Every year, American building owners lose billions of dollars as they overpay for energy to power their lighting, heating, and cooling systems, as energy is wasted in obsolete equipment or leaks out of a porous building envelope. The right energy efficiency measures can reduce costs by 20% to 40%, but they can also require substantial upfront sums. Additionally, distributed generation solutions such as solar or cogeneration can be combined with efficiency upgrades to provide an even more complete energy solution.
While facility managers (fms) understand that such measures would yield savings in the long run, the cost to finance equipment upgrades seems prohibitive in the short term—another large chunk of cash diverted from more urgent investments.
A recent survey by Noesis Energy found the most common reason energy efficiency projects don’t get internal approval is that they are “not budgeted.” In a National Small Business Association (NSBA) survey, business owners cited “cash flow” as the biggest impediment to making their businesses more energy efficient. Instead, many fms stick to low- or no-cost measures (turning down thermostats and dimming lights) rather than comprehensive upgrades.
This chart from the U.S. Energy Information Administration (EIA) illustrates from which energy sources the nation derived its energy during 2012. (Source: U.S. Energy Information Administration)
When energy prices go up, NSBA respondents said they were more likely to raise prices, cut business travel, or reduce staff than invest in technology that would improve their facilities’ efficiency. Sure, it would be great to replace that inefficient HVAC system, but even if an fm gets approval on their project proposal one still has to come up with the money.
REIT Structure Joins The Mix
Traditionally, financial institutions have been wary of energy efficiency projects, even though these investments are reliable and can actually yield a positive cash flow. An option that is becoming available is to borrow from a Real Estate Investment Trust (REIT). These structures have been in existence for many years, but fms may see more REITs focusing on investing in renewable energy and other sustainability projects. Hannon Armstrong, a sustainable infrastructure finance company based in Annapolis, MD, recently transformed into an REIT dedicated to investing in energy efficiency, clean energy, and other sustainable infrastructure. The firm’s new structure allows it to fund upgrades with its own money, rather than borrow it from a bank.
One of the first projects the company undertook after its transformation was an 800 room hotel in Hawaii. The $700,000 investment includes installing high efficiency, heat pump water heaters to meet the hotel’s baseload demand; piping, pipe insulation, and circulation pumps; additional hot water storage tank capacity; and automated controls for the hot water system.
The annual energy savings add up to $110,000, and, after financing costs, the hotel will realize immediate annual savings of $17,000. After the financing period of 10 years, the hotel will receive the full benefit of its annual savings. With this approach, this hotel benefits from the upgrades and has no out-of-pocket costs. And, since the total energy savings exceeds the debt repayment, they also see their monthly expenses decrease.
At the U.S. Coast Guard sector in San Juan, Puerto Rico, a clean energy solar project was the answer. Rising fuel oil prices, as well as costs associated with importing the fuel to the island, led to the Coast Guard paying a high cost per kilowatt-hour for electricity. Under an REIT financing structure, the Coast Guard was able to finance the $22.5 million project, which included the installation of approximately 3,000 kilowatts of solar photovoltaic panels covering more than 200 separate buildings located across three separate sites. In addition, more than 600,000 square feet of roofing was replaced with new cool roofs in order to foster electricity savings and a proper support for the solar photovoltaic systems.
The Coast Guard sector now receives more than 4,000,000 kilowatt-hours annually of solar energy, generated and consumed on-site. This financing structure allows the Coast Guard to achieve a lower cost of electricity and to receive the maximum benefits from federal tax credits and other local incentives.
Beyond Energy Savings
The benefits of installing energy efficiency measures go beyond the potential for utility bill reductions and tax breaks.
Avoiding equipment downtime and failures. After the financial crisis of 2008, many fms stopped making capital improvements and are working with outdated equipment that should have been replaced years ago. Financing energy efficiency upgrades means that fms have an opportunity to bring their properties up to date without using their own capital.
