The PACE makers

New York Midtown
Photo by David Iliff. License: CC-BY-SA 3.0

America’s most visible octogenarian is on a power diet. The Empire State Building, built in 1931 and reigning as the world’s tallest building for 40 years, has gone through an efficiency makeover. The 140-storey skyscraper is now a poster child for the building energy movement.

Part of a $500-million retrofit that began in 2009, the initiative has already exceeded its performance target. When interior renovations are completed, total savings of $4.4 million a year are expected on what will amount to a $20-million investment. That’s excluding the 250 jobs the retrofit created and the 50 per cent premium that can now be charged to tenants.

The fact a return like that was possible for such a big old building offers a lesson for all property owners: energy efficiency pays. Unfortunately, major barriers remain, at least in the minds of those who control the purse strings.

A 2012 survey by industrial conglomerate Johnson Controls found that 26 per cent of commercial property decision-makers considered “lack of funding” as the biggest barrier to going ahead with big energy-efficiency projects. It may be a drop from 30 per cent in 2011, but funding challenges have remained the top concern since Johnson Controls launched the annual survey seven years ago.

This puts energy efficiency low on the list of items to tackle, particularly when property owners are often already skeptical about the payback. “People are not certain of the savings opportunities, and there’s the fact that natural gas prices are pretty low right now,” said Mary Pickering, vice-president of the Toronto Atmospheric Fund, an agency that oversees emission-reduction programs for North America’s fourth-largest city.

Getting over the funding barrier is essential from a climate change perspective. Buildings represent as much as a third of total global greenhouse gas emissions, according to the United Nations Environment Programme, and most of those buildings are located in big cities.

In the United States, commercial and residential buildings together consumed 74 per cent of all electricity and represented 41 per cent of primary energy consumption in 2010, according to the U.S. Department of Energy. Nearly three-quarters of that energy came from fossil fuels, making the GHG footprint of buildings massive. (In Canada, buildings consume a comparable portion of total primary energy.)

In other words, there is tremendous potential to shrink that footprint. So much, in fact, that President Obama has called for a doubling of U.S. energy efficiency by 2030. It can be done, says the Alliance Commission on National Energy Efficiency Policy, which considers building retrofits an important part of getting there. The alliance estimated that a $72-billion investment in building-related energy-efficiency measures would result in $167 billion in energy savings in 2030.So where does that $72 billion come from?

Municipal lending

It may come as a surprise to some, but a big part of the answer may lie with a creative financing approach pioneered in the 1990s in – of all places – the Yukon, a sparsely populated territory in northern Canada known for its mountains, caribou and salmon fishing.

In the Yukon, as in other states and provinces, municipalities already used a financial tool called a local improvement charge, or LIC, to recover the cost of services that only benefit a certain neighbourhood – for example, new playground equipment in a park or a new sidewalk. The upfront cost, initially covered by the government, is typically divided across all property owners who are expected to directly benefit from the project. Those property owners then pay back the funds over 10, 15, even 20 years through an additional line item on their municipal property tax bills.

The Yukon government decided in 1998 to use that same approach to fund on-site, off-grid renewable energy systems and eventually energy-efficiency retrofits for specific buildings. The twist is that the property owner alone would be responsible for repayment via a surcharge added to their annual property tax bill. The program proved quite effective.

The idea, however, really didn’t catch on until several years later, when some Canadian environmental groups and, soon after, Berkeley and other progressive municipalities in California began to seriously consider LICs as a way to break through the funding barrier that was holding back the potential of energy efficiency. The first U.S. pilot programs emerged around 2007 under the name Property Assessed Clean Energy, or PACE.

David Gabrielson, executive director of PACENow, a not-for-profit advocacy group for PACE programs, said this novel use of LICs in the U.S. began with a focus on the residential market. “In a way, the concept spread virally throughout the U.S.,” said Gabrielson, explaining that municipalities with climate action programs saw PACE as a way to drive a significant reduction in emissions. “It spread through 24 states in 24 months.”

Officials found it attractive for a number of reasons. First, it wasn’t based on subsidies. Instead, municipalities would simply leverage their ability to borrow money (through a bond issue) at a low interest rate, then turn around and offer low-rate loans to property owners. Second, repayment of those loans (plus interest and perhaps a modest charge for administering the program) could be collected over 10 years or more through an existing billing mechanism already in place for property taxes. Third, if the property sold, the lien related to that loan would simply transfer to the new owner.

If designed properly, the idea is that annual energy savings from a retrofit would more than cover the added charge on the property bill. It would be painless for the property owner, painless for the municipality, and would achieve the dual goal of reducing city emissions and creating local jobs that would result from the increased economic activity. Win-win-win.

Then in July 2010 it came to a halt. The U.S. Federal Housing Finance Agency (FHFA), created in 2008 to oversee mortgage finance giants Fannie Mae and Freddie Mac, said it didn’t like PACE. The concern was that the added debt burden on homeowners would increase the likelihood of a default on mortgage payments. Also, the lien related to the energy-efficiency loan had priority over the mortgage. If a homeowner defaulted, the municipality would be repaid before mortgage lenders.

