Energy efficiency can save co-ops and condos money, but it can also require expensive investments. Installing high-efficiency boilers, new lighting systems, and energy regenerative elevators is beyond many buildings’ means. That may soon change, however, if a City Council bill introduced on November 28 becomes law. The legislation may offer co-ops a potentially low-cost way of financing such green improvements. The bill, Intro. 1252, “Establishing a Sustainable Energy Loan Program,” would allow New York City to have a type of energy-loan program used in 33 states and the District of Columbia. It’s called PACE, an acronym for Property Assessed Clean Energy.
“PACE is a voluntary, municipally sponsored financing program that allows building owners to get long-term, inexpensive financing to do qualifying types of renovation projects that have a public benefit, which is reduced greenhouse emissions by the building,” says Peter Erwin, an associate at the New York City Energy Efficiency Corp.(NYCEEC), a nonprofit specialty finance company. “You would normally qualify the project by proving there are energy savings, and in exchange get PACE financing.”
Terence Cullen, spokesman for the bills’ prime sponsor, Democratic Councilman Costa Constantides, says, “This creates a real funding mechanism for certain landlords to help them make the upgrades. They are required to reduce carbon emissions. We want to make sure landlords have the capacity to make these upgrades without exceptionally high costs passed on to the residents.”
How Does It Work?
The money for PACE loans comes from local governments that issue bonds to raise lending capital. Each individual municipality has to pass a statute allowing PACE loans. This is why PACE is available throughout New York State, including Westchester County and Long Island, but not yet in New York City. A partner lending institution then makes loans to finance improvements that reduce an existing building’s energy costs. But instead of repaying the lender, the building makes payments through an assessment on its property taxes (with a corresponding tax lien on the property). This makes it be extremely difficult if not impossible for condominiums, in which each unit pays its own individual property tax, to acquire a PACE loan.
Unlike the 5- to 10-year terms of most bank loans, the length of a PACE loan is tied to the useful life of the improvement, up to 20 years. While that ultimately means higher interest costs, since interest is compounding over more years, the annual payments are smaller, since the loan term is longer. The theory is that the energy savings realized from the improvements will more than cover the repayment costs.
“Because you amortize the cost of the project over a longer period, the energy savings are likely to outweigh the cost of servicing the debt,” explains Robert Fischman, managing director of commercial programming and sustainability strategies at Energize NY, the financing arm of the nonprofit Energy Improvement Corp., which has the stated mission of reducing greenhouse gas emissions and enabling energy efficiency improvements.
In addition, a building’s projected energy savings is factored into the loan. “One of the advantages of PACE is that the size of a loan is based on the energy-cost savings of the measures installed,” says Erwin of the Energy Efficiency Corp. “Therefore, lenders may size larger loans” – allowing bigger projects – “and debt service should be offset by operational savings.” There also may be ancillary benefits, he adds, like lower ongoing building maintenance costs, higher property values, and in some cases, lower insurance premiums.
What are the nuts and bolts of a PACE loan? They don’t work the same everywhere, since each municipality has its own needs and other specifics, but the general outlines are similar. Let’s take as a hypothetical example a 60-unit co-op valued at $30 million, with an underlying mortgage of $10 million. Let’s say the average unit’s monthly maintenance payment is $1,500, with $1,000 of that going for mortgage and property-tax payments and the remaining $500 for operating expenses – utilities, staff, and so on.
Let’s say this co-op has done an engineering study that finds it can install co-gen – a natural-gas-fueled power plant to co-generate electricity and heat – for $500,000.
Assuming a 20-year loan for that amount, “the monthly payment could be as low as $3,000, depending on the interest rate,” Erwin says. Repaying that monthly $3,000 would normally mean either increasing each unit’s monthly maintenance an average of $50 or issuing a temporary $50 monthly assessment. But, he continues, co-gen typically lowers a building’s energy bills by 15 to 50 percent, “and therefore, the co-op could conceivably finance the co-gen with no [assessment or] increase to residents’ maintenance charges, and without tapping other scarce financing resources such as its existing mortgage or an equity line of credit.”
Whether PACE interest rates are lower than those of a conventional loan depends on prevailing market trends. Fischman says the rates from Energize NY, the primary PACE lender throughout New York State, move with the market, but recently were 5.5 percent for shorter-term loans and 6.5 percent for longer-term loans. Erwin of NYCEEC – which may be the frontrunner to administer PACE loans in New York City – says the nationwide rates range from 6 to 8 percent.
