WEB EXCLUSIVE: Performance Contracts, PACE Bonds, And More

On April 26, FacilityBlog reported information on the fourth annual Energy Efficiency Indicator (EEI) survey, which Johnson Controls commissions in partnership with the International Facility Management Association (IFMA). Presented here are answers to follow up questions that TFM asked of Johnson Controls after attending a Webcast on this topic late last month. Derek Supple, program director for global energy and sustainability there, addressed my questions recently.

TFM: According to the results discussed on April 19, 2010, about 40% of those surveyed [1,400 facility professionals across North America] don’t know or have not yet prioritized their strategies for reducing their organization’s greenhouse gas emissions. It was also noted that 40% have no formal energy plan. While the capabilities and goals are expected to vary for different organizations, what steps would you recommend facility professionals take toward creating a formal energy plan?

Supple: The best steps for creating a formal energy plan include:

  • Assess energy management goals/priorities among stakeholders across the organization.
  • Identify key needs gaps and key practices gaps.
  • Create process/system for collecting accurate energy information.
  • Inventory current energy use, energy expenditure, and energy intensity.
  • Benchmark internally and externally to estimate opportunity for improvement.
  • Set well defined targets based on goals and the estimated opportunity.
  • Establish technology infrastructure to provide visibility for ongoing monitoring.
  • Create data-driven action plan of programs and projects.
  • Drive continuous improvement by implementing programs and projects.
  • Measure and verify the savings/impact of programs/projects.
  • Communicate achievements to internal and external stakeholders.

TFM: The importance of incentives as a tool for pursuing energy efficiency measures was down from the 2009 survey. Why might incentives be less important? Is it a lack of knowledge on what’s available? Or might facility professionals be thinking that incentive money is decreasing soon?

Supple: To clarify, in comparison to 2009, incentives were considered less important compared to other factors driving energy efficiency investments, such as climate concerns. The 2009 survey was conducted during the weeks following the announcement of the American Reinvestment and Recovery Act (ARRA) when government incentives for energy efficiency were top of mind.

90% of EEI North America survey respondents were from the private sector. Many private sector facility professionals believed there would be government incentives for energy efficiency through ARRA in early 2009. In reality, there were very little energy efficiency incentives for private sector buildings available through ARRA funding. Thus, it is probably a function of the expectations becoming more realistic.

TFM: A new question for the 2010 survey asked where respondents plan to source funds from for energy efficiency improvements going forward? 52% stated “in-house”; 20% “grants/incentives”; 14% “performance contracts.” Why do you think performance contracts represent this lower percentage? What can we tell facility professionals about performance contracting to open up more energy efficiency opportunities to them?

Supple: While performance contracting is the third most popular among the financing options listed in the survey, there is potential for that model to see broader participation rates. 90% of today’s performance contracting market consists of projects in government, educational, and healthcare facilities. The performance contracting model has seen more limited use in the commercial real estate, corporate owner-occupied real estate, and industrial facilities. 

There are a variety of reasons for this, including:

  • Some building owners prefer to procure efficiency improvements on an individual measure-by-measure basis rather than whole building retrofits. By procuring individual improvements, technologies, and/or components one at a time, the organization may benefit from greater competition among vendors and thus lower prices and lower vendor margins. However, by doing so they often sacrifice the potential for deeper and more cost-effective energy savings through integrated design whole building retrofits, as well as sacrificing the ease and quality control of using a turnkey contractor through a performance contract.
  • Some organizations have the technical ability to identify and self perform efficiency retrofits in-house rather than hire an ESCO.
  • Some building owners have more capacity to take on risk; Some owners assume that ESCO projects cost more in order to cover performance guarantee risk.
  • Some building owners don’t require measurement and verification of energy savings achieved through investments.
  • Performance contracts generally guarantee savings for—and often enable building owner to secure attractive financing for—deep energy retrofits with five to 15 year simple paybacks on upfront investments. Private sector facility professionals typically require projects to pay back in two to three years or less. Therefore, there is a smaller need for financing and long-term performance guarantees. Organizations are unlikely to enter into these a multi-year performance contracts if there is uncertainty as to how long the organization will own/occupy the building.
  • Many commercial real estate entities do not have an investment grade credit rating or any available collateral to secure financing required for a whole building retrofit completed under a performance contract.
  • There are split incentives between owners and tenants in tenant-occupied commercial real estate, which prevents owners from entering into performance contracts for whole building retrofits. In triple net lease buildings, owners must pay the cost for these retrofits while tenants benefit from the energy cost savings, and owners often can’t pass along the retrofit costs to tenants.

