By conflating energy efficiency in buildings with renewable energy, and treating them as if they somehow are additive to sustainability, the underwriting industry is doggedly digging itself another hole by means of green financing initiatives. It may not become a worthy successor to the tsunami of mortgage fraud that nearly sank our financial system, but is certain to become another self-inflicted wound, judging by the growing numbers of green mortgages and other financing solutions. Whenever there is a realistic renewable energy alternative, buildings are potentially sacrificing future asset appreciation because the terms of loans coerce them into pursuing energy efficiency rather than renewable energy. This type of Green underwriting is the ally of bad or non-existent energy policy, primarily because of diminishing returns on energy efficiency. Bad financial planning does the rest.
As demonstrated on this blog, energy efficiency in itself is not an objective, unless one first addresses a make or buy decision to determine if it is economical to generate electricity at the building level. Energy efficiency is an attribute of whatever system you have, and if you started out with a fossil fuel system and you spend your money on making it more efficient, you are also committing yourself to paying energy bills for the foreseeable future, unless there is a solid component of renewable energy in your program.
Green Underwriting Will Founder on the Rock of Energy Efficiency
Would be "green" mortgages, and other forms of would be "green" financing for energy retrofits, and other financial instruments (PACE bonds come to mind), are all hitching their ride to energy efficiency as a primary objective, and as demonstrated on this site, energy efficiency as applied to an existing fossil fuel based infrastructure is an absolutely desperate measure of last resort, which should only be pursued if you cannot implement green power infrastructure economically.
Diminishing returns mean that every next step in efficiency is explosively more expensive than the last, and programs like the NYSERDA MPP are designed to get around that issue, but in effect leave the building owner stranded without any options for subsequent improvements. By contrast, if you implement green power technologies as a retrofit strategy, you will experience, as you do the engineering and the economics, that your project will enjoy compound returns. Initially, the capital requirements are higher, but in the long-term, the returns are very promising. Normally we estimate that such green power-driven buildings could command a 10-20% premium within 10 years.
Green Power: What Green Underwriting Should Be
The prime rationale for PACE bonds was always the capital intensity of energy retrofitting, but as this story makes clear, the PACE community missed the boat in the confrontation with Fanny and Freddy. They came away with only a Pyrrhic victory, and the reason was that they got lost like everyone else in energy efficiency, and the complete obfuscation of the original objective, which was the transition to renewable technology. The nature of the renewable transition is exactly that it is more capital-intensive up front, and this is what PACE bonds were designed to address. If their use were limited to renewable energy conversions, they would promptly be indispensable, and they would indeed reduce risk for underwriters. So perhaps PACE could enforce the standards. Right now PACE bonds are just a lost opportunity, if they go along with the general energy efficiency craze, which is based on bad financial planning. What's more, if PACE bonds did fill this role, they could function alongside regular mortgages, and indeed provide an assurance of asset appreciation.
Green Underwriting: Don't Underwrite Operational Savings with Long-term Money
The biggest problem with would-be "green" mortgage products is that energy efficiency is a disastrous objective and benchmark to use, which may marginally improve the financials of a building, but can never make the sort of massive advances that are possible by leveraging renewable technologies. Energy efficiency typically achieves 20-30% reductions in consumption, renewable energy conversion can achieve 25-50% reductions in the first phase and 75% within 10 years. More importantly, with green power technologies, a building has an energy price hedge, and therefore goes up in value with every energy price hike, while the "energy-efficient" building next door merely sinks in value slower than if it did not invest in. The availability of financing and replacement cycles with dictate the order in which such a transition can be made.
Thankfully, there have already been signs or market hesitation around ill-conceived energy efficiency loans such as NYSERDA's. The whole business of subsidized energy efficiency loans is about "investing" in the difference between the Titanic going down in five minutes or ten, Energy Star labels or not.
Incentives Should Be Targeted Only for Renewables
Any renewable energy infrastructure in a building will add value, for it moves energy from the liability to that asset column. With careful planning, miracles are possible. It is hopefully going
Conclusion
Green underwriting is bound to be a failure as long as it sets energy efficiency as a primary objective, and the major opportunities for real estate asset enhancement are by definition with green power technologies.
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