As carbon reduction goals become clearer for each building, the financial challenges to meet them will too. Scaling the money side of the carbon equation will be no small feat, according to the Federal Reserve Bank of New York, whose new report, “Sustainable Affordable Housing — Strategies for Financing an Inclusive Energy Transition,” lays out some of the financial challenges everyone will face as the carbon reduction goals become more understood.
For the co-op/condo community, a few of the significant ones are:
- “Deep Green” investments. These are the kind of improvements that will actually reduce a building’s greenhouse gas emissions. They are more expensive, often more disruptive to residents, and require more technical expertise than simple energy efficiency upgrades.
- ROI. The return on decarbonization investments are not sufficient to cover the perceived additional risks the new systems pose. For example, electrification measures may not provide operational savings that can offset the project’s capital cost, even though it can help decarbonize your building.
- Early-stage capital. It costs a lot of money just to figure out what your decarbonization roadmap should be. Your building may not have the capital needed for this, quashing any projects before they even begin.
- Lender consent. Supplemental capital often requires consent from your building’s existing mortgage holder. This consent is often not forthcoming, and can stifle financing from Property Assessed Clean Energy (PACE) and other programs. Also, many underlying loans are often securitized, which means the originating lender lacks the discretion to provide consent.
A Tough Choice: Electrify or Pay Fines
A case study of a rental building highlighted in the Federal Reserve report illustrates the challenges boards will face as they consider decarbonizing. The report looked at a building with a gas-fired boiler and weighed the cost of electrification against paying annual fines. Extrapolating the financial details that are transferable to a co-op, it imagines a 40-unit co-op facing a fine of $50,000 a year beginning in 2024, and a $70,000 fine in the second compliance period beginning in 2030.
Electrifying the building would cost around $30,000 per unit. Add soft costs into the mix and the total project would be around $1.1 million. Most co-ops would need to finance such a large project, and would take out a supplemental loan or line of credit. Assuming a 5% interest rate and a 20-year amortization, the additional cost for servicing this loan could be $90,000 a year. In addition, operating expenses would likely increase by about $7,000 a year, because electricity at the present time is more expensive than gas.
Some will choose to pay an annual fine, which looks like it will cost less than electrification. But the unknowns associated with this strategy are risky, as changes in future fines and carbon limits could be more harmful and costly. And, of course, apartment values would likely be impacted in a building choosing to pay annual fines instead of “doing the right thing” for the environment.
Boards Will Become The New Pioneers
Unlike buildings where profit is the driver, co-ops and condos will find themselves balancing the financial pocketbooks of apartment owners, the help and aid available from city, state and federal governments and private investment strategies against annual fines if carbon reduction goals are not met. Underlying these calculations will be a board’s fiduciary responsibility to maintain apartment values, making sure that apartments can be financed by purchasers going forward. As lenders and insurance providers begin to assess the risk of those who ignore Local Law 97, the pressure will be on.