Getting Big Investment to Retrofit Small Buildings
Small- to medium-size commercial buildings (50,000 square feet or less) make up 90 percent of all U.S. buildings and 50 percent of total floor space and energy consumption. While the aggregate opportunity for energy efficiency is large, most projects are paid from capital, and the small scale of each project generates little interest among investors.
Getting retrofit investments in small commercial buildings presents a challenge since investors will rarely wait decades for energy savings to accrue and require the same level of due diligence as on larger projects. Because investors hesitate to invest in smaller retrofits, the limited track record in turn portrays the investments as high risk. Limited investor experience and the perceived high risk of small building retrofit financing leads to a self-perpetuating cycle whereby investors remain wary.
In April 2011, we Talked Small Building Retrofit Finance after a finance workshop held in Boulder by Rocky Mountain Institute and the Northwest Energy Efficiency Association (NEEA). Now that nearly three years have passed, what, if anything, has changed in retrofit financing for small commercial buildings?
New financial tools
Fortunately, financing options are emerging to make it easier to cut energy waste in small buildings, where almost 50 percent can be saved at a profit. In July 2013, DOE announced $10 million in new programs to accelerate energy savings in small businesses, with four of the six funded programs tackling the financing challenge. According to the article Financial Innovation Is The Next Big Thing In Clean Energy And Efficiency, efficiency financing products are on the cusp of engaging long-term investors, like pension funds, and sovereign wealth funds.
The Energy Efficient Buildings (EEB) Hub in Philadelphia identified the five types of financing available to small businesses: public, private, nonprofit, quasi-governmental, and public-private partnerships.
- Public financing comes from government loans or bonds, such as the Property Assessed Clean Energy (PACE) structure, which last year climbed to $60 million in financed projects. A PACE loan is tied to the building, not the owner, making the payment (a line-item on the property tax bill) easily transferrable.
- Private financing ranges from bank loans to performance contracting, with energy efficiency mortgages at the forefront in New York in 2013. Like PACE, mortgage financing stays simple by keeping the loan payment wrapped into an existing obligation.
- Nonprofit financing requires a committed and forward-thinking group of business leaders and investors, such as The Reinvestment Fund’s Sustainable Development Fund (SDF), which funded seven of eight wind projects in Pennsylvania.
- Quasi-governmental financing blends limited public funds with private sector capital, at times using an Energy Services Agreement (ESA) model.
- Public-private partnerships bring private capital to execute a municipal program, such as with the two-year old New Jersey PACE public-private partnership model.
Details about these financing options can be found in the EEB Hub’s June 2013 report, Financing and Real Estate Platform Launch.
Despite recent breakthroughs in financing options, barriers persist. The EEB Hub’s report identified the following persistent barriers to energy retrofit investments in small commercial buildings, some of which the efficiency industry can solve:
- Lack of demand from tenants for energy savings
- Uncertainty over payback
- Limited proof of concept in the market
- Lack of reliable energy data
Last year the EEB Hub held a panel that proposed recommendations to address these barriers, including: using net present value (NPV) to better capture the expected long-term benefits from energy efficiency investments; bundling loans, with a public entity involved as a financing partner, to address the scale of small buildings projects; and relying more on pension funds, with banks acting as intermediaries, given the time horizon and yield expectations. Yet until an adequate history of performance for smaller loans is available, retrofit financing for small commercial buildings is limited to organizations with strong credit.
Learning from the solar sector
Despite only emerging as a major industry in the past decade, the solar industry has extensively employed financing solutions to scale growth. Innovations in solar energy financing may offer concepts and tools that can be applied to efficiency investments, particularly for small commercial buildings. In five years, solar leases went from 10 percent of the California solar market to 75 percent (and now cover 90 percent of the Arizona market) by offering panels and maintenance for free, as well as monitoring of the performance of the installed system. Energy efficient equipment leases (particularly for HVAC equipment), often provided by the vendor, remove the upfront cost barrier associated with improvements as well as the hassle associated with full ownership.
The solar industry also demonstrates the power of crowdfunding to finance projects. Crowdfunding lets almost anyone invest in specific solar projects, creating a large pool of investors to jumpstart solar projects across the globe. Mosaic offers a solar investment platform that impressively raised millions from thousands of investors across the U.S. in its first year of business. A platform for small building retrofits like that offered by Mosaic would widen the prospective pool of investors and boost the availability of financing for retrofits.
The availability of options to finance small building retrofits is a key need in the market. Although options for small commercial buildings largely remain in development, financial innovations for energy efficiency are beginning to achieve scale (the big bucks) for homes and larger commercial buildings. Just a few weeks ago, Kilowatt Financial closed a $100 million debt facility from Citi to finance energy efficiency loans for homeowners. Joule Assets will invest $100 million over the next three years in demand response and efficiency projects—and expects to escalate to at least $500 million. To spur efficiency investments in rural communities, the USDA made $250 million available to residential and business customers of rural electric cooperatives. And last year, EnergyRM announced a new Metered Energy Efficiency Transaction Structure (MEETS) that involves the utility, and aims to attract investors to retrofits. Financial innovations like these could be used to capture the vast opportunity presented by retrofits in small commercial buildings.
Another way to increase investment in retrofits is to include non-energy benefits into retrofit value calculations. RMI recently released a practice guide, How to Calculate and Present Deep Retrofit Value, that offers a framework that evaluates both the energy and non-energy benefits of retrofits, such as gains in employee productivity, greater retention, improved health, lower maintenance costs, increased occupancy, and higher least-up and sales rates. This better captures the full value of investments in deep energy retrofits and thereby bolsters their value proposition. Moreover, investments in deep energy retrofits often become feasible when paired with “triggers” such as capital expense investment cycles and occupant turnover.
Even though small commercial building retrofits possess significant energy and non-energy benefits, this opportunity will likely remain dormant unless new financial tools become readily available. Both traditional financing options as well as financial innovations like those observed in the solar industry will help accelerate and amplify investments in small commercial building retrofits.
A Preservation Green Lab (PGL) study found that small building energy efficiency could reduce 17% of commercial energy use. In avoided carbon emissions, that’s equivalent to displacing more than 50 coal-fired power plants. By unlocking this opportunity, saved money (an estimated $30 billion a year) can be put to more productive uses than energy bills, maintenance, or absent employees. The question to ask is not if retrofit investments in small commercial buildings will occur but rather who will take advantage of the next big thing in clean energy.