Here’s a complilation of three informative articles on financing green projects by Shari Shapiro:
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.
Leases
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.
Performance Contracting
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. And energy improvement mortgages: 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.
A few rules for green project finance:
1. Find a bank or financial institution committed to green projects. Some banks now have financial arms that are dedicated to financing renewable projects.
2. Pick a model. It’s easier to tweak an existing project finance model than to create a new one from scratch. Construction? Equipment?
3. Recognize the need for tweaks. Whatever the model (see No. 2), it will need to be tweaked for the unique features of green building and renewable projects.
4. Set out the deal terms in advance, particularly the obligations of the parties in the event of default.
5. Identify and address the roles of the lender and borrower with respect to any incentives or other government financing that is part of the project. Each incentive has its own requirments regarding transferability and assignment, and ownership status is often an important factor.
6. Make sure your green project pencils out. Seems simple and obvious, but when seeking financing, it is important that the project actually be a wise investment.
7. Provide as much data about the beneficial financial features of the green project as possible. The growing body of data about the financial benefits of green buildings and the balance sheets of renewable energy projects should enable borrowers and lenders to better evaluate the risks and benefits of green projects.
8. Where available, use green specific financing tools, like energy efficient mortgages. A good primer is available here.
9. Be prepared to cross-collateralize. There is so much risk aversion that many financial institutions seek cross-collateralization of non-green projects to alleviate the fear, real or imagined, associated with financing green projects.
10. Acknowledge a longer financing timeline. Getting all parties on the same page regarding the financing deal and the documentation may take longer than traditional projects. But, as lenders and borrowers get more projects under their belts, this timeline will shorten.
The Good News About Government Incentives
- Programs are available at almost all levels of government — The federal government offers grants, tax breaks, loan guarantees and technical assistance for green building and renewable energy components of commercial, residential and industrial projects. The Office of Energy Efficiency and Renewable Energy has a pretty user friendly site. States also run incentive programs, and many states have renewable energy credit trading programs (also known as RECs or green tags or SRECs, etc.), which enable producers of renewable energy to get an extra stream of income from their property. For special groups, like Native American tribes and veterans, additional resources are available.
- Some programs come from unusual sources — Not all green building and renewable energy incentives come from government. Utilities sponsor a lot of programs for both commercial and residential projects (for example, see the programs available from PECO here). Some nonprofits and even faith-based organizations are providing green incentives. A loyal Twitter follower highlighted this program by the Jewish Free Loan Association (available to those of any faith) that provides interest free loans of up to $5,000 for energy efficient upgrades for homes and small businesses in the Los Angeles area.
- Don’t neglect technical assistance programs — One of the most underutilized incentive is technical assistance. Of course, homeowners and businesses can access technical assistance programs. Municipalities, small businesses and Native American tribes also can get thousands of dollars in technical assistance for free or reduced cost. For example, in New York Con Edison provides small businesses with a free energy audit. This can ensure you maximize the benefit of your green project both environmentally and financially.
And The Bad News…
1. The new House is seeking to cut almost all federal green incentives — According to Green Building Chronicle, the Republican Study Group, made up of more than 100 GOP House members, is targeting the wholesale elimination of funding for:
- Department of Energy Grants to States for Weatherization, $530 million annually;
- EPA’s Energy Star Program, $52 million annually; and
- Federal office space acquisitions (which have helped the government build a market for LEED-certified buildings), $864 million annually.
Just to be clear, in a bill seeking $2.5 TRILLION in cuts, these reductions would account for .14 percent of the savings.
- States and municipalities are strapped for cash — Like the federal government, states and municipalities are strapped for cash, and may cut their green incentives to provide things like trash pick up and police.
- Some programs are not worth the effort to apply — All programs require paperwork, verification and in some cases, prevailing wage rates. Sometimes the benefit is not worth the hassle.
- Some programs reward green bling rather than cost effective green improvements — Some programs reward the installation of renewable energy components or other “green bling” as opposed to better insulation or new windows. It is key to do a cost benefit analysis of any proposed green project to ensure that it has the greatest return on investment.
For more information, the DSIRE database of federal and state renewable energy and energy efficiency programs is always useful, and be sure to check your state and local environmental departments and local utilities.