Cities and counties throughout the U.S. are developing new finance programs that support green retrofits in their communities. Called PACE, these programs represent one of the most promising tools available to local governments eager to bring new jobs, energy bill savings, and environmental benefits to their residents.
Last month, a rather cryptic letter issued by Fannie Mae and Freddie Mac suggested that property owners with mortgages from these lending giants would be prohibited from participating in PACE programs. The move attacks the constitutional right of local governments to assess property taxes and throws a massive wrench in American green job growth and investment. Now a broad coalition of industry, environment, and government groups is working hard to meet this challenge head on and get PACE back on track.
Our members and others have been asking us about the implications of Fannie and Freddie’s actions – and what can be done to help keep PACE moving. To help explain the situation, we penned an article that we’ve reposted here.
Article published in Greentech Media on June 8, 2010:
http://www.greentechmedia.com/articles/read/will-fanny-and-freddy-stop-pace/
Local governments have the constitutional authority to assess property taxes and use those taxes to pay for projects that benefit the public good. For over a hundred years, cities and counties have been using a widely adopted mechanism of land-secured financing to make improvements to sewage systems, sidewalks, street lights and other projects that serve a public purpose.
PACE (Property Assessed Clean Energy) programs use that same authority to finance energy efficiency, solar, water conservation, and other green retrofits on private property. Under these innovative PACE programs, the taxes are only assessed on those properties that have voluntarily opted to participate. By allowing property owners to spread payments across this kind of long-term, line-item addition to their property tax bill, PACE helps Americans overcome the single greatest barrier to efficiency and renewable energy improvements: upfront costs.
By putting boots on roofs and hammers in hands, green retrofits create thousands of local jobs. Even modest estimates for national PACE implementation expect the creation of approximately 160,000 long-term, green jobs for our economy.
Recognizing its tremendous implications for jobs and the environment, PACE has seen strong support at all levels of government. In early 2009, Congress passed legislation to make sure federal tax law doesn’t stand in the way of PACE progress. The PACE model was a cornerstone of Vice President Biden’s ‘Recovery through Retrofit’ policy recommendations. The Department of Energy has allocated over $100 million in Recovery Act dollars to help get PACE programs up and running. The White House and the Department of Energy have developed guidelines for emerging programs that mitigate risk for both homeowners and mortgage lenders. To date, at least 22 states and the District of Columbia have authorized their local governments to roll out PACE programs. And hundreds of cities and counties are quickly making good on their new authority to build local green economies. Thousands more have the opportunity to implement similar programs.
Unfortunately, on May 5th, Fannie Mae and Freddie Mac put this positive momentum at risk. The government-chartered entities, which collectively back around half of the mortgages in the US, issued “lender guidance letters” that seemed to suggest that PACE programs were incompatible with their mortgages.
The response was fast and furious. Letters of PACE support poured into the Federal Housing Finance Agency (FHFA), which oversees the two quasi-public lending entities. Governors including Schwarzenegger and Richardson, state attorneys general, mayors, officials from the Department of Energy, and representatives from across the PACE community all urged the FHFA to work with Fannie and Freddie to rescind or revise the lender guidance letters. Central to this effort was a call for a meaningful conversation with PACE stakeholders about specific criteria the financial regulatory community believes is necessary to enable PACE financing programs to proceed.
That decision is working its way through the halls of the FHFA and other regulators. Senior officials at FHFA have indicated that clarifications are forthcoming and that they are engaged in a thorough review of underwriting standards. Given the high level of political and business leadership directly involved in the discussion, we are optimistic that the regulators will encourage new lender policies that better reflect PACE’s modest risks and significant returns.
In the meantime, the move from Fannie and Freddie has many asking why these financial institutions — themselves the subject of intense scrutiny for their role in the mortgage crisis and ongoing federal bailout requests — are standing in the way of real economic recovery?
Specifically, the lender guidance letters expressed concern about “new” debt negatively affecting the security of their mortgages – an assertion that we believe is misplaced. Federal guidance specifically stipulates that PACE-funded improvements need to be cash-flow positive within a small window of time. In other words, the property owner’s utility bill savings must generally outweigh their increase in property tax payments. The money that a homeowner would use to pay for PACE improvements is already being used to pay his or her utility bills each month. There is no new debt created. If homeowners can’t pay their utility bills, there is very little incentive to pay the mortgage on a powerless, waterless home. But reduce the cost of a property’s monthly energy bills through PACE and you’re putting money back in the pockets of the property owner, funds that actually reduce the risk of default on the mortgage.