“This position certainly put a damper on the enthusiastic development of residential PACE programs,” Gabrielson said. Some municipalities, such as Babylon, New York, frustrated by having Fannie Mae and Freddie Mac meddle with local or state affairs, continue with their programs despite the threat. They’re betting the FHFA won’t have the stomach to go after them. “It’s like, I dare you to come after me,” said Gabrielson, adding that the FHFA just won’t acknowledge the over-arching benefits of the programs. “So there’s a lot of bitterness out there.”

Meanwhile, U.S. interest in the PACE program model has shifted from the residential to commercial space, where Fannie Mae and Freddie Mac have little if any jurisdiction and the commercial lending community has been more open to the idea. Gabrielson said there are 16 commercial PACE programs across seven U.S. states in early stages of development, and all have emerged in the past 18 months. “They are just now beginning to take applications for funding and getting approval from lenders. So 2013 is shaping up to be a very good build on the baby steps that have been taken so far. We’re starting to develop some serious momentum.”

Programs in San Francisco, Washington, D.C., and Toledo, Ohio, are among the most advanced. The size of the loans issued to commercial building owners can range from $50,000 up to $5 million, and they can be paid back over 10 years or more – terms that a private lender would never accept. “The programs have potential to help building owners solve many challenges,” according to a report from the Johnson Controls Institute for Building Efficiency.

“For example, efficient lighting, upgraded wall and roof insulation, high-efficiency HVAC systems, solar panels, and many other improvement measures are eligible,” the report said. “Under all programs, all improvements have to be permanently affixed to the building.” With many programs, projects must achieve energy savings of 10 per cent or more to qualify.

Building owners, once they understand how PACE works, typically embrace the model. Not only can energy-efficiency projects increase property value and allow for the charging of higher tenant rents – as the Empire State Building project demonstrated – but a PACE model also makes it possible for the landlord to pass on loan repayment obligations to tenants. “In this way, PACE structures overcome the landlord-tenant split incentives barrier to building efficiency projects,” states the report. “The building owner incurs no current costs and acquires permanent property improvements.”

Canada wakes up

Despite the fact that the PACE concept seemed to originate from the Yukon territory, the use of LICs to fund energy efficiency in homes and buildings has not yet grabbed hold in Canada. The one exception is a pilot project in Halifax, Nova Scotia, that supports the purchase and installation of domestic solar hot water systems.

Around 2010, however, interest in the PACE model (sometimes called Property Assessed Payments for Energy Retrofits, or PAPER) began to grow in the province of Ontario, sparked in part by a series of reports funded by the David Suzuki Foundation. Sonja Persram, a consultant who wrote the reports for the foundation, said the papers spearheaded an education campaign that caught the attention of officials at all levels of government, including city councillors in Toronto.

The big break came in spring 2012 when Ontario’s Ministry of Municipal Affairs and Housing tabled amendments to provincial legislation that defined how municipalities could use LICs. The proposed changes called for “flexibility” in the application of LICs for projects “including, but not limited to renewable energy and water conservation.” It left the door open for energy-efficiency retrofits as well.

The proposed amendments were signed into law by then-minister Kathleen Wynne, just two weeks before she stepped down from her cabinet post to run as premier of Ontario, a contest she won in January. PAPER proponents are encouraged that the woman who empowered Ontario municipalities with her signature is now running the province.

Pickering said the Toronto Atmospheric Fund immediately stepped in to ensure the opportunity was managed properly. “We said, let’s not all run off in different directions and figure this out for ourselves. Let’s get collaborative, pool our money, and get some common testing structure together,” she said. “I was surprised at how fast municipalities came to the table.”

What resulted was the creation of the Collaboration on Home Energy Efficiency Retrofits in Ontario, or CHEERIO, a partnership of 22 municipalities (and growing) that is examining different aspects of PAPER program design, legal issues and communications challenges. It’s also doing market research to find out what homeowners across the province think about the new funding mechanism, and what lessons can be learned from efforts in the United States.

Research to date indicates that homeowners are somewhat skeptical, both with the idea of cities acting as a lender and the suggestion that annual energy savings will exceed any surcharge on property taxes. “It’s the newness that some homeowners are unsure of,” said Pickering, adding that there’s a lingering perception that the surcharge (lien) will affect home resale. “People are a little bugged about that.”

Still, municipalities are determined to move forward, with Toronto likely to be the first city to pilot a program, possibly by this fall. Pickering said PAPER/PACE programs are timely financing tools for what she called the “post-incentive” era, where the federal and provincial governments have stopped offering rebate programs to spur conservation and energy efficiency. “It’s discouraging we have lost those incentives. They drove activity for the past 10 years,” she said. But now cities in Ontario are empowered to fill that funding gap. “Incentives come and go, but it will be nice to have something we can rely on that’s always available.”

Ontario has been less focused on the commercial retrofit opportunity, but proponents are closely watching how commercial PACE programs roll out in the U.S. Gabrielson is careful not to position PACE as a silver bullet. Like Ontario homeowners, many commercial building owners are still uncertain and skeptical. “It’s not the core business objective of most building owners to make their buildings more energy efficient. They’ve got other things on their mind,” he said. “Second, they’re not convinced if they do X, Y and Z it’s going to save them money. And third, we’ve just gone through a period where all building values got smashed.”

The federal government has also failed to set the tone of discussion, he said. “There’s no coherent, consistent national imperative behind it.” In the United States and Canada, perhaps there should be.

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