- 1. Banking on Energy Efficiency in Real Estate Wednesday, October 13 10:45 a.m. - 12:00 p.m.
2. Kate Q. Knight (Moderator) AIG Global Real Estate Beau Engman Vice President, Commercial Energy Solutions, Johnson Controls John Christmas Senior Vice President, Hannon Armstrong Bob Hinkle President and CEO, Metrus Energy Greg Hale Center for Market Innovation, Natural Resources Defense Council Nina Albert Chief, Office of Green Economy, District of Columbia 3. Proprietary and Confidential FINANCING ENERGY EFFICIENCY IN THE COMMERCIAL BUILDING SECTOR BARRIERS AND OPPORTUNITIES Fall 2010 4. Proprietary and Confidential DISCUSSION CONTEXT Low-cost, quick-payback measures are not interesting. New construction 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. 5. Proprietary and Confidential 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. (1) Source: Co-Star Group (2) E.g., Washington D.C. and NYC; San Francisco and Los Angeles also considering similar mandates (3) The General Services Administration is the single largest lessee of commercial space in the nation. Mandate starts in 2010. 6. Proprietary and Confidential AVAILABILITY OF ENERGY EFFICIENCY FINANCING Markets that Work Federal MUSH Markets that Dont Work (yet) Residential Office Buildings Retail / Food Service Hospitality Key Differences Owner is credit-worthy No Mortgage No Holding Period Horizon No Split Incentive 15% 85% 7. Proprietary and Confidential THE FINANCE PROBLEM IN ENERGY EFFICIENCY Commercial Investment Property Sector High upfront cost + Returns over time = Need for financing Despite clear energy efficiency benefits Lower operating costs/increased cash flow Potential increase in occupancy Potential increase in property value Potential energy efficiency credits there are financing barriers Commercial properties owned by unrated, limited liability shell entities, Properties fully pledged under mortgage / mezzanine investment, Mortgagees disallow 3rd party liens on real property improvements, (1) E.g. a new chiller 8. Proprietary and Confidential CURRENT STATUS With PACE stuck in the regulatory mud, does the industry have a Plan B? Ideally without relying on ARRA funds Creating a commercial performance contracting market, using the Federal ESPC market as a model 9. Proprietary and Confidential Federal ESPC: the Lenders Perspective Acceptable hybrid credit: If savings are verified, agency pays If not, contractor pays Firm cash flow Standardized contract Standardized M&V protocol Proven technologies No energy price risk Diversity of contractors Projects bundled by aggregators to critical mass for securitization 10. Proprietary and Confidential Creating a Commercial Performance Contracting Market, using Federal as a Model Goal is to simulate the same hybrid credit structure. 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: Owner obligation limited to verified savings Contractor pays shortfalls directly to lender If savings are verified but owner defaults, USG pays lender 11. Proprietary and Confidential Commercial PC -- the Lenders Perspective Acceptable hybrid credit Same of Federal Firm cash flow Same of Federal Standardized contract BOMA BEPC Standardized M&V protocol Same as Federal Proven technologies Same as Federal No energy price risk Same as Federal Diversity of contractors Wider diversity Projects bundled by aggregators Wider diversity 12. Proprietary and Confidential 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 eventually be priced lower than Federal ESPC for four reasons: greater volume, more competition, wider diversification, and make-whole provision. * Current yields on 10-Year US treasuries are roughly 2.75%. Federal ESPC Commercial PC Baa Corporate PACE Commercial Mortgage 5.00% 5.50% 5.75% 7-8% ?? 13. Proprietary and Confidential Implementation Lenders/contractors screen projects according to published eligibility criteria* Lenders aggregate projects into portfolios of critical mass. DOE may issue single guarantee covering entire portfolio. DOE due diligence should focus on government exposure: property profile. DOE should 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. 14. Proprietary and Confidential The Argument for Performance Contracting Primary 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. Industry has a template commercial contract: BOMA BEPC 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. 15. Proprietary and Confidential Contact: John J. Christmas Hannon Armstrong Capital, L.L.C. 1997 Annapolis Exchange Suite 520 Annapolis, MD 21401 410-571-6164 www.hannonarmstrong.com 16. Banking on Energy Efficiency in Real Estate Wednesday, October 13 10:45 a.m. - 12:00 p.m. 17. FINANCING SOLUTIONS FOR ENERGY EFFICIENCY IN COMMERCIAL BUILDINGS Banking on Energy Efficiency Urban Land Institute Fall Meeting,Washington DC October 13, 2010 www.MetrusEnergy.com 18. Commercial Building Conundrum 18 Highly underserved market Few financing options; Large volume of EE projects with 3-7 year paybacks Significant investment opportunity $18B/year (U.S. EIA/LBNL) $250B over next decade (ACEEE) Current limitations Credit risk of single purpose LLCs Constraints of the existing mortgage Split incentives owners and tenants Lack of prioritization of EE by owners 19. No First Cost Financing Solutions Remove first-cost barrier by funding 100% of front-end cost of projects Efficiency ServicesAgreement (ESA) Leasing options for EE retrofits Under the ESA: Metrus finances, owns, and operates an efficiency retrofit project Customer pays for only realized energy savings ESCO designs, installs, and maintains a project 19 Metrus ESCOCustomer Efficiency Services Performance Contract (ESPC) Efficiency Services Agreement (ESA) 20. & Customer BAE Systems Industrial (defense contractor) ESCO Siemens Industries Efficiency Services Agreement 10-year ESA term Covers maintenance and repair/replacement on selected equipment Customer has periodic buyout options Comprehensive multi-facility program Project Size > $1M (Merrimack, New Hampshire) Lighting retrofit Kitchen equipment controls Demand control ventilation Air compressor replacement Transformer replacement Project Performance Avg. Electricity Savings = >1M kWh/year Avg. Natural Gas Savings = >30k therms/year Various Non-Energy Savings Emissions Reduction = >400 tons of CO2/year 20 Project Case Study: 21. Strategies for Commercial Real Estate 21 CHALLENGES SOLUTIONS & STRATEGIES FOR EFFICIENCY PROJECTS First Cost Hurdle Fund 100% of all project design and implementation costs Credit Risk of Building LLCs Finance deals in top-tier markets; owner occupied or with stable rent rolls Tap into existing state-level programs that offer credit support Expand existing DOE loan guarantee program to include EE projects Mortgagee Waiver Work to obtain waiver on new EE property; seek participation at EE project level from existing lender or a regional commercial real estate lender Securing Debt Make permanent equity investment in each project alongside debt to provide lending partners with added security Pursue project-level debt from the existing lender on a building Split Incentives Set customer payments based on units of energy savings (akin to a utility bill) Building Sale During Project Term Existing owner pays early termination value or new owner (if credit is acceptable) can assume the EE contract obligations Limited EE tax benefits Provide commercial EE with tax benefits on par with renewable energy 22. Contact Information 22 Bob H i n kle i nfo@MetrusEnergy.com www.Me trusEn e rgy.c om 23. Banking on Energy Efficiency in Real Estate Wednesday, October 13 10:45 a.m. - 12:00 p.m.