Financing Retrofits for All, II

Last time, I described a non-profit bank’s program for financing building energy retrofits, as a way to speed the green-collar recovery. Here, I describe two new, innovative approaches to financing efficiency upgrades in buildings—meter loans and local improvement districts—and one old-school, utility-run approach that may be the best bet of all.

First, though, a couple more points about the challenges of financing energy efficiency improvements in buildings.

One big challenge is to guarantee that retrofits will save enough money to repay the loans, not only on average across all buildings but also in each individual building. Guarantees are hard to come by, because building energy systems are complicated and buildings’ occupants may have other goals beyond energy savings. For example, if before a retrofit tenants were keeping their thermostat low to save money, they may turn up the heat after a retrofit. In effect, they’ll decide to take some of the benefit of efficiency in increased comfort. (As I noted before, low-income families are especially likely to turn up the heat. Who can blame them?)

A related challenge is to harvest all of the efficiency potential in each building. Owners and loan makers are commonly tempted to skim the cream, investing only a modest amount of money and making only the cheap, high-return retrofits—changing light bulbs, installing shower aerators, and upping insulation in easy-to-reach attics. To put ourselves on a clean-energy path, we need to do deep, comprehensive retrofits—retrofits that double building energy efficiency, for example, by changing heating systems, insulating walls as well as ceilings, replacing windows and doors, and installing appropriate renewable technologies such as ground-source heat pumps and solar water heaters.

Deep retrofits are expensive, even if they save the most money over the life of a building. They are less sure to generate monthly energy savings during the term of the loan that pay for their loan servicing costs. Deep retrofits may pay for themselves over 20 years, rather than the six years or so that’s typical for existing conservation loans. When a loan term is as long as 20 years, many property owners will wonder whether they’ll ever see the financial benefit. Will they still own the building in 20 years?

This concern in particular is what inspired the creation of meter loans and local improvement districts, both of which allow conservation loan debt to transfer from one building owner to the next.

Meter loans (sometimes called “tarriffed improvement programs”) are retrofit loans collected by a gas or electric utility on its monthly bills. The loans themselves can come from the utility or from a bank, public agency, or nonprofit such as ShoreBank Enterprise Cascadia. They obligate the current and any future owners of the electric or natural gas meter to pay for energy improvements made to the building.

Oregon utilities are already authorized to serve as intermediaries for such loans, but meter loans are rare in that state, as elsewhere. Also, they haven’t been any more successful than other conservation loan programs, according to this study. In fact, as I mentioned, two Cascadian utilities years ago discontinued their once-large meter-loan programs, preferring to pursue other efficiency strategies.

Local improvement districts are even more innovative. In July, California granted authority to its cities to loan money to building owners to pay for energy upgrades and solar panel installation and to collect loan payments on property tax statements. Because local improvement districts loans are structured as public spending projects for which the property owner is levied a special assessment (a type of property tax), the assessment—like other property tax obligations—transfers with the title deed on resale. Consequently, deep retrofits with long-payback periods are no longer risky investments for property owners. What’s more, such loans are less likely to suffer defaults than other conservation loans because, legally, even in bankruptcy proceedings, special assessments get paid before private loans such as mortgages. Other loans, such as meter loans, line up after mortgages.

In Washington and Oregon, local improvement districts are legally reserved for projects that provide a public benefit—typically the construction of public infrastructure such as a new transit or sewer systems. Furthermore, the normal rules require that local improvement district dollars go into projects on public property that remain in public ownership. So deploying local improvement districts to finance retrofits for all will require a slate of legal reforms: defining energy conservation or climate protection as a public benefit and waiving requirements concerning public ownership.

Oregon Governor Ted Kulongoski may introduce legislation soon to allow localities to create such districts for building retrofits. In Washington, the Priorities for a Healthy Washington project may do the same. In one scenario under consideration, the state would authorize local governments to create Climate Benefit Districts. These districts could then sell public bonds on private capital markets to raise money, and they could invest the funds in local building retrofits. (Of course, as I noted, conservation loan programs never pay for themselves entirely. They require public subsidy—a good use for economic stimulus dollars.)