Enhancing building value. Increasingly, municipalities—New York, Seattle, and Chicago among them—are requiring managers to disclose the energy efficiency of their buildings. Tenants, with internal pressures to meet sustainable guidelines for their businesses, are pressing building owners to meet higher energy standards. Property buyers are factoring efficiency performance when they determine valuation. Efficiency upgrades greatly enhance a building’s value to tenants and buyers.
Safeguarding from rising energy costs. According to the U.S. Energy Information Administration, total energy demand will increase an average 1.6% from 2012 to 2035. Even with the dampening effect on utility rates from lower natural gas prices, much of a consumer’s bill is dominated by transmission, distribution, and customer service charges, and these charges continue to trend upward.
Perform a baseline audit. Fms who are interested in obtaining financing for energy efficiency projects should either perform an audit with an in-house or third-party consultant or energy services company (ESCO). The audit will evaluate energy cost per square foot of each building and compare it to peer buildings. An audit should cover all facets of the facility’s energy consumption—from the HVAC system to lighting—and may also include distributed generation options.
Evaluate the financial returns. Which improvements will generate the greatest energy savings? How much is the facility willing to invest? What kind of payback is being sought? Depending on the scope of the project, the entire financing can frequently be paid off in three to seven years, leaving the owner with the energy savings dividend free and clear. Longer term financing (up to 15 years) is available for more complex projects.
Obtain financing. There are several models here for fms to consider.
Energy Service Performance Contract. With this structure, an ESCO proposes system upgrades and associated paybacks, and a financial partner provides the financing based on the ESCO’s guaranteed savings.
Property Assessed Clean Energy (PACE). Currently 31 states and Washington, DC have PACE enabling legislation in place, which allows facility owners to pay for energy improvement measures through their property taxes. PACE projects may or may not involve an ESCO specifically, but these will still involve a financial partner. (See the accompanying sidebar for an update on PACE.)
PACE Financing: Points To Consider
Property Assessed Clean Energy (PACE) helps achieve one of the primary goals of facility managers (fms)—to improve building performance. PACE is a financing mechanism that can be used to implement renewable energy, energy efficiency, and water conservation upgrades to buildings. The mechanism can fund a full-scale retrofit or a simple lighting replacement.
PACE funds 100% of an improvement project, therefore obviating the need to use internal budget resources. Financing is provided or arranged by a local government and is repaid with an assessment over a term of up to 20 years. The assessment mechanism has been used nationwide for decades to access low-cost capital to finance improvements to private property that meet a public purpose. Usually, a PACE assessment is added to the annual property tax bill and is collected along with other assessments. This repayment mechanism may vary slightly depending on a state’s or municipality’s existing property tax collection procedures.
PACE is a local government/community initiative. Once a state adopts PACE enabling legislation, a municipality can arrange financing for interested property owners. It is important to distinguish PACE from federal government mandated initiatives; PACE is completely voluntary and local. Property owners, acting in their own self-interest, implement upgrades that can save money and increase property values.
“2013 has been a turning point year for PACE,” says David Gabrielson, executive director of PACENow, a foundation funded, non-profit advocate for PACE. “With more than 25 programs operating nationwide and growing awareness that PACE results in higher building value, 2014 looks to be a breakout year.”
Currently, 31 states and Washington, DC can implement PACE. Projects have been completed in seven states and Washington, DC through 16 different programs. Another nine programs are accepting applications for funding and closing on the first completed project. PACENow is monitoring completions and recording market pipeline data, which is narrowly defined as applications for financing. As of October 2013, there is more than $100 million in project applications for funding.
There are 26 active commercial PACE programs operating in over 400 municipalities. (See the table in the online version of this article at www.TodaysFacilityManager.com to see the scope and financing of municipal programs.)
PACE can work for large and small projects on just about any commercial facility. To date, almost half of all PACE projects involved small commercial buildings (less than 50,000 square feet). Funded commercial PACE projects range from $10,000 to $3.2 million. Theoretically, there is no upper limit for a commercial PACE project as long as there is available private capital.
