Property Assessed Clean Energy Bonds (PACE): Overview
Property Assessed Clean Energy (PACE) programs are a financing tool used by local governments to loan property owners funds for energy improvements/retrofits such as renewable energy systems (e.g., solar panels and small wind turbines), energy efficiency measures, and water-saving features that reduce the amount of energy used to treat and heat water. The PACE loan repayment obligation attaches to the property via an added property tax assessment instead of the individual.
RATIONALE
According to the U.S. Energy Information Administration, residential and commercial end-users account for 41% of U.S. energy consumption. Moreover, non-renewable fossil fuel and nuclear sources provide the vast majority of this energy. Because buildings have a long lifetime, performing energy improvements/retrofits today can dramatically reduce the environmental impact of our buildings. However, two realities deter property owners from greening their homes and commercial/industrial buildings: the upfront costs and a payback period that may exceed the length of time the owner possesses the property. PACE programs promote energy improvements/retrofits by providing upfront capital for such greening projects and by attaching repayment to the underlying property and not the property owner who initially received the PACE financing.
EFFORT REQUIRED
In most cases, the state legislature must allow its cities and counties (municipalities) to form a special tax/assessment district to finance energy improvements/retrofits on private property. If a state does not authorize PACE programs, then municipalities could encourage their state government to pass PACE-enabling legislation. If a state permits PACE programs, then an interested municipality would appoint an individual charged with leading a team to design its PACE program (e.g., goals, scope, and eligibility criteria) with input from local stakeholders (e.g., building owners) and potential partners (e.g., renewable energy system installers and developers). This team would also determine whether the municipality will internally manage bond processing and purchasing, funds distribution, and program administration or hire a third party to perform all or part of these tasks. Next, the municipality must secure funding for its PACE program and follow state/federal requirements for the establishment of its PACE program and special tax/assessment district. Once the municipality completes legislative, financing, and program structuring actions, it should educate the community about the financial and environmental benefits of energy improvements/retrofits and provide property owners with details regarding the cost of PACE financing and the availability of funds.
BENEFITS
By shifting most up-front costs from property owners to the municipality, PACE financing arrangements accelerate energy efficiency improvements to a community’s building stock thereby reducing the pollution and other risks associated with fossil fuel and nuclear sources of energy in addition to the cost savings of reduced energy bills. If structured properly (e.g., funded through bonds), PACE programs can create no liability to the municipality’s funds. Additionally, PACE financing arrangements also reduce lender/bond owner risk because property tax liens are senior to mortgage debt.
PACE financing arrangements benefit the local region by immediately creating energy improvement/retrofit jobs, lowering the energy bills of improved/retrofitted buildings, and increasing the value of the underlying property. Like interest paid on a home mortgage, homeowners can deduct the interest component of PACE loan repayments at the federal tax level. Moreover, PACE programs are equitable because only those property owners who opt in pay for the program and only the current owner of an improved/retrofitted building pays the additional property tax assessment.
RISKS
If improperly designed and/or implemented, a municipality may not obtain the greatest environmental and financial benefits from its PACE program. This can discourage property owners from participating in the program and result in the municipality falling short of its environmental goals. Improperly structuring of PACE-related liabilities can pose a threat to a municipality’s finances. For example, if PACE bonds are structured as a “general obligation” of the municipality, then the debt might create a direct liability to the municipality’s general fund, count against its debt limit, and/or impact its credit rating.
Existing lenders may be concerned about PACE programs because of the senior nature of PACE liens, especially in markets with declining property values. Therefore, municipalities with severely depressed property values may want to wait until home prices have stabilized or require a minimum loan-to-value ratio. Moreover, PACE bond investors may require an early-foreclosure covenant from the municipality, which could increase the number of local foreclosures in the event of PACE loan repayment delinquencies. A municipality may be able to avoid an early-foreclosure covenant by establishing a reserve fund that pays debt service in the event of such delinquencies.
Municipalities should carefully set expectations regarding potential costs and projected savings because overpromising and under delivering can hinder the effectiveness of the PACE program. Moreover, informing the community well in advance of the establishment of the PACE program may delay some consumers from making improvements.
ACTION AGENTS
If a state does not currently authorize municipalities to establish PACE programs, then the State Legislature, Governor, municipal leaders, non-profit/civic organizations, and the energy improvement/retrofit industry must work to pass PACE-enabling legislation. If a state has passed such legislation, then the municipal government should work with PACE financial/administrative professionals, non-profit/civic organizations, and the energy improvement/retrofit industry to craft a PACE program that addresses the identified goals of the community.
COSTS
Total costs depend on the size and scope of the PACE program and generally include start-up costs, initial expenses, and ongoing costs. For each category, costs include municipal personnel time for overseeing the PACE program, fees paid to third parties, and marketing expenses. Because, some administrative tasks require the same amount of staff time for small- and medium-sized programs, a municipality can achieve economies of scale with larger programs. A municipality can recover PACE program administration costs through, among other things, application fees, a fee added to the project cost, an increased interest rate, and other sources (e.g., the general fund, grants, and federal stimulus funds).