Like meter loans, local improvement districts would seem to resolve some of the challenges of financing deep retrofits for huge numbers of building owners, as part of an economic turnaround. But they are also new and untested. So far, the city of Berkeley, California, has launched a pilot project to implement this new authority. It expects to install 40 rooftop solar energy systems through the pilot. Boulder, Colorado, meanwhile, has created a local taxing district to finance building energy upgrades. It’s hardly a track record that inspires confidence. It’s more a worthy experiment at this stage. The City of Seattle is eager to create such a district itself, after winning legislative approval. The City might engage ShoreBank to execute the lending portion of the program.

Still, the legal and legislative hurdles to local improvement districts are formidable, and an older approach may be a safer bet. Or, at least, this older approach might form the best backbone for large-scale investments in the short term.

As I mentioned last time, more than 150 programs make loans to finance building energy upgrades in North America. The overwhelming majority of these programs have lackluster records, but two stand out. The biggest in the United States is that of the Sacramento Municipal Utility District, which made 3,200 loans in 2007 and has served about a quarter of all households in its service area since the program’s launch 30 years ago. The biggest program on the continent is that of Manitoba Hydro, which made about 8,100 loans in 2007. The success of Manitoba’s program despite the utility’s low electricity prices is something close to astounding. It suggests similar success may be possible in Cascadia, where electric rates are also low.

Interestingly, both programs are run directly by public utilities—by government-owned utilities. They’re not run by third party nonprofits like ShoreBank Enterprise Cascadia nor by municipalities’ local improvement districts. Instead, the utilities built themselves specialized departments to do conservation lending, staffed by loan officers with banking experience. (Side note: an awful lot of financial professionals with real estate expertise are looking for work these days. WaMu is laying off more than 3,000 people from its Seattle headquarters this winter.) In addition, these utilities offer a bundle of additional incentives, beyond the loans, such as large cash rebates for energy-smart appliances.

The lesson of Sacramento and Manitoba is that how payments are collected—on the bill, on the property tax, or on a separate bill (which is what these programs do)—matters less than how the loans are marketed. Because of humans’ innate aversion to making complicated choices (which, I’ve argued, also causes default driving), among the most important ingredients of success in Manitoba and Sacramento is the deep and thoroughgoing involvement of those places’ contractors—the people that building owners already trust to help them improve their properties. In both places, contractors are the most important sales force and intermediary for the utility lending programs. Plus, these programs are efficient, well staffed and well organized. In Sacramento, once a contractor and building owner have submitted a loan application, the utility approves or declines within 24 hours. Manitoba is almost as fast, and it has a colossal network of engaged tradespeople: 1,100 contractors and 200 retailers are enrolled in its program. Manitoba has essentially deputized its building tradespeople as loan officers and conservation evangelists. In fact, Manitoba’s program reminds me of SustainableWorks, which I described here. It’s a whole-systems approach that provides financing as one part of the package.

In British Columbia, Oregon, and Washington, both public and private utilities already have the legal authority to run programs like Sacramento and Manitoba’s. In fact, Washington amended its state constitution in 1979 specifically to authorize government-owned utilities to offer conservation loans as freely as private utilities companies can. This amendment lifted the constitution’s usual prohibition against giving public dollars or credit to private parties. The state’s Attorney General Rob McKenna could strengthen this amendment by revising a too-restrictive interpretation of it issued by his predecessor in 2001.

Cascadia’s utilities do not lack authority; they do lack will. As creations of the state, they would get a will transfusion in a hurry, if legislators and regulators made successful energy conservation the principal factor in calculating their rates and returns on investment. Decoupling would be a good start.

Meter loans, local improvement districts, and ShoreBank’s conservation loans are all promising paths to financing retrofits for all. All of these contenders, furthermore, complement each other. But replicating Sacramento and Manitoba’s programs in Cascadia—massively, under government directive, and likely with an infusion of federal stimulus dollars—seems like the main route from where we are to where we want to be: a green-collar recovery, a revitalized construction industry, increased energy independence, waning greenhouse-gas emissions, and cozier buildings with lower operating costs. It’s a welcome opportunity in the midst of this economic storm.