PACE can finance any renewable energy and energy efficiency improvement permanently attached to the property. To date, nearly 25% of PACE funded projects were renewable energy projects. Some examples of improvements that can be financed include: solar photovoltaic or fuel cells, high efficiency lighting fixtures, occupancy and daylighting sensors, HVAC equipment, cool roofs, exterior LED lighting, and insulation.
When considering PACE it is important to demonstrate that it makes financial sense. What makes PACE an attractive retrofit source is that most projects are required to be cash flow positive, and financing is structured so that energy savings will offset the additional property tax assessment each year. Therefore, PACE funded improvements result in real energy cost savings.
PACE is designed to overcome a number of financial barriers to energy efficiency investment, and these features could be communicated to a facility’s CFO.
- Insufficient internal capital budget for financing of facility improvements has been cited a barrier to undertaking energy efficiency and renewable energy projects. PACE is a way to avoid tapping into a capital budget because 100% of financing is provided or arranged through a PACE program in the municipality. Zero upfront cash investment was important to Teamsters Local 848 in Los Angeles County, CA. A recently completed $236,350 solar project on a Teamsters meeting hall will result in energy use reduction of 83%.
- PACE funding is provided for up to 20 years. Long-term financing is rare in the commercial real estate market, where most debt ranges from five or seven year terms. PACE makes projects more cost-effective because it extends funding over the period of useful life of an improvement. Consequently, PACE projects typically achieve a higher return on investment.
- PACE is a tax like assessment, which is paid annually or bi-annually with property taxes and assessments. Property owners can decide to treat PACE as a tax expense where only the current year’s financing cost appears as an expense on the income statement and not the investment in full. With this accounting, PACE is not added to the balance sheet as debt. Therefore it will not hinder the owner’s ability to take on additional debt for other projects.
- PACE assessment stays with the property upon sale. If the owner decides to change locations, restructure a business, retire, or reinvest elsewhere, PACE assessment is automatically assumed by the new owner. This allows current owners to undertake a deeper retrofit and not worry about having to pay it off upon sale.
- PACE financing results in decreased energy use and, therefore, in greenhouse gas reduction. A commitment to sustainability can help business branding. For instance, the manager of a mall in Connecticut immediately understood that the environmental impact is important to “a progressive and forward-thinking” building owner when he pitched a $170,000 exterior LED lighting upgrade. Similarly, the owners of a Big Boy restaurant in Ann Arbor, MI saw an opportunity to cut costs and be stewards of the environment.
- If there are tenants involved, PACE solves the split incentives problem by allowing owners to pass payments through to tenants. Tenants, responsible for the energy bills, will pay for their portion of the costs to create improvements and benefit from lower utility bills. As a result, the building owner incurs minimal costs while retaining permanent property improvements.
- Some PACE programs offer free energy audits that could involve a simple walk-through or an ASHRAE Level II audit. Meanwhile, tax credits, incentives, and rebates have been widely applied and combined with PACE financing.
On-Bill. At present, 24 states have authorized on-bill financing or on-bill repayment in which repayment of the loan is made directly through the customer’s utility bill. Depending on the jurisdiction, the participating utility may or may not need a corresponding financial partner.
Capital Lease. Sometimes a manager merely needs financing for a project. A capital lease provides a straightforward financing solution that amortizes over the payback period of the energy efficiency improvement.
Monitor and maintain. Fms should initiate ongoing operation and maintenance contracts with their ESCO. It’s important to monitor, measure, and validate savings against projections.
Of course, there is a final reason to make a facility more sustainable—it’s the right thing to do. It will help decrease dependence on fossil fuels and make the world a better place for future generations. But there’s no need to discuss that with the CFO. The numbers speak for themselves.
Article by Jody Clark, vice president at Hannon Armstrong, an Annapolis, MD based company that makes debt and equity investments in profitable sustainable infrastructure projects. She received an M.B.A. from Loyola University Maryland and a B.S. degree from Kalamazoo College in Michigan.