The letters also call into question the century-old tool of local governments to finance projects through land-secured tax financing. In response, the top-notch legal team at Paul, Hastings, Janofsky & Walker LLP took a close look at land-based finance issues under both federal and California state law. Thoughtfully summarized in a white paper you’ll find here (PDF), they concluded that PACE falls squarely within local governments’ constitutional authority. If Fannie Mae and Freddie Mac are successful in stripping away these special financing districts for energy efficiency and renewable energy, it calls into question the other 37,000 special assessment districts allowing public improvements in communities across the country.
The stark truth is, PACE is part of a very limited set of policy options available to local governments for addressing the serious challenges of economic revitalization, energy security, and — let’s not forget — climate change. This model is one of the best tools we’ve seen yet for chipping away at the carbon-intensity of our nation’s built environment. As is true of any effort to address the formidable challenge of climate change, PACE can only be one piece of the solution. But as the months and years tick by without strong national or international carbon policy, it’s becoming ever clearer that PACE — a local tool for direct progress — deserves to move forward.
I strongly support PACE and other intelligent means of financing a move toward efficiencya nd renewable energy. But I think there are a couple issues in your opinion piece that need to be addressed. First, your argument about PACE not jeopardizing a mortgage because it actually increases the homeowner’s ability to cover debt by lowering her utility costs is true only for homeowners. Nearly a third of households in the U.S. live in multifamily buildings, and over 40% of all households rent. Unless there is a clear and specifid link between the renter’s lower energy bills and the rental income the landlord receives, then mortgage debt coverage is not improved. This is one classic example of split incentives.
Second, even when there is a mechanism, such as through adjusted utility allowances in affordable housing, the expected energy cost savings will most often not materialize; at least not at the expected rate. This is because low-income households (and nearly 80% of renter households would qualify as low-income) do not purchase all the energy (comfort) they want or should have. They only buy as much energy as they can afford. So once you make the building more energy efficient, they can afford a higher level of comfort, and it is reasonable to expect they will “buy” a higher level of comfort. This does not mean that energy efficiency failed. Just the opposite. It means that more households will now be able to afford a decent, reasonable level of energy utility. But it does not mean that the actual stream of energy COST savings used to pay back the investment will be smaller than the ex ante calculated stream of energy cost savings. It is not wise to set up the expectation among lenders that all the calculated savings will materialize, when tenants will use of the savings to keep the winter T-stat at 69F now, instead of the 62F they endured before the retrofit.
Again, let me repeat that I support PACE. I just want to see us be realistic about it so that the epilogue is positive.
I support PACE and urge all FHA and private lending institututions to do likewise. HOWEVER, in all I have read I have not seen the requirement that the 30% INVESTMENT TAX CREDIT (ITC) obtained from making the solar investment BE USED EXCLUSIVELY TO PAY DOWN THE PACE LOAN.
Allowing this ITC to be kept by the homeowner is like permitting a “cash out” visavis the PACE financing. The property would be left with a loan balance which can only marginally be serviced by the projected electricity “savings” (i.e. adds about 15 years to an already long payback) and the value of the house would most certainly be impaired.
To summarize, I support PACE financing but only if there is a mandatory pre-payment (if not a Federal assignment of) from the resulting Investment Tax Credit. This will close what I percieve as a serious deficiency in current PACE financing structures.
William C. Turkel
Keep the PACE program and protect its future
The previous statement has a few flaws…Many Renters don’t pay utilities, they’re included, especially in multiple unit buildings. Many other rental buildings are partially lived in by the owners, and the utilities are not always separate and are wholly or partially paid for by the owner. Also, most folks who invest in solar utilities etc. are doing so for their own savings, thus use. It’s unrealistic to expect that a building or home owner will invest extra dollars on an improvement that will offer them no benefits at all. Even if they rent out their whole building, they will probably have less overhead costs, (hot water heating, brighter hall lighting.etc.) and be able to offer more desirable apartments, (enabling them to charge higher rents). Statistics are not adequate enough on their own for a valid argument unless much more completely thought out.
I strongly support PACE as it is only a part of econmic revitalizing options offered local governments to improve the environment and economics presently. It will help assure affordable housing while encouragin solar energy to homes.
This is a program that will do great things for our efforts to continue going GREEN!
I think Mr. Turkel’s comment regarding the Federal ITC merit more discussion.
