5 ways city-focused climate funds drive efficient buildings
For the first time in history, half of the world’s population lives in cities. Cities hold economic weight, inspire a sense of belonging and loyalty (just ask a Red Sox fan) and are hubs for innovation and investment.
Increasingly, cities are focusing on what can be done at the local level to promote clean, healthy and prosperous communities and stepping up to the plate with commitments such as America’s Pledge to meet Paris climate goals in the absence of a firm federal commitment. Through these bold acts, cities are making possible more ambitious action at the state and national level.
City-focused climate funds, which finance projects in a city that reduce greenhouse gas (GHG) emissions and increase resiliency, can provide positive environmental, economic and health impacts. Such funds, including New York City Energy Efficiency Corporation (NYCEEC), The Atmospheric Fund (TAF) in Toronto, the London Green Fund (LGF) and Sustainable Melbourne Fund (SMF), have been able to create a substantial impact relative to the monies they have deployed by focusing on delivering value beyond access to capital alone.
Typically, these entities are revolving funds designed to be self-sufficient: interest and principal repayments are used to deploy new loans. Initial funding sources for these entities vary from government funds to utility incentives to private capital. Depending on the city, these climate funds have varying relationships to local government, from a unit of the municipality to full independence. These funds tend to target market-level returns, although some may be willing to make below market investments or provide more flexible terms in pursuit of GHG reduction goals. With slight modifications to address city-specific needs, existing city climate funds can scale to many other cities in the United States and around the world.
While city climate funds can provide financing for a range of clean tech and efficiency projects, we focus here on efficiency financing for large and mid-sized commercial buildings given the considerable role that buildings play in a city’s overall emissions. Indeed, while buildings contribute to roughly 40 percent of overall U.S. emissions, in big cities such as New York and Chicago they can contribute up to 70 percent. Although construction of green buildings, which we define as those that go meaningfully beyond existing building codes to meet specific environmental goals, is becoming increasingly popular, the existing building stock faces barriers to implementing meaningful energy efficiency measures. Fortunately, well-structured city-specific funds can help overcome those barriers.
Barriers to energy efficiency investment and financing
The barriers to investing in building energy performance are well known and documented across multiple studies (PDF) and industry stakeholder surveys. While certain barriers are more prominent in certain cities based on market demographics and realities, the challenges faced in driving increased investment in energy efficiency are largely consistent regardless of location. These include:
Access to capital: Building owners may encounter a lack of financing options or high-cost financing that does not reflect the risk profile of energy efficiency projects; this can be particularly acute for small borrowers and small projects.
Insufficient payback or return: Projects may not meet a building owner’s (or lender’s) return thresholds, due to high upfront costs and/or long payback periods, as well as uncertainty of returns.
Landlord-tenant split incentives: Roughly half of all commercial buildings are leased. Building owners are unlikely to invest in efficiency if its tenants stand to capture all the benefits (in terms of lower utility bills).
Performance (savings) uncertainty: Building owners and financiers may not have sufficient confidence in the forecasted energy savings.
Uncertainty of resale value: Owners lack assurance that the real estate market will appropriately value efficiency investments. This is particularly true if the investment payback period is longer than the owner expects to hold the building. Therefore, owners may not invest in efficiency unless the financing instrument can be easily transferred to a subsequent owner upon sale.
Lack of technical expertise: Both building owners and financiers may not have the necessary technical understanding of energy efficiency measures to make informed investment and lending decisions.
Fragmented, small borrowers: The market for buildings is quite fragmented. Owners of small building portfolios may not have the right banking relationships to help finance energy efficiency projects, and financiers looking for scale may not have interest in financing those small projects.
Standardization: These projects often lack the type of standardization that banks rely on to build a pipeline of transactions to finance.
Lack of awareness or prioritization: Building owners may not be aware of energy efficiency opportunities, or they may not prioritize these opportunities if they don’t adequately understand the costs and benefits.
How city climate funds address barriers
While these barriers traditionally have held back energy efficiency financing, the public and private sector alike have a massive opportunity to capture a $290 billion opportunity in net present value in commercial buildings alone available from energy savings — while also creating better indoor and outdoor environments, improving the value of real estate assets and enabling more competitive and vibrant city centers.
City-specific funds provide five key ways to address these barriers:
1. Access to alternative and innovative financing:
City climate funds can provide building owners with more than capital. They offer innovative financing products that address multiple barriers. Importantly, these funds can provide financing approaches that:
- Address landlord-tenant split incentives by shifting repayment obligations to the tenants who benefit from the landlord’s investment in energy conservation measures.
- Absorb performance risk through tools such as energy services agreements in which the building owner only pays for actual energy reduction.
- Tie debt to property ownership/tenancy through on-bill repayment mechanisms or property assessed clean energy.
- Provide off-balance sheet solutions to allow building owners to avoid additional debt at the corporate level.
- Reduce upfront costs, including installation, due diligence and financing costs, in order to improve project economics.
For example, the Sustainable Melbourne Fund has implemented environmental upgrade agreements, which allow tenants to contribute to the repayment of the efficiency investment through savings on their utility bill. The energy savings performance agreement model developed by TAF in Toronto allows building owners to pay none of the upfront cost of the efficiency investment and to receive 10 percent of the savings for 10 years (with 90 percent going to TAF) and 100 percent thereafter.
2. Technical support: The NYCEEC provides technical assistance in addition to financing. This in-house technical expertise allows NYCEEC to assist with energy audits and technical assessments, providing building owners who lack this technical expertise with much needed support in evaluating which projects to undertake.
3. Simplification: As a centralized resource, city climate funds can reduce complexity and be a hub for information on available incentives, rebates, green building certification, regulation and economics that is tailored for the local market. This valuable local resource helps reduce information gaps for building owners for whom dedicating time and human capital to energy efficiency may not be a top priority.
4. Aggregation and standardization: A city climate fund can aggregate many small projects with similar characteristics to reduce overall financing costs as well as drive standardization of documentation and deal structures. The narrow geographic focus of these funds makes this type of aggregation easier.
5. Mobilization of private investment: City climate funds have demonstrated success in mobilizing private investment alongside the funds’ capital. By structuring energy efficiency loan products and undertaking technical due diligence, city funds open up a path to participation for market lenders with little expertise in the relevant technologies and their performance. For example, the London Green Fund brought in private investors such as local banks to achieve its targeted GHG reduction goals.
In addressing these barriers, city climate funds are able to meet existing demand for energy efficiency projects and, by their very presence, can spur increased demand for these measures. The availability of financing structures targeted to the local market, buoyed by other forms of relevant support, can provide the resources and motivation necessary to encourage building owners to undertake energy efficiency projects — and perhaps to be more ambitious in their efficiency targets.
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