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By Elias Hinckley on May 3, 2013 with 2 responses

Bipartisan Support for Bill to Encourage Energy Efficiency

Recently Sens. Jeanne Shaheen (D.-N.H.) and Rob Portman (R.-Ohio) reintroduced the Energy Savings and Industrial Competitiveness Act.  The bill is meant to spur the use of energy efficiency technologies in residential and commercial buildings as well as in industrial and manufacturing operations. One of the key focal points of the bill is on supporting the update of building codes to integrate energy efficiency improvements and requirements.

Over at OurEnergyPolicy.org the Alliance to Save Energy (ASE) is hosting a discussion on whether this bill is an effective approach to energy efficiency. While this is a positive step (and reducing waste does seem like a natural place for bipartisan support), I think there are some other simple steps we could take to move things forward faster, and one easy way would be to accelerate the adoption of proper evaluation of energy efficiency with mortgage lenders. Here was my response to ASE:

Laying the framework for updating building codes is a simple and obvious step towards promoting more efficient energy use in commercial residential and industrial buildings so yes, I think this is an excellent idea. The step that I would like to see, and that I believe would have a more material impact on investment in building efficiency would be to tie energy efficiency and use projections to the credit review process.

Efficiency upgrades are generally up front expenditures and the value is realized through savings over time. Often these are systems (or improved systems) that are integrated into a building and so not easily borrowed against as a lender can’t recover in the event of default because the specific energy efficiency upgrades can’t be removed and resold (challenges are both physical and legal).  Further adding to this challenge is that lenders (and appraisers) don’t accurately value efficiency upgrades, which means that a complete financing often won’t cover the value of the building plus the efficiency upgrades. The result is that the upgrades have to financed with the building owner’s cash and recovered over time – this substantially limits the appeal of these kinds of investments.

Here’s a simple example: Buyer is going to pay for a building to be constructed at a total cost of $100. Bank will lend buyer $75 for 20 years, buyer will use $25 of its own cash. Instead buyer would like to include $20 in efficiency upgrades that will reduce energy costs by $4/year for a total building cost of $120. Bank, however, sees the same building – same market, same sq. ft., same exterior. Bank will lend buyer $75 and buyer’s equity requirement is now $45. Most efficiency upgrades don’t happen with this math.

And the result is the same even where the Bank recognizes only a partial value of the upgrades: bank will now lend buyer $80 on an assumed value of $107 (because the bank does not recognize the increased value of several of the installed efficiency systems based on existing valuation methods). Buyer’s equity investment in the efficient building will be $40 on a loan to value ratio of 66/33 rather than $30 on 75/25 split as would have been the case had the bank treated the efficiency upgrades at full value in the larger financing package.  The additional $10 is often enough to cause buyer to walk away from at least some of the efficiency upgrades.

The curious result should be obvious. The buyer has significantly more free cash from the energy savings than is necessary to pay the principle and interest on the incremental amount borrowed for the efficiency upgrades. The building is more valuable because it costs less to use. Despite these facts, the bank is still using tradition valuation methods and the result is that an investment that makes financial (not to mention social) sense doesn’t happen.

Adding a set of energy use and efficiency criteria to lending requirements, and requiring the reduction in net energy use and expense be considered in the valuation of property would immediately cure this inconsistency. However, legislating lending standards, which are generally market driven won’t really work – with the notable exception of FMHA and USDA residential loans.

Changing the FMHA requirements may seem like a small and possibly insignificant step, but it isn’t. When PACE (property assessed clean energy) bonds were first introduced, FMHA took a hard stand against the financing tool (more on that here and here). While there has been some progress on commercial uses of PACE progress remains slow and one of the key challenges has been an unwillingness of underwriters to adopt a process directly in conflict with FMHA standards – some of this may be for industry consistency, but some seems more like an unwillingness to learn a new language. By forcing energy into the FMHA standards the reverse could be true, an expansion of the existing language and discourse on lending standards would act as a significant pull on others (and of critical importance, provide a template for non-FMHA loans) to begin to incorporate these consideration into loan underwriting.

For anyone else that would like to join the dialogue you can join the conversation there, but please be sure to add your comments here as well.

  1. By Camburn on May 3, 2013 at 5:58 pm

    People are not dumb and will get the best value for their dollar. Business most deff will work to get the best value for a dollar spent.

    Basic economics indicates this.

    A competitive environment is the most efficient environment.

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  2. By ben on May 8, 2013 at 1:05 pm

    You’re fishing in a good spot on the brook. Mortgage financing must evolve to sensibly account for the value accompanying energy effciency upgrades and a borrower’s enhanced capacity to meet debt-service obligations. What is missing here is, in part, a mortgage banking industry willing to lead rather than simply seek refuge in the shade of the status-quo. Regrettably, the financial collapse of the past decade left little room for profiles in courage within an industry suffering plenty of balck eyes and battered balance sheets. Expecting today’s bankers to take up the banner and lead from the front is probably wishful thinking.

    Is it reasonable to assume that our current economic circumstances preclude a new set of public policies aiming to spur widespread implementation of energy efficiencies? Perhaps. Yet, we faced equally daunting challenges in the late 70′s when we advanced initiatives to highlight the urgency for greater energy independence and security. Some say we stopped at half-measures. Others complained we did too much. The results probably speak for themselves.

    Efforts to fuel the adoption of energy efficiency systems ought to acknowledge the historic and productive role that expensing plays in recovering capital. To the extent that energy savings-related capital outlays contribute dependably to quantifiable operational savings, such efficiencies should enjoy a commensurate level of credit
    to help risk-mitigate additional capital commitments. The mechanics of how such credits are calculated, documented and submitted for treatment need not deviate significantly from existing energy credit programs. The issue is one of appropriate percentages. To the extent that renewable energy seeks equalizing treatment via MLP structures, so too might the argument be made that revised energy credits/tax expenditures due in fact serve the interests of our households, places of business, communities and, yes, the entire nation.

    It’s time for Congress to support capitalisation by further enabling energy efficiency measures to factor the fruits of its productive labors in the form of tax relief. If the notion of dynamic analysis in economics (principally embraced by conservative-leaning politicians) is to be given credence than the robust commercial activity and economic growth accompanying a reinvigorated energy/building services sector should logically return substantial resources to the public treasury.

    Elias, thanks for your thoughts and encouraging dialogue on the issue.

    Ben

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