Is there a good reason for affordable housing practitioners to start paying attention to utility company-sponsored green retrofit programs? Ask an industry insider and they’ll likely tell you no — there are 12 billion good reasons. In the next 10 years, utility companies are set to budget a conservative estimate of $12 billion for programs that could help finance affordable housing energy-efficiency retrofits, including everything from small-scale updates like light-emitting diode (LED) bulbs to more comprehensive treatments that replace power-hogging HVAC systems with the latest energy-efficient products.
Non-appropriation-tied sources of multifamily preservation funding are scarce and energy price hikes are stretching already tight budgets. And so, affordable housing advocates are getting serious about finding ways to effectively use these programs to help fund energy-related capital improvements, effectively adding a new funding source that can make rehab projects more feasible.
How Much Does It Cost to Power a Toaster Oven?
“Why does energy-efficiency work?” Michael Volker, director of regulatory and energy services at Midwest Energy Inc., asked rhetorically on a National Housing Trust National Utility Working Group conference call last December. “I come at this from an economic perspective. Economics says you don’t need to intervene in a well-performing market, but we all know that the end-use market for energy isn’t well-performing.”
Volker, a no-nonsense utilities representative who also teaches college economics, isn’t one to be persuaded by the altruistic reasons to devote private resources to improving affordable housing stock. For Midwest Energy and most other utility companies across the country, prioritizing energy efficiency comes down to dollars and cents. If the companies don’t find ways to decrease customer energy consumption, they will be forced to build costly new power plants and energy grid infrastructure to keep up with demand and capital expenditures, which will add far more fixed costs to the bottom line than are likely to be recouped in energy usage revenue.
End-use energy markets aren’t optimally performing for several reasons. The first: imperfect information. Most energy users simply don’t have enough facts to make informed decisions about their utility usage.
“Think about it this way,” Casius Pealer, principal at Oystertree Consulting, explains. “If you ask nearly anyone, they can tell you exactly how much it costs to fill their car with gas any given week, but their refrigerator? Their AC unit? Ask someone how much it costs to power their toaster oven for a week and see what they say. Sure we get utility bills, but they are after the fact, and lump all of these costs together.” The takeaway is that consumers are entering the utilities market without the information they need to make economically efficient decisions, and are often using more energy (and spending more money) than they otherwise would.
Volker calls the second end-use energy market failure the “first cost barrier,” meaning that the initial costs associated with taking on a large-scale energy retrofit — such as replacing an old boiler or installing an energy-efficient cooling system — are frequently too cost prohibitive for an affordable housing owner with a lean operating budget. Add to this the complexity of most multifamily projects, where there are frequently many layers of financing that stand in the way of the building being used as collateral without permissions from numerous lien holders, and it becomes nearly impossible for affordable asset holders to make their buildings more efficient.
Last, there is the problem of split incentives. Enterprise Green Communities describes it like this: “In affordable multifamily buildings, the benefits of green are often split between the tenants and the building owner.” In other words, building owners have to pay the upfront costs for retrofits, while the tenants are frequently reaping the benefits through lower utility bills, and in affordable projects, owners aren’t easily allowed to raise rents to make up the difference.
Michael Volker sees these market failures as potential threats to his bottom line and is steering Midwest Energy around them by offering his mostly rural Western Kansas customers an energy-efficiency retrofit program called How$mart. The program works like this: a customer requests an energy audit, through which the utility develops a customized conservation plan that outlines the best opportunities for energy savings for that particular unit. The utility acts as an Energy Service Company (ESCO), by providing the upfront capital for the retrofit, which is then paid back through a fixed surcharge on the customer’s utility bill, a financial mechanism called on-bill repayment (OBR). The surcharge is legally required to be no more than 90 percent of the savings of the project and the repayment is tied to the premises for a 15-year term on most residential projects.
The How$mart model has been mostly used in market-rate projects, but has worked in affordable projects as well. “One of the beauties of How$mart is the ability to pool funds to create more efficiency improvements,” Volker says. In affordable projects, Midwest Energy will allow customers with access to subsidized weatherization program funds to, for example, use those monies to update their home’s thermal shell, while counting that improvement as the customer’s contribution to the total cost of the energy-efficiency retrofit. With the customer contribution requirement met, How$mart can then finance another aspect of the retrofit, such as updating the HVAC system. How$mart has also been applied to multifamily deals, although Volker admits that overcoming the split incentive barrier is difficult. “It can be done,” he says, “but it can be complicated.”