It might possibly be cheaper for co-ops to raise money for these kinds of projects by refinancing the underlying mortgage. But PACE loans at least represent an alternative for comparison shopping. Fischman does note that the federally backed mortgage-underwriting corporations Fannie Mae and Freddie Mac do not allow PACE financing on properties they underwrite.
Will Your Mortgage-Holder Allow?
Another potential obstacle, says veteran real estate attorney Geoff Mazel, a partner at Hankin & Mazel, “is that many co-op buildings have mortgages that may not allow for secondary financing,” such as PACE.
But Fischman disagrees. “It’s not a secondary mortgage, it’s a tax charge,” he says. Even so, mortgage-holders still must provide consent since PACE loans, being repaid via property taxes, are placed ahead of mortgages in case of foreclosure.
So why would a mortgage holder ever consent? “This is a question we get all the time,” Fischman says. “Ninety-nine out of a hundred times we get consent since a PACE loan project upgrades the property, improving the energy performance of that property and therefore its cash-flow perspective. You’re improving the value of the underlying asset that the first mortgage company has the note on. If for some reason a property runs into a bind and ends up being foreclosed on by the mortgage company, the property is worth more than it would have been.”
Erwin concurs. “The value of the building increases, and the loan-to value on the mortgage decreases,” he says. “Operating expenses remain the same or decrease, net of the new PACE charge, so the co-op’s ability to make mortgage payments is not affected, and the PACE charge is a tax assessment on the property, not a debt liability. So if the building was ever sold or foreclosed upon, the PACE assessment would carry over to the next owner – instead of having a big balloon payment come due before the mortgage lender could be repaid.”
One quick note: this is all untested as far as New York co-ops are concerned. While some co-ops elsewhere in the country have taken out PACE loans successfully, no New York State co-op has so far, but a number of rental-property landlords have done so.
Meanwhile, Back At City Council
The bill to allow PACE financing in New York City is part of a collection of three related bills by the same sponsor, all introduced on the same day. One of these bills, Intro. 1253, would set stringent targets for buildings over 25,000 square feet to reduce their greenhouse gas emissions. PACE financing would be one way to pay for costly retrofits if Intro. 1253 were to become law.
What’s the likelihood of the bills’ passing? It’s impossible to predict; almost certainly, they will be tweaked and amended. People who testified at a December 4 hearing noted that buildings with even a single rent-regulated unit are exempt from Intro. 1253’s emission requirements. The Real Estate Board of New York estimates this means that more than a third of all buildings over 25,000 square feet will not be forced to limit their greenhousegas emissions. And according to the Natural Resources Defense Council, that means the city would be unable to achieve its greenhouse-gas reduction goal of 40 percent by 2030.
The State Legislature, which regulates rent-stabilized apartments, may be addressing this. The sticking point is the Major Capital Improvement (MCI) pass-along, in which landlords making capital improvements can raise rents by a certain percentage of the improvement’s cost. “My understanding,” says Mazel, the real estate attorney, “is that there is a proposal in Albany to eliminate the MCI pass-along, which will be significant legislation.”
In the meantime, where do Intros. 1252 and 1253 stand? “We’re still reviewing testimony,” says Cullen, the sponsor’s spokesman. “And we’re still examining how PACE is going to work on the nitty-gritty throughout the city.” He reiterates that the program runs smoothly statewide.
“I’m hoping there will be modifications” to the bills, says Mary Ann Rothman, executive director of the Council of New York Cooperatives & Condominiums. While strongly supportive of reducing greenhouse gases and of Constantides’ efforts, she calls requirements in the bills’ initial drafts “very, very onerous. I’m hoping they’ll be toned down in the final versions.”
“Co-op and condo owners and boards are all for taking necessary green measures and improving the environment,” Mazel says. “But legislation this profound needs to be looked at carefully, and we all need to take a deep breath and figure out how to move ahead.”
How PACE Financing Works
- City or County creates a land-secured financing district or similar legal mechanism
- Property owners voluntarily sign up for financing and install energy projects
- the lender provides funds to property owners to pay for energy projects
- Property owner repays bond through property tax bill (up to 20 years)