FINANCING ENERGY EFFICIENCY IN THE COMMERCIAL BUILDING SECTOR

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FINANCING ENERGY EFFICIENCY IN THE COMMERCIAL
BUILDING SECTOR Is There Hope Post-PACE? Fall
2010
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DISCUSSION CONTEXT

• Federal, State, Local and Institutional already
  addressed.
• Newly-constructed commercial already addressed.
• Deep reductions in energy intensity in existing
  commercial investment properties are the
  challenge.
• Efficiency in public/institutional buildings is
  policy-driven, while efficiency in commercial
  buildings is market-driven.
• Focus is addressing market barriers to retrofit
  financing in the existing commercial sector.

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ENERGY STAR AND INCREASED TENANCY
Multiple other studies show similar results
Co-Star study shows higher occupancy rates for
ENERGY STAR buildings
National average comparison of occupancy rates of
Energy Star-labeled buildings vs. non-labeled
buildings over a two-year period.

• Lower operating costs/increased cash flow
• Potential increase in occupancy

• Potential increase in property value/sales
  valuation
• Federal tax deduction

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AVAILABILITY OF ENERGY EFFICIENCY FINANCING

• Markets that Work
• Federal
• MUSH
• Markets that Dont Work
• Residential
• Office Buildings
• Retail / Food Service
• Hospitality
• Key Differences
• Owners not credit-worthy
• Assets are Pledged

3.5 billion/yr
12 billion/sf
13
80 billion/sf
87
0.0 billion/yr
The Focus of PACE Financing
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CURRENT STATUS
On-Bill Financing not broadly applicable ARRA
funds unable to be leveraged With PACE stuck in
the regulatory mud, does the industry have a Plan
B? One possibility expanding the federal Title
XVII program to create a commercial performance
contracting market, using the Federal ESPC market
as a model
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Creating a Commercial Performance Contracting
Market, using Federal ESPC as a Model
Goal is target and remove the point of market
failure LLC counter-party risk. Solution is to
simulate the hybrid credit structure of a Federal
ESPC. Critical elements -- back-stopping the
property LLC with a Federal guarantee. --
confining the guaranty to LLC default, not
performance. This would effectively simulate the
hybrid credit structure of a Federal contract
LLC payment obligation tied to verified
savings (Government-backed) Contractor payment
obligation tied to unrealized savings
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The Argument for Performance Contracting
Primary financing tool utilized in the
Federal/MUSH markets PC effectively parses
counterparty and performance risk, allowing the
former to be singled out for a guaranty. The
value in EE retrofits is not the equipment cost,
but the creation of ongoing savings over time.
It is clear that the realization of long-term
savings is tied to verification and
liability. The capital markets have accepted
performance contracting. Option A (MV) will
facilitate lending to small-sized contractors and
properties.
Performance contracting is the best means of
assuring energy consumption and GHG emissions
reductions will endure.
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Exposure to the Taxpayer

• High-occupancy
• Moderate debt
• Strong cash flow
• Etc.

• Structural goal Large, widely-diversified pool
  of PC loans to high-performing commercial
  properties.
• Geography
• Building purpose
• Building size
• Building age
• Etc.
• Loss Reserve Goal Assessed based on broad
  market average (i.e. 5), while exposure is
  limited to high-performing buildings.

Eligible
Ineligible
All large commercial buildings
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Underwriting Federal ESPCs Lenders Perspective

• Acceptable hybrid credit If savings are
  verified, agency pays
• If not, contractor pays
• Firm cash flow
• Proven technologies
• Standardized contract
• Standardized MV protocol
• Projects bundled by aggregators to critical
  mass for securitization

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Underwriting Commercial PC Lenders Perspective

• Acceptable hybrid credit Same of Federal
• Firm cash flow Same of Federal
• Proven technologies Same as Federal
• Standardized contract BOMA BEPC
• Standardized MV protocol Same as Federal
• Projects bundled by aggregators Same as
  Federal

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Critical Success Factors The Owners Perspective
Make it simple !!!!! Streamlined contract Cost
of capital Efficient approval process with DOE
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Cost of Capital
Best proxy for pricing Commercial PC is Federal
ESPC. Federal ESPC pricing average roughly 225
bps over USTs. Commercial PCs may require a
slight premium, e.g., 50 bps, at the outset,
suggesting pricing at 275 over USTs. Cost
comparisons on 10-Year Projects --
Commercial PC may be priced lower than
Federal ESPC for four reasons greater volume,
more competition, wider diversification, and
make-whole provision.
Federal ESPC Commercial PC Baa Corporate PACE Commercial Mortgage
5.00 5.50 5.75 7-8 ??
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Efficient Implementation
Lenders/contractors screen projects according to
published eligibility criteria Owner/contractor
screen candidate properties against the
criteria Lenders aggregate projects into
portfolios of critical mass. DOE may issue
single guarantee covering entire portfolio. DOE
due diligence focused on government exposure
property profile. DOE may outsource initial
review process to a property management firm
(JLL, CBRE, CW, etc.) or a management consulting
firm (BAH, Bearing Point, Accenture etc.)
Current appraisal, historical occupancy, debt
service coverage, debt-to-value, etc. With
largely objective criteria, there will be three
levels of industry vetting owner, contractor
and lender. Four if review is outsourced.
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Contact John J. Christmas Hannon Armstrong
Capital, L.L.C. 1997 Annapolis Exchange Suite
520 Annapolis, MD 21401 410-571-6164 www.hannonarm
strong.com