Since the program’s inception, How$mart participants have averaged just over $49 in monthly energy cost savings. This correlates to reducing electric use by a fifth and cutting gas use by a third. Surcharge payments have averaged just over $41 per month. Although $8 a month in savings may sound unimpressive at first, that’s just for now. According to the U.S. Energy Information Administration’s 2013 forecast, electricity prices alone stand to rise 2 percent a year over the next 30 years, adding up to an 80 percent increase over the 2010 figure. Projected increases in oil, natural gas, and coal prices are even larger. If actual costs follow projections, reducing gas usage by a third over the next three decades isn’t just impressive, it could be vital for preserving a development’s affordability.
Volker knows what the last question usually is when he talks about this program. “You want to know what we’re making on this,” he says at the National Utility Working Group meeting. Like most utilities, Midwest Energy is rate-regulated by a statewide oversight commission that restricts allowable rates of return. Under Kansas Corporation Commission guidelines, the utility can collect a 6.9 percent rate of return on all of its business lines (“extremely low compared to most utilities’ allowed RORs,” Volker says), including the energy-efficiency investments it makes through How$mart. “In other words,” Volker says, “our investment in energy efficiency is supposed to be like regular utility service — just as profitable.” However, as the utility works to grow the program, they’ve elected not to collect the allowable return for the time being and are just covering the incremental costs of the program. “Good will of our customers is important to us.”
Like Moving a Fleet of Oil Tankers
Although encouraging examples of successful utility company energy-efficiency financing programs like How$mart do exist, practitioners working on this frontier would tell you that there are still plenty of rows to hoe in bringing good models to scale across the country. Matt Schwartz, president and CEO of California Housing Partnership Corporation (CHPC), which facilitates the Green Rental home Energy Efficiency Network (GREEN), a coalition of more than 40 organizations including affordable housing practitioners, utility company representatives, and conservation advocates, has been deeply engaged in moving California energy-efficiency programs toward greater ease of use and effectiveness. So far, it has been a highly iterative process. Schwartz explains, “Getting utilities and public regulatory bodies to change is like moving a fleet of oil tankers. It takes time to forge new partnerships and to explain your work to people who don’t know much about affordable housing.”
There are a few challenges in bringing quality programming to scale. The first is that state Public Utility Commissions (PUCs) vary greatly in their interest in such initiatives. While some states have implemented aggressive mandates and specific energy savings targets that require developing larger-scale retrofit programs, others seem satisfied with sticking to lower-impact, direct-install programs, such as updating light fixtures and switching out shower heads to low-flow varieties. “Northeast states have been out front in terms of states having a history of pushing energy efficiency,” says Todd Nedwick, assistant director of public policy at the National Housing Trust and convener of the Trust’s National Utility Working Group. “In other parts of the country, we run into issues where the PUC isn’t pushing the utilities to do as much with energy efficiency, so the same incentives aren’t there.”
Another challenge is that utilities are not currently set up to develop large-scale energy-efficiency programs. “The way many utilities are currently organized is to have one program for commercial customers and one for residential customers,” Nedwick says. “So an owner may have to apply separately through each program, which is very time and resource intensive. One of the important changes we’ve been lobbying for is a ‘one-stop shop’ model, where one person at the utility understands the specific needs of multifamily projects.”
Regardless of these barriers, some programs may still be too complex to be worthwhile for affordable housing managers to consider, especially for those with smaller portfolios. “In many states, including ones with the best-funded programs, what organizations often find out is that the programs are much more difficult to work with and in the end perhaps don’t offer as much as folks might hope up front,” cautions Stephen Burrington, principal at Serrafix, a Boston-based consulting group.
But, as history has shown, new jobs develop to handle these complexities. “Think of it like the [Low-Income Housing] Tax Credit Program,” Pealer says. “In the 1980s, everyone talked about how confusing tax credits were and how difficult they were to use. Now there are accountants and underwriters and all sorts of other professionals in the field who specialize in tax credits and know how to use them. It isn’t that the model got less complicated; people just figured it out or paid someone else to.”
A New Pot or a Larger Pie?
Although utility company financing for energy-efficiency projects is a relatively new phenomenon, there is some disagreement as to how “new” the money behind it really is. Is this an opportunity for attracting private sources of equity to affordable housing or is it just a new public source of funds? The answer you’re likely to get from the field: yes.
