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

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FINANCING ENERGY EFFICIENCY IN THE FINANCING ENERGY EFFICIENCY IN THE COMMERCIAL BUILDING SECTORCOMMERCIAL BUILDING SECTOR

Is There Hope Post-PACE?Is There Hope Post-PACE?Fall 2010Fall 2010


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.


ENERGY STAR AND INCREASED TENANCY

Multiple other studies show similar results

Multiple other studies show similar results

Co-Star study shows higher occupancy rates for ENERGY STAR buildings

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


AVAILABILITY OF ENERGY EFFICIENCY FINANCING

• Markets that Work– Federal– MUSH

• Markets that Don’t Work– Residential– Office Buildings– Retail / Food Service– Hospitality

• Key Differences– Owners not credit-worthy– Assets are Pledged

13%

87%80 billion/sf

12 billion/sf

The Focus of PACE Financing

$3.5 billion/yr

$0.0 billion/yr


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


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


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 (M&V) 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.


Exposure to the Taxpayer

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.

Ineligible

Eligible

All large commercial buildings

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


Underwriting Federal ESPCs

Lender’s Perspective

Acceptable hybrid credit: If savings are verified, agency paysIf not, contractor pays

Firm cash flow

Proven technologies

Standardized contract

Standardized M&V protocol

Projects bundled by ‘aggregators’ to critical mass for securitization


Underwriting Commercial PC

Lender’s Perspective

Acceptable hybrid credit Same of Federal

Firm cash flow Same of Federal

Proven technologies Same as Federal

Standardized contract BOMA BEPC

Standardized M&V protocol Same as Federal

Projects bundled by ‘aggregators’ Same as Federal


Critical Success Factors

The Owner’s Perspective

Make it simple !!!!!

Streamlined contract

Cost of capital

Efficient approval process with DOE


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% ??


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, C&W, 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.


ContactContact::

John J. ChristmasJohn J. ChristmasHannon Armstrong Capital, L.L.C.Hannon Armstrong Capital, L.L.C.1997 Annapolis Exchange1997 Annapolis ExchangeSuite 520Suite 520Annapolis, MD 21401Annapolis, MD 21401410-571-6164410-571-6164www.hannonarmstrong.comwww.hannonarmstrong.com

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