy efficiency improvements. Enactment of local PACE legislation would create an entirely new revenue stream for greening the City's biggest energy consumers, its buildings. According to NRDC, New York City would likely issue PACE bonds through a new local development corporation or similar City subsidiary. PACE bonds cannot be plain vanilla general obligation bonds guaranteed by property taxes because they are "taxable revenue bonds". Repaying a PACE bond would be guaranteed in two ways. First, a loan to a property owner would be structured to make monthly energy savings greater than monthly loan payments. Second, PACE bonds would have a super-lien status, which means investors are paid before mortgage holders in cases of bankruptcy or loan defaults.

The PACE model offers financing to owners who voluntarily undertake energy-related upgrades. The statutory language would need to spell out whether PACE funds would be available for upgrades required by law because the emphasis so far has been on voluntary actions. Legislation should also be careful to distinguish the needs and financial facts of single-family or multifamily residential owners from those of office building landlords. For instance, loans for office buildings are much shorter than home loans and owners of commercial property often calculate their decisions in terms of a one-to-four year return on investment.

Fine print aside, the direct benefits of making PACE financed investments in a building's energy efficiency are quite clear. By reducing consumption they act as a hedge against price volatility or escalation in the cost of fuel and electricity. PACE bonds could potentially benefit rent-controlled or rent-stabilized tenants in New York City if building upgrades financed in this manner were not deemed to be major capital improvements (MCIs) that raise rents. In addition, a PACE-financed investment is a good way to position a greener property in a competitive marketplace.

Now for the hardest parts. PACE legislation will have to define the public purpose to be served by such financing. Babylon, for example, identified its intended public purpose by defining carbon dioxide emissions as a solid waste so as to allow its pre-existing solid-waste financing to cover energy-efficiency building improvements. Passage of a PACE bill will be determined in part by the buy-in of typical mortgage lenders. Their concerns over the impact of new super-lien debt on properties with existing mortgages will have to be addressed. So too, bond buyers and underwriters will have to be convinced that PACE investments make sense. Finally, legislation must grapple with the vexing issue of what happens if utility rates soar, so that even model energy consumers are forced to pay much higher bills while keeping up with PACE and mortgage obligations.

Can legislation resolve these issues and launch financing that's innovative, effective and prudent? I think so. Will New York City's new benchmarking legislation raise the level of awareness about building performance and generate support for energy improvements? I am optimistic.

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