Financing Energy Retrofits and Capital Destruction

Creative finance solutions for energy retrofits abound, but most underwriters, including alternative financing programs such as PACE bonds, fall for the generally accepted delusion that energy efficiency should get top priority. This is a mistake - majoring in a minor - which increases underwriting risk, instead of decreasing it, for several reasons:

• If you start out with "energy efficiency" of an existing installation, that is not an energy retrofit at all, for you blithely accept that the design that was in place was the best one possible, and you are merely upgrading it, as in with more efficient versions of the same technology. The point of an energy retrofit is to use newer technology, which may necessitate a different design. An efficiency improvement in most cases is not a capital investment, but an operational expenditure.
• Since many of the newer technologies are about generating energy with solar, wind, geothermal, or even hydropower, they all imply a different model, and different designs. Specifically they enhance the capital asset, the building, with independent generating capacity. Financially they are also a permanent price hedge against energy price increases.
• Energy efficiency upgrades are also by nature short-term, they usually only achieve about a 30% improvement, which is easily wiped out by a few price hikes, therefore such upgrades should not be financed with long-term money, let alone be subsidized.

As demonstrated in earlier posts, financing energy efficiency with long-term money in most cases is a mistake, because the typical 30% or so improvement is all too easily wiped out by one or two price hikes, and because of the issue of diminishing returns, there is no follow-on strategy, and therefore it is financially unsound. Financially, energy efficiency is a horrible dead-end and should be avoided like the plague: again, it increases underwriting risk if it is pursued at the expense of an existing renewable option. As a strategy, investing in energy efficiency should be an absolute last resort, if you can't do anything better.

Renewables are an immediate and permanent asset of the building, regardless if you use solar, wind, or geothermal, or hydro-electric, plus any improvements to the building envelope now come back to you directly in terms of reducing the installed capacity you need. Renewables are an immediate energy price hedge. Because of diminishing returns, "investment" in energy efficiency is financially a shaky proposition, while renewables immediately raise building value.

Energy Retrofits Gone Wrong

Energy retrofits that prioritize energy efficiency amount to capital destruction, assuming there was an economically viable renewable option available. Thus underwriters of financing for buildings who focus on energy efficiency first are in most cases likely to be deteriorating their portfolio and needlessly increasing underwriting risk. This is long-term money for a short-term benefit, and that does not make for financial stability of the asset. Even PACE bonds have completely missed this issue, and all programs that I know of focus on energy efficiency first.

With proper financial planning, which is to say a 30 year capital budget for energy upgrades to a building, it will become very visible that renewable options are financially superior, for 30 years of zero energy bills will outweigh 30% energy savings. Or to put that differently, renewables may initially have a longer payback, but, properly evaluated, the renewable solution with a 7 year payback, may be superior over its life to a 4 year payback on an efficiency component, which "saves" 10%. The renewable energy equipment comes with zero energy bills, or in the worst case some 10-15% in back-up from a fossil fuel source.

How to underwrite energy retrofits

renewables improve value

The bottom line is that responsible financiers should demand a 30 year CAPM analysis of energy retrofits to the building, which could include an installation that could be spread over several years, and obviously realistic measures for maintenance and operating costs, noting that O&M are typically lower for renewable energy than for fossil fuel. Further, underwriters should rate projects based on the percentage of energy that is derived from renewables. The higher it is, the greater the financial stability of the building. My consulting firm DaBx Demand Side Solutions, publishes the DaBx Renewable Energy Retrofit Portfolio Standard (DaBx RERPS)

Conclusion: renewables reduce underwriting risk

Financing energy efficiency means financing short-term operational improvements with long-term money; energy retrofits with renewables reduce underwriting risk and improve the asset value of the property.