These tax assessments actually function quite differently than a traditional loan, and the mechanics and administration of buying down the initial assessment would necessarily complicate the program.
Perhaps more options for bridging the ITC amount for 12 months, either through a different assessment or municipal financing mechanism, or a revision in policy.
Does Vote Solar have any comments regarding treatment of the ITC for PACE Financing?
~Ben
Some very key points have been brought up here. Thanks to all who are contributing to the discussion. In my testimony in favor of PACE before the Senate Energy Committee in my home state, our state senators had many of the same questions.
The first thing to remember is that efficiency and solar energy benefit whoever pays the utility bill. A rental tenant can certianly pay for efficiency upgrades or an alternative energy system, but they will only benefit if that tenant pays the utility bill _AND_ is able to live in the dwelling long enough to get through the “payback” period of the intial investment. However, they must also get the propoerty owner’s agreement before making a major modification like that to the property.
A property owner who pays for an upgrade or a system can only benefit if they include utilities with their rents. In such a case, the tenants don’t see the change in electricity expenses. However, they will probably be aware that a solar electric system has been installed and might increase their usage since they think the landlord is now getting “free” electricity. The sunlight is free, for sure, but capturing and converting it to electricity isn’t. If the tenants don’t change their habits and continue to use the same amount of energy, then the property owner benefits. If the tenants do start using more energy, then the property owner will have to raise rents to compensate. In this scenario, no one benefits.
Reducing your carbon footprint or doing your part to clean up the noxious discharges from power plants are worthwhile whether you’re a renter or not. Due to the complexities highlighted above, though, there is little motivation for rental property owners to invest in efficiency or distributed generation (like a wind turbine or solar panels on the roof).
Because PACE’s primary mechanism is a lien on the property, PACE is exclusively for the property owner. A tenant can’t obligate their landlord to pay a property assessment. Trying to apply PACE to rental property is a bit like using a computer as a doorstop. Yes, it can be done, but it’s not what the tool was designed for.
PACE is a way for property owners to install efficiency upgrades or renewable energy systems onto their properties. This tends to favor owner-occupied properties rather than rentals.
Regarding the ITC, it’s not necessary to stipulate what is done with the ITC because a project must be self-sustaining to be eligible for PACE. If the project cost must be defrayed by the ITC in order to meet the viablilty hurdle, then it’s self-enforcing. If anyone is concerned about the accuracy of projected savings calculations, then the hurdle rate can be adjusted to account for the margin of error in the calculations. For example, requiring the annual savings to be 120% of the annualized cost will hedge strongly against faulty calculations straining the project’s viabilty.
Every project is supposed to receive a financial evaluation. Municipalities that cut corners on this step are not serving their communities. Period.
Energy savings calculations are both complex (many parts) and complicated (unclear and unpredictable interactions between many of the factors). Therfore, this hurdle rate adjustment would make sense for such projects. Solar electricity, though, is quite predictable if done by a qualified (CERTIFIED) installer who knows how to evaluate the amount of energy that a given design can capture throughout the day and across all months of the year.
A good point is brought up about how to help property owners who don’t have the cash to float the ITC amount. For that matter, many states have rebates that are payable after the initial purchase, too.
Fortunately, a property tax bill only comes once a year (at least in the several areas where I’ve owned property). This provides a built-in grace period that will be long enough in most cases for the system to be commissioned and any applicable rebate to be received. It’s alo likely that the tax year will end before the PACE assessment is due, allowing the property owner to receive their tax benefit for that first year. In cases where timing conspires to reduce this inherent grace period, a delay of one additional year in the assessment (or at least the billing) will provide ample time for the ITC refund to be paid as well.
As an aside, most of us put off filing our tax return until April, but it is possible to file as soon as you receive your W-2. They are required by law to be mailed by the end of January. You can have your tax refund February 21st if you’re prompt with your filing.
So, it would seem that a solution to the “Bridge” challenge is to delay the assessment until after the tax year has ended. This can either be done for every project or only those which are completed within a few months of the assessment coming due.
its timee to do what is right let pace continue tomove forward.
Jason P – unfortunately I think you are missing the point regarding the ITC bridge.
It is not when the assessment is due year 1, but when the payment is due to the contractor.
If a PACE lien is only attractive when the principle amount is reduced by the ITC, then bridging that is critical. Someone is going to have to come up with that cash…
a 120% annual savings hurdle would kill the program.