A Well Liked Energy Retrofit Lending Program Comes Up Against Fannie and Freddie
Making energy-efficient changes to a property is, let’s face it, expensive, at least in the up-front costs. Though the goal is ultimately to save money in the long run through the efficiencies provided by the changes, those changes still require a pile of up-front cash. In recent years, we’ve seen a number of programs specifically designed to help offset these costs, and one of the most effective is the PACE program.
The Property Assessed Clean Energy (PACE) program implements a specialized form of lending in which property owners, both residential and commercial, are lent money to make energy-efficient retrofits to properties (both energy-efficient modifications and small renewable energy systems, like micro wind turbines and solar panels). PACE bonds are issued in the form of municipal bonds that in many cases feature subsidized interest rates. The loan is then paid back over a long period – 15 to 20 years – through an annual assessment on the improved building’s property tax bill, in a manner similar to that of a sewer tax assessment. The program is generally viewed with enthusiasm as a way to accelerate commercial and residential energy-efficient retrofitting. Enthusiasts tout the program’s low fiscal cost, potential for job creation, increases to property value, acceleration of energy-saving installations, and the fact that the program improves borrowers’ cash flow and credit profile, as the resulting energy savings are greater than the annual tax cost.
It’s also a loan that is guaranteed to be recouped should the property go into default, since tax liens take priority over mortgage debt in the case of foreclosures.
Not everybody likes that last bit. In fact, on May fifth of this year, government-sponsored mortgage finance giants Fannie Mae and Freddie Mac, which together guarantee half the mortgages in the U.S. — sent a weird letter to lenders that appeared to be warning them off the project. Apparently, what has Fannie and Freddie so tweaked is the fact that, because the money used to finance PACE projects are essentially tax liens, if the mortgage goes into default, the PACE program has dibs on recovering its money – even before the mortgage lender. In the letter, Fannie and Freddie promise to provide “additional guidance” should the project move beyond the “experimental stage.”
The PACE program is so well liked by everybody else (Scientific American magazine cited it as one of its “20 World Changing Ideas”) that the federal government has pulled together a task force under the umbrella of several federal agencies to push the project, and invested $100 million of stimulus recovery act cash. Twenty-two states have officially adopted their own version of a PACE program, primarily to bipartisan political support. One would presume that this implies that the program has moved beyond the “experimental stage,” as stated by the Fannie and Freddie letter. Yet, the “additional guidance” promised by Fannie and Freddie has not arrived, and their mysterious recalcitrance appears to have officially put many PACE projects on hold.
The job creation potential of the program is fairly obvious. Property owners, residential, commercial or industrial, can choose from an array of contractors and energy auditors to do their projects. Contractors need only attend a training session for the program and register with their state or municipal PACE program. It’s not a stretch to conclude that the program will provide contractors with work that property owners would not otherwise have chosen to go ahead with.
The U.S. has very high turnover when it comes to housing. Americans change their residences more often than any other first-world country’s citizens. This has been problematic for the purpose of financing home energy efficiency projects. Traditionally, improving the energy profile of a property means incurring debt that falls upon the individual property owner exclusively. When the property is sold, the seller still owns the debt, even though the new owners reap the benefits. The PACE program was designed to alter this by tying the debt for the property improvements to the property itself, which means that when the seller transfers the property, he or she is also transferring the debt. Since energy efficiency retrofits often take years to pay for themselves, property owners who made the improvements have a choice between selling the property before they’ve recouped their investments and losing money, or remaining tied to a property they wish to sell. As a result, property owners have been reluctant to make the changes.
Alfred Pollard, general counsel for the Federal Housing Finance Agency, Fannie and Freddie’s regulator, said, “The goal of enhancing energy efficiency, which we share, should not overcome the need for prudent underwriting.” Otherwise, Fannie and Freddie are remaining mum on their objections. According to the Wall Street Journal, the mortgage entities are technically not allowed to comment on public policy, which is why they are not talking to the press overly much about their objections. But program observers fear that Fannie and Freddie, or the lenders themselves, will merely raise rates in the states and municipal locations that have PACE programs in an attempt to cover losses that might occur from foreclosures on PACE-financed properties.
One possible solution to the stand-off is for PACE programs to limit the amount of lending to a fixed percentage of the property value, therefore limiting the amount that might be lost by a lender in the case of a foreclosure, and also put clauses in place that make properties currently worth less than the amount of the outstanding mortgage loan ineligible. In addition, it might help ease lenders’ concerns if suitable documentation could be provided at the time the loan is made that the energy-efficient additions to the property will substantially increase its value.
– Tracey E. Schelmetic