Some are cautiously optimistic about energy savings becoming a new avenue for drawing on private capital; as more reliable data on the long-term savings projections of energy efficiency projects emerges, more questions are popping up about the potential return on investment that can be promised to investors willing to underwrite the up-front costs of large-scale retrofits. Others are more hesitant about who should be invited to participate in financing these kinds of projects so early in the game. “I don’t think we want to invite Wall Street in just yet. We still need to work out protections for tenants. We don’t want to see a new foreclosure crisis with energy contractors roaming the country trying to sell [energy retrofit project] debt door to door,” Schwartz says.
Well-run programs, like How$mart, currently rely on a number of funding sources: municipal bonding programs such as Property Assessed Clean Energy (PACE), state and philanthropic grants, intermediary financing via Energy Performance Contracting (guaranteed by a privately-held ESCO), third-party loans, and utility savings, to name a few. Where does Volker see new money for these kinds of projects coming from? “Hopefully the federal government,” he replies. To clear the slim margins available on these kinds of projects, low- to no-cost capital is essential. “For every 1 percent drop in my interest rate, I can afford an additional $450 in up-front investment for the project, which translates into a lower buy-down requirement for the customer.”
For the time being, most energy-efficiency retrofits will likely have what Hunter Johnson, president and CEO of LINC Housing in Southern California, calls a “lasagna” of funding sources. LINC Housing is currently partnering with CHPC in an innovative pilot to green a number of the affordable units in its portfolio using on-bill repayment, where a utility bill surcharge will be used to pay back some of the upfront costs of the project. The first project in this series is 274-unit City Gardens in Santa Ana, California, which will be treated with a new Energy Star-rated furnace, low-flow plumbing fixtures, energy-efficient lighting, a passive solar hot water system, and new landscaping to relieve heat island effects and reuse grey water. “We have an early childhood center in the building and the kids are getting so excited about ‘going green,’” Johnson says. “We’re thrilled about what this project has meant for them.”
Fifty percent of the project will be financed by debt, Johnson estimates, and 50 percent by a direct grant, rebate, or funding source with no obligation to repay. Enterprise Community Partners will be acting as the third-party lender for the debt portion, which will be partially repaid through utility on-bill repayment. “Enterprise will be doing a one-off loan for the project that will be financed by a private bank,” says Johnson. “We’re in a chicken-and-egg situation right now with private lenders; all of them want to see data that the energy savings will materialize, but none of them want to be the first to do a project that will get us that data.”
Matt Schwartz of CHPC, LINC Housing’s partner in the City Gardens project, has been navigating the on- bill repayment portion of the deal and identifying what is needed to make these projects easier to complete in the future. First, assistance in paying for comprehensive energy audits so that savings can be reliably estimated and shared with prospective lenders; second, low-cost capital (below 5 percent interest) to increase feasibility for multifamily owners; and third, a loss reserve fund to protect lenders’ capital against risk since buildings aren’t being used for collateral. Even with these hurdles to clear, Schwartz is enthusiastic about the potential of these programs. “What is really exciting about this work is that there is this self-contained source of financing that can actually help pay for these energy improvements. It’s like there was a bank that was there the whole time, we just need to figure out the right tools to use it.”
Blocking and Tackling for Change
What comes next for affordable housing practitioners interested in making the most of these utility-sponsored programs? “More blocking and tackling,” says Michael Bodaken, president of the National Housing Trust and one of the nation’s most ardent advocates for these kinds of programs in the multifamily arena. That is, focusing on the day-to-day work of meeting the right person at a utility interested in championing the cause of developing quality energy-efficiency programming, working with policy makers to suggest opportunities for making regulations better fit the needs of retrofit projects, and talking with affordable housing owners about their difficulties to taking on such a project.
“You don’t start with the community development folks; you start with the energy advocates,” Bodaken says. “You say to them, ‘Do you know what is missing in your thinking [about energy efficiency]? Multi-family.’ And amazingly the energy advocates need very little persuasion because they are coming to the problem from a climate change perspective and see that it is far more efficient to get 100 units weatherized than just doing one at a time. Then, you get them to bring in the utilities. What is really critical here, though, is to not look like you’re saying ‘This is a new pot of money and we want some of it.’ That’s greed and it won’t get you anywhere. You have to show them how you are prepared to help them meet their goals. And then, ‘Oh by the way, this helps meet one of our goals, too.’ You have to take time to learn their motivation for change.”