Download pdf - Banking on Energy Efficiency in Real Estate

Banking on Energy Efficiency in Real Estate

Wednesday,

October 13

10:45 a.m. - 12:00 p.m.

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

Proprietary and Confidential

FINANCING ENERGY EFFICIENCY IN THE COMMERCIAL BUILDING SECTOR

BARRIERS AND OPPORTUNITIES Fall 2010


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.


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.


AVAILABILITY OF ENERGY EFFICIENCY FINANCING

• Markets that Work

– Federal

– MUSH

• Markets that Don’t 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%


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


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


Federal ESPC: the Lender’s 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


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


Commercial PC -- the Lender’s 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


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%

??


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.


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.


Contact: John J. Christmas Hannon Armstrong Capital, L.L.C. 1997 Annapolis Exchange Suite 520 Annapolis, MD 21401 410-571-6164 www.hannonarmstrong.com

http://www.hannonarmstrong.com/


Wednesday,

October 13

10:45 a.m. - 12:00 p.m.

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

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

No First Cost Financing Solutions

• Remove first-cost barrier by funding 100% of front-end cost of projects

– Efficiency Services Agreement (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

ESCO Customer

Efficiency Services Performance

Contract (ESPC)

Efficiency Services Agreement

(ESA)

&

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:

http://www.baesystems.com/index.htm

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

Contact Information

22

B o b H i n k l e

i n f o @ M e t r u s E n e r g y. c o m

w w w . M e t r u s E n e r g y. c o m


Wednesday,

October 13

10:45 a.m. - 12:00 p.m.