Green Finance is a growing segment of the finance business, and as usual with anything new, it is full of fads and fallacies, and it sometimes does not live up to its billing. One part of green finance is large-scale projects, but since buildings are a large part of the problem in terms of GHG emissions, the opportunity for major renewable energy projects in buildings is huge. Evidently, the term green always risks being useless, and smacks of greenwashing, which in many cases it is. To begin with, the current practice mostly focuses on energy savings, not on improving property values, which only renewable energy would do. As a result, it is focused on marginal contribution, and equipment finance. More importantly, this methodology is by nature conducive to financial instability for the underlying property:
- Relatively small "savings" from energy efficiency: because most 'energy savings' strategies yield only a small incremental improvement--typically in the 20-30% range, which is easily wiped out by a price hike or two, and the effect on property values is negligible;
- Efficiency improvements are not unique in nature: because the same efficiencies are available to everyone, eventually all buildings will catch up, and be the same again. Boilers are now 95+% efficient and replacing older units that were 50-60% efficient, but going from 95% to 96% some day is not meaningful. Same for LEDs replacing fluorescents and incandescents.
- Financing short-term enhancements with long-term money is a risk factor: these programs frequently finance short-term improvements with long-term money, which does not contribute to long-term financial stability of the properties that avail themselves of such financing.
- No follow-on strategy: because of diminishing returns: all "energy savings," or "energy efficiency" strategies suffer from strongly diminishing returns for subsequent investments, so the energy savings strategy is a financial dead-end. Again, not good news for long-term property values.
Considering that the only objective for the property owner should be to maximize property values, and the only objective of the government should be the reduction of GHG-emissions, the current mishmash of rules and incentives adds to the confusion, and frequently creates constraints that prevent the best projects from happening. The supporting roles in creating this confusion are played by the government, including tax incentives which are typically tied to a technology, such as solar panels or water heaters, and programs by the utility industry, and/or semi public institutions such as New York's NYSERDA which provides incentives for property owners to do what's good for the grid.
Good intentions aside, it must be understood that none of these programs are designed to help a property owner maximize property values, which is the only objective the property owner should have. When you put them altogether, these programs amount the a government sponsored capital destruction, to the extent that they tempt property owners to do things that are not conducive to improving property values, in the name of being green.
Green Finance - the theory
- What you can do with it is what makes it green
The green finance theory that supports all of these wonderful developments is that at the macro level the highest marginal return is thought to be on improving the efficiency of the systems we do have, and that's why macro-economists tell policy makers to provide incentives for energy efficiency. This approach puts the world on its head exactly, because the first point is that our energy model is wrong. The new model is based on renewable energy, which will increasingly mean buildings producing their own energy. And so, on the margin the biggest advances in "energy efficiency" in aggregate come not from the absolutely moronic spending on more and more energy efficiency, but from finding the low hanging fruit for converting to renewable energy, which is the only permanent solution, and the only one that enhances property values.
Lastly, the reassuring notion that "energy efficiency improvements" are self financing in nature is fallacious. The theory is that it improves operating cash flows, and thus are lenders assured of the ability to repay. This may seem harmless when it pertains to equipment financing, it is still destructive to property values in the long-term, if it crowds out viable renewable energy projects and prioritizes worthless efficiency improvements that fail to make a radical change. It becomes positively disastrous if the financing stretches for longer terms with a real estate collateral. In that case it makes the mistake of financing short-term measures with long-term money. In general, the mistake here is to prioritize the projects that are easy to finance, at the expense of the projects that would add value.
Green Finance - the practice
The unfortunate corollary to the usual energy efficiency financings is that, again because of diminishing returns, only the first few energy savings projects can be financed this way, after which by definition subsequent efficiency projects become prohibitively expensive, and this kind of abusive finance dries up, leaving a property owner stranded.
What happens in practice is that tax incentives, advantageous financing, and various subsidy and incentive programs that are all equipment driven, or driven by the energy suppliers, e.g. subsidized natural gas conversions(NYC Clean Heat), all serve other interests besides the property owner. As a property owner it behooves you to beware of all these wonderful offers. All of these programs have a potential hidden cost, namely they steal asset appreciation from the property owner.
The popular free energy audits are another ally of this fleecing of property owners. They are fine for a renter, to reduce their utility bills, but for a property owner, they are useful information, but no action should be taken unless a proper long-term plan exists with a view to improving property values. They promote frittering away money on trivialities, and never doing the big steps that are necessary. They trade on people's needs to do something, anything, and cheat them out of their money.
Green Finance, resiliency, and Property Values
Just as much as you cannot save yourself rich, all energy savings programs, taken in isolation, produce capital destruction, unless they stand in the context of making the property energy independent with renewable energy. The thing to do as a property owners, is to have your own 30 year DCF (Discounted Cash Flow) model of energy improvements to your property, based on a good grasp of the engineering, for there may be intense engineering interdependencies, which dictate in what sequence things should be done.
What you will learn if you do this long-term capital program, is that once you take one step in the direction of renewable energy, you have the benefit of potentially compounding returns in subsequent phases of implementation. At the very least you will see that you now start having two options at almost every turn, namely either more efficiency (insulation etc.) or more generating capacity - you are doing a direct trade-off.
It should also be noted that building resiliency is another obvious victim of prioritizing energy savings over renewable energy. For again, with making the fossil-fuel, grid-dependent systems more efficient, we are making ourselves dependent on the grid for longer. We are investing our own in customer retention by our energy vendors. No wonder many energy vendors and utilities are only too happy to provide 'subsidised finance' for such programs. Look at the site of the NYC Clean Heat program, and you'll find all the usual suspects there (CPC, NYSERDA and various energy companies), providing a range of green finance options, or so they think.
Of PACE bonds and property values
PACE bonds should have been the savior in this situation, but instead they got embroiled with Fannie and Freddie a few years ago, and since they had made the general mistake of prioritizing energy efficiency, their arguments did not carry much weight and the program had to accept some limitations and trade-offs, so that it cannot presently fully live up to its potential. One can only hope that PACE programs could adopt standards like the DaBX Renewable Retrofit Portfolio Standard, so as to regain their relevance, and indeed prove very clearly why sound renewable energy investments are much more conducive to rising long-term property values than energy efficiency overhauls ever will be.
Conclusion
We only just came off a property bubble resulting from easy money for second mortgages, ARMs, reckless lending and mortgage fraud, which undermined the market for all property owners. Now we risk robbing property owners of asset appreciation in the name of being green if we prioritize energy efficiency over renewable energy where such an alternative exists.
Green Finance, where it pertains to buildings, and any forms of real estate, is deeply flawed in its current form, because of its pre-occupation with energy efficiency. The only way to select meaningful priorities is with a 30 year capital budget for each property. Green finance should prioritize renewable energy over energy efficiency, because that moves energy from a liability to an asset, and is conducive to raising property values as well as improving air quality.
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