11 Ways to Finance Commercial Real Estate Energy Retrofits
to the U.S. Department of Energy, commercial buildings account for 35 percent
of U.S. (and 40 percent of global) electricity consumption. Most commercial
real estate professionals accept that energy efficient buildings can, and do,
impact the value of the underlying asset. Notwithstanding this recognition,
existing commercial buildings on average spend 30 percent of their budgets on
operating costs and account for close to 20 percent of all global carbon
they understand the benefits, the challenge for most commercial real estate
owners and operators is not whether to implement energy efficient retrofits,
but rather how to pay for or finance such improvements.
following list is a basic primer of ways to finance these types of retrofits in
commercial real estate space. It is not intended to be fully inclusive and does
not discuss the benefits or drawbacks (and there are many) of each financing structure.
But it does offer an introduction to a topic that has become, and will continue
to be, of critical importance to the commercial real estate industry.
Expenditure Financing. Due largely to the lack of consistent alternative
funding sources, most energy retrofits to date are financed through the cash
flow, reserves, capital raises, or reallocation of internal funds from the property
Financing. Both secured and balance sheet debt financing through commercial
banks, credit unions, and other types of lenders is available in limited
instances, and for limited borrowers. Debt financing from federal and state
sources is also provided through a variety of state or local programs. A few
examples of these programs include federal legislation such as The American
Reinvestment Act of 2009, President Obama’s Better Building Initiative, and Small
Business Administration loan programs, as well as state or local revolving
funds such as the Green Jobs-Green New York Program administered by the New
York State Energy Research and Development Authority. Program-related
investments through non-profit organizations, such as the MacArthur Foundation,
structured as low interest bridge or subordinated loans or loan guarantees are
often leveraged through community development financial institutions to secure
funding for energy efficiency projects.
Financing. While not widely used, some experts have suggested that private
corporate or municipal bonds, such as the Federal Qualified Energy Conservation
Bonds and the CDFI Bond Guarantee Program, are a feasible structure for scaling
large efficiency retrofits through the creation of funds or special purpose
entities designed to finance multiple smaller transactions.
Financing. If and when authorized by state law, Property Assessed Clean
Energy Programs are a form of tax lien financing that allow owners to borrow
from local government sources (16 currently in the U.S.) or private investors
through a private placement. The loans are typically repaid through long-term
special assessments up to 30 years, levied against the borrower’s property tax
Financing. This financing structure utilizes funds provided by third-party
capital sources and a repayment procedure administered by local utilities.
Specifically, the borrower repays the loan over a short term (typically not
exceeding 36 months) through a supplemental charge on the owner’s utility bill.
Energy Utility Financing. There are a small number of sustainable energy
utilities throughout the U.S. -- for example, the Cambridge Energy Alliance -- that
are created by state or local municipalities for the purpose of providing or
arranging project financing and facilitating public-private partnerships to
foster energy efficient and renewable energy-related development.
Financing. Under this structure, an energy service company enters into
long-term contracts with owners to design, construct, and often finance the
retrofit project. In turn, the ESCO is repaid through a shared savings,
guaranteed savings, or performance contracting model. With a typical
performance contract, an ESCO assumes some portion of the risk over a retrofit
project’s useful life by offering a guaranty of energy.
Service Agreements/Performance Contracts. Energy service agreements and performance
contracts expand the traditional ESCO model through third-party ownership,
management, and maintenance of the installed efficiency equipment. This
eliminates the owner’s initial capital costs, which can be substantial, and
allows the owner to simply make scheduled payments to the energy efficiency
firm, such as Metrus Energy and CalCEF, typically based upon the level of
energy savings as operating expenditures for the asset.
Financing. While differing in form and substance, many utilities offer
financial incentives, rebates, grants, and loans for energy retrofits.
Typically, the loans are repaid through an on-bill structure underwritten and
administered by the utility.
Credits and Incentives. Often used in conjunction with other financing
tools, federal and state governments offer tax incentives (including credits,
grants, and rebates) to encourage owners and operators to make capital
investments into energy efficiency retrofits.
Leases. While not conducive for deep or large-scale retrofit projects,
leasing of energy efficient equipment allows owners to reduce or largely
eliminate upfront capital costs through lease and lease purchase agreements
that can be structured as either capital or operating leases.
The foregoing summary is only the beginning.
A commercial real estate owner should not only assess the values, challenges,
and risks of each financing structure with the economic realities of a particular
asset, the owner must also seek the input of professional advisers to assist in
navigating the opportunities and potential pitfalls.
Michael C. Polentz is co-chair of the Real
Estate & Land Use Practice Group at Manatt, Phelps & Phillips, LLP, located
in the Palo Alto, Calif., office.