The industry needs to increase awareness among facility professionals about a variety of contract structures and financing models, including performance contracting, that are available to help them overcome the upfront cash investment barrier to energy efficiency and renewable energy improvements in buildings.

Facility professionals should be educated to correct misconceptions about performance contracting. By combining the expertise of energy services companies with private financing, performance contracting creates a low-risk, cash-flow-positive opportunity for building owners to achieve deep energy savings through building retrofits.

TFM: Can you talk about the workings and the status of PACE [Property Assessed Clean Energy] bonds?

Supple: Workings of PACE — 
PACE financing programs, also known as tax financing programs, allow property owners to pay for energy efficiency, renewable energy, and/or water efficiency projects through a voluntary contractual assessment paid on their property tax bill over a five to 20 year term.

It should be noted that PACE bonds are only one type of PACE financing.

Similar to when a local government places an assessments for a special improvement district in order to fund the upfront cost of street improvements or telecommunications infrastructure, PACE districts work the same way, except that they are voluntary. Instead of taking out a loan to undertake a project, the building owner applies to join the special improvement district, the local government funds the project and collects payments from the property owner as a special assessment on the property tax bill.

The tax assessment stays with the property, not the individual or company, upon sale of the property.

This innovative and scalable financing model theoretically overcomes several key barriers to the adoption of cost effective energy efficiency retrofits in buildings.

  • First cost: Reduces the upfront costs to owners for clean energy projects by amortizing the project costs over time and providing immediate positive cash flow.
  • Scarce capital: Makes more funding available for retrofits at attractive rates and terms by creating a market for privately financed clean energy securities. There is virtually no risk of loss to lenders because property tax liens are equal or senior to mortgage debt and have a very low default rate.
  • Holding period: Supports deep energy savings retrofits with longer paybacks. If the owner sells the property, both the energy savings benefit and the remaining loan payments are passed on to the future owner.
  • Split-incentives: Supports projects in tenant-occupied as well as owner-occupied buildings since property taxes qualify as pass-through expenses.

Status of PACE programs — 
PACE financing is not yet available to most building owners today. States must first pass enabling legislation to allow local governments and taxing authorities to create PACE programs. To date, 23 states have either passed PACE-enabling legislation or already authorize such special assessment districts with a public purpose through other statutes.

After the states pass enabling legislation, then the local governments must design programs, secure financing to fund the programs – for example, through bond sales, microbonds, state or federal government funds, lease financing from private institutions, or municipal pension funds, etc. – and market them to property owners in the area.

While there are several active residential PACE programs around the country, the only active programs available to commercial buildings are those in Sonoma County, CA; Palm Desert, CA; and Boulder County, CO. Commercial PACE programs are emerging in San Francisco, Los Angeles, New York, and Washington, DC, among others.

TFM: In the survey, 75% of respondents stated they believe carbon emissions reporting will move toward being a reality in next two years. Where can facility professionals go for guidance if and when the time comes? And can we predict what data and other information they might want to begin tracking ahead of time?

Supple: The Institute for Building Efficiency, [an initiative of Johnson Controls], is a good source of information for facility professionals about pending and recently enacted energy and climate policies. Johnson Controls NGO partners throughout the world, such as The Climate Group, the Alliance to Save Energy, the World Resources Institute, the Business Council for Sustainable Energy, and the Greenhouse Gas Management Institute also provide a wealth of information. There is a rapidly growing industry of advisory services on this topic available to facility professionals, provided by real estate management firms, management consulting firms, and boutique carbon management consultancies.

It is very easy to predict what data they will need to gather and track, and a large fraction of facility professionals are already doing so on a voluntary basis ahead of time. In short, organizations must track their utilities consumption and process/fugitive emissions released on-site. A great source to get up to speed on what must be measured is the Greenhouse Gas Protocol, which has emerged as the international standard for completing organizational greenhouse gas emissions inventories.