The Basics of Alternative Financing for Green Projects
[Editor's Note: This is the second of Shari Shapiro's multipart series on green financing. Part 1 on the 10 rules of green financing and Part 3 on government incentives are available on GreenBiz.com and GreenerBuildings.com.]
Because of the enormous popularity of my post on green project finance, have decided to do a series its various aspects.
Today we will discuss alternative financing mechanisms for green projects. Over the next few weeks, I will do posts on incentives available for green projects, the latest in the PACE controversy, and the basics of renewable energy finance. If you have suggestions for other posts you would like to see as part of this series, feel free to email me.
Please note, I am not a finance professional, and the goal of these posts is simply to give a high-level overview of potential financing mechanisms. As with all financial decisions, please consult your financial professional and attorney for advice specific to your project. And now, without further ado, a primer on alternative green financing mechanisms.
Basically, there are only a few mechanisms for financing projects. Self-finance (your bank account); equity finance (someone else's bank account); debt finance (the bank); government finance (Uncle Sam's bank account); and grant finance (
your parents' third party bank accounts).
These mechanisms are no different for green projects. However, there are some interesting variants that have developed for financing green projects of various types. Many of the financing concepts are not mutually exclusive. To the extent that one of the models, like energy efficient mortgages, is applicable mostly to a specific sector, it can be used as a model for a specific project's financing arrangement with a particular financier.
For commercial scale (and even residential) green and renewable energy projects, variants on leases have become an interesting project financing model. Essentially, a provider leases the equipment (typically to the owner of a facility through a long-erm lease), which reduces the up front costs.
There are a wide variety of leases available, and the decision among which lease is the best solution is largely based on tax and payment considerations. Most leases radically reduce or eliminate up front costs. Some leases allow the lessee to take advantage of the tax incentives, renewable energy credits and depreciation on the green equipment, others do not.
For a great overview of lease variants for renewable energy projects, see here.
Performance contracting is essentially a loan from the provider of the green/renewable equipment (known as an Energy Services Company, or ESCO) that is paid for out of the savings or benefits of the green project. For example, suppose you want to install energy efficient improvements on a facility which will cost $1,000 and will save $100 per year.
Typically, the ESCO arranges the financing, and you pay the ESCO through reduced energy bills, sharing the energy cost savings over a predetermined length of time, after which all of the energy savings revert to you.
The ESCO often guarantees the energy savings from the project. This mechanism is used for both energy efficiency and renewable energy projects, and can be used with projects of almost any scale. The DOE has a handbook on performance contracting available here.
Grants In Lieu
As part of the stimulus bill, the Department of Treasury made available "1603 grants," which are grants in lieu of tax credits that reimburse up to 30 percent of the cost of installing certain renewable energy projects. Here are the Department of Treasury's full description of the program and an FAQ (pdf).
Energy Efficient Mortgages and Energy Improvement Mortgages
A form of debt financing, energy efficient mortgages (and their friend, Energy Improvement Mortgages) work on the premise that implementing energy efficiencies on a property will free up cash which can pay down a debt. The Department of Energy has a great handbook and other resources available here. HUD has qualifications guidelines, approved lenders, etc. available here.
Mortgageloan.com has a nice overview here:
Green, or “Energy efficient” mortgages, let you borrow extra money to pay for energy efficient upgrades to your current home or a new or old home that you plan to buy. The result is a more environmentally friendly living space that uses fewer resources for heating and cooling and has dramatically lower utility costs...At this time, Energy Efficient Mortgages aren’t second mortgages. Though they are created separately from your primary mortgage, they are ultimately rolled into your primary mortgage—so you only make only one payment per month.
Technically, energy efficient mortgages:
give borrowers the opportunity to finance cost-effective, energy-saving measures as part of a single mortgage and stretch debt-to-income qualifying ratios on loans thereby allowing borrowers to qualify for a larger loan amount and a better, more energy-efficient home.
are used for existing homes and allow borrowers to include the cost of energy-efficiency improvements in the mortgage without increasing the down payment.
The problem with energy efficient mortgages is that they are pretty small scale. For example, the FHA program only backs EEMs for one to four units.
Image CC licensed by Flickr users Jim Linwood.