March 18, 2014 | Brendan McEwen

What are the pros and cons of on-bill financing, PACE, and tax increment financing? Our new guide helps cities weigh all the options.

Energy upgrades are widely recognized as a crucial component of building a more prosperous, green, and just America. By some estimates, fully 30 percent of energy use from commercial buildings is wasted. Reducing this energy use through building improvements will protect the climate, create economic opportunity, and save money.

Driven by the need to retrofit more buildings, local governments are trying a wide variety of financing tools. However, comparing them is tricky. What are the pros and cons of an energy services agreement, on-bill financing, PACE (property assessed clean energy), and tax increment financing?

The Institute for Market Transformation and the Massachusetts Institute of Technology’s Community Innovator Lab (MIT CoLab) have teamed up to produce a new guide outlining the various financing tools for energy upgrades of commercial buildings. The guide is geared toward local governments interested in accelerating energy efficiency in their communities, and it will also be useful to building owners, managers, and members of the energy services industry.

The scale of financing required is substantial. The Rockefeller Foundation and Deutsche Bank Climate Change Advisors estimate that a total investment of more than $70 billion is needed to upgrade America’s commercial building stock, compared to only about $1.5 billion in third-party project financing currently deployed each year. And the need for investment will increase even further as we integrate renewable energy into our buildings, and as other novel energy services come to market.

Why the investment gap? Financing has been hindered by a number of key barriers, including:

  • “Hold” barriers – Some owners will not invest in upgrades unless they can readily pass responsibility for financing payments to future owners.
  • Limited debt service capacity and need for “off-balance sheet” financing – Businesses have multiple demands on their limited cash reserves and debt capacity. Thus they are hesitant to enter into financing arrangements that could reduce their access to debt for other projects.
  • Split incentives – Some owners will not invest in upgrades if they cannot pass costs for financing through to tenants who benefit from lower utility bills.
  • Lack of financing for smaller projects – Markets for retrofits are relatively nascent. Because of high transaction costs, many energy service providers and financiers require high minimum project costs before they will provide financing, excluding smaller buildings and projects. Project aggregation, dedicated programs, new underwriting practices, and greater scale will allow more small projects easier access to financing.

IMT and MIT CoLab’s guide helps local governments and other stakeholders make sense of the tools that can overcome these barriers, outlining their function, local governments’ role in implementing them, and their ability to address key challenges.

We hope the guide will be valuable in the exciting work of upgrading buildings in your community.

Brendan McEwen is sustainability manager for the City of Richmond in British Columbia and a research affiliate at MIT CoLab. He is the former associate director of CoLab’s Green Economic Development Initiative.

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