When it comes to protecting the environment and fighting climate change, California has always been a first mover. Now the state is boldly acting to unleash a new market that saves energy, cuts pollution and drastically increases clean energy investment for California’s residents.

In March, California approved a $10 million reserve that will revive the Property Assessed Clean Energy (PACE) program for residential customers. The loss reserve program, administered by the California Alternative Energy and Advanced Transportation Financing Authority, is intended to ease concerns expressed by the Federal Housing Finance Agency (FHFA) by providing funds to reimburse the first-mortgage lender for the PACE payments it paid while in possession of the property during a foreclosure. In addition, the reserve can cover overdue PACE payments in the event the county sells the property for unpaid taxes.

First developed in Berkeley in 2008, PACE is an innovative financing technique for clean energy retrofits that gives energy efficiency projects a huge boost throughout the U.S. Property owners agree to a long-term tax assessment on their home or building in exchange for the upfront funding to pay for a retrofit. What’s great about the program is its ability to essentially eliminate one of the biggest barriers to energy efficiency retrofits: upfront costs.

And, just as with any other property tax assessment, the obligation transfers to the new owner upon a sale of the property. This transferability allows property owners to consider projects with longer payback periods, as the obligation does not become immediately due upon sale. From a lender’s perspective, because this obligation is part of a property tax bill, it has a very high likelihood of being repaid, even under a foreclosure.

Successful PACE programs have the potential to net great results - from reducing greenhouse gas emissions and improving energy efficiency, to reducing total energy costs for both residents and businesses. Unfortunately, in July 2010, the FHFA - the regulator for Fannie Mae and Freddie Mac - threatened to take action against homeowners and municipalities that participated in PACE programs for residential properties. The FHFA’s pronouncement has effectively curtailed most residential PACE programs.

Commercial success

Since its first use at a San Francisco office building in 2012, PACE has been a resounding success in the commercial sector. In fact, the commercial markets have quickly taken to PACE and continue to set new deal-size records. In February of this year, ribbons were cut marking the completion of a $7 million energy efficiency upgrade to the Universal City Hilton - the largest project of its kind in the U.S.

Los Angeles’ record-setting project is the third in a string of major commercial building retrofits in California in just the past two years, all thanks to PACE. The promise of large-scale, commercial PACE was first demonstrated in 2012, when the ProLogis Pier 1 Building in San Francisco received the first-of-its-kind financing for $1.4 million of energy efficiency upgrades. This project kicked off what has become one of the most successful clean energy financing programs in the nation.

In July 2013, the Environmental Defense Fund (EDF) helped Sacramento Mayor Kevin Johnson’s office set a new commercial PACE record when the Metro Center Corporate Park closed a $3.16 million deal through the Clean Energy Sacramento program. But these records don’t last long: Each of these new projects received more than double the financing of the previous project - a positive sign for the future of commercial PACE programs in California. In fact, there are currently 25 active commercial PACE programs in 10 U.S. states - proof that the trend is growing beyond the Golden State’s borders.

Historically, most of the PACE transactions have gone toward financing energy efficiency improvements. To date, PACE transactions have generally been structured as a set of fixed payments to finance retrofits managed by the property owner. Functionally, these transactions have been quite similar to loans. In the solar sector, however, the vast majority of financings have been structured as leases or power purchase agreements (PPAs) in order to fully capture the tax benefits associated with solar investments. This has generally resulted in a fairly low use of PACE by solar installers and limited installations of solar on commercial properties.

Connecticut is breaking new ground by allowing leases and PPAs to participate. The state has set up its commercial PACE program to also include financing solar projects by using financing structures - leases and PPAs - that tend to provide the lowest-cost solutions for building owners. The lease or PPA payments simply become part of the property tax bill. If necessary, true-up mechanisms could be used to adjust payments and ensure that customers are not overbilled.

Last year, Connecticut finalized nearly $20 million of transactions for commercial properties. Similarly, Toledo, Ohio, executed $18 million of commercial PACE transactions in 2013.

Residential concerns

In California, the residential market started out equally strong but cooled off when the FHFA raised concerns that PACE financing could be potentially hurting home mortgage holders like Fannie Mae and Freddie Mac.

Still, a few California programs have decided to offer residential PACE and have barely been able to keep up with demand, proving that the program can thrive for home-
owners.

Sonoma County’s residential program has financed upgrades for nearly 2,000 homes since it began in 2009. To date, Sonoma has financed $52.8 million of PACE retrofits.

Since December 2011, the Western Riverside Council of Governments has offered a residential PACE program to homeowners, called Home Energy Renovation Opportunity (HERO) Financing.

HERO partners with local governments to make energy efficient, water efficient and renewable energy products more affordable for homeowners. Under the program, $134 million has been invested in clean energy upgrades for homeowners in a region of Southern California with a population of 1.45 million people. At that rate, almost $30 billion of clean energy retrofits could
be financed if a similar residential PACE program were adopted nationwide.

Sonoma and Riverside counties have clearly demonstrated that there is significant consumer demand for clean energy retrofits that improve comfort and save money. Ultimately, California is poised to see a massive increase in residential energy efficiency and investment through PACE, all while helping residents save money, use cleaner energy and protect the environment, too.

California’s latest proposal, ushered in by Gov. Jerry Brown, will harness the success of PACE and its untapped potential, while easing the concerns of the FHFA. The new reserve will pay mortgage holders - such as Fannie and Freddie - for specific losses they incur due to a PACE financing, so they don’t have to worry about losing money because of PACE. We are hopeful the FHFA will bless this approach so that more states can attract private clean energy investments at no cost to taxpayers. S

Brad Copithorne is financial policy director for the EDF. Scott Hofmeister is an energy efficiency associate with the EDF, with a focus on clean energy and energy efficiency finance.