For nearly 10 years, the concept of financing residential and commercial energy efficiency projects with green bonds has been a growing phenomenon. Better known as PACE or Property Assessed Clean Energy loans, this type of alternative energy finance is the highest growth sector type of financing in the U.S. lending industry. For investors, the green bond finance industry and contractors performing the energy retrofits, this is explosive growth market that has over $4.0B in projects financed to date and the market is still in its earliest days.
In 2007 the first residential PACE program started in Berkeley, California and today Thirty-four states and the District of Columbia, have passed legislation which has created the market for PACE programs, according to PACENation, the leading industry trade association. PACE loans have raised nearly $4.0 Billion for residential projects so far and of that $500 Million for C-PACE programs, which allow for financing on commercial and multi-family assets. This market is doubling year over year and is expected to reach $15Billion by the end of 2018.
What makes PACE financing uniquely different from commercial loans or traditional home equity lines, is the loan type is approved by local governments and designed to incentivize homeowners to make their homes energy efficient, structured like an additional property tax lien that is attached to the property. Because of this structure the property owner can pass on the financing cost to the next owner of the property since typical loans are financed over 25 years. From a risk perspective, this substantially reduces the default rates on the financing since it follows the property and not the owner. Should a property owner default and file for bankruptcy, the PACE lien is intact and continues on to the buyer of the home.
For commercial PACE projects, the energy efficiency investments are effectively “off balance” sheet and provide real estate investors, hotels and the like with a compelling path to increase an assets NOI and ultimately its Net Asset Value.
Though the goals of PACE are noteworthy, one of the program’s major critiques is that until recently the lenders have not been strict about underwriting the applicants’ creditworthiness and have instead focused more on the underlying value of the property, the owners equity base in the home and the market value impact of the energy improvement. The loans usually require no down payment, adding debt to property tax bills as reported by the Wall Street Journal who has covered the industry in numerous articles. The research however reveals that their is little evidence in the market that PACE loans have higher default risk as noted in a new ratings report from Morningstar Credit Ratings who said PACE poses low to little risk of driving a borrower into a foreclosure. The securities backed by the PACE revenue streams also are highly rated, Morningstar said.
Liquid new market for Green Bonds
Early market makers in the space include PACE fund provider Renew Financial, whose CEO was instrumental in the creation of the PACE concept a decade ago in Berkley when he was in city hall. Renew Financial will finance and fund well over a $1 billion in transactions this year. While PACE loans are relatively small compared to mortgages--ranging in size from $5,000 to more than $100,000, with an average of about $20,000, they do have slightly higher than average interest rates of 6% -10%, which are based on the credit profile of the home owner. Large lenders like Renovate America, who runs the HERO fund, has recently acquired energy software startup CakeSystems to help home owners model home energy use and estimate the savings of its customers.
Energy savings and reductions in homeowner’s electric, water and gas bills is the driving incentive to offset the cost of the financing, in addition the states and local governments are endorsing PACE as a solution to tackle environmental and sustainability goals at scale. Allowing most homeowners the goal to “net zero” when considering the cost of the loan where the energy savings pays for the loan over time.
Attractive Investment Opportunities for Investors
The Smart Home, Cleantech and Energy efficiency sectors continue to achieve strong fundamentals for Venture and Private Equity investors. Mercom Capital Group, a leading investment advisory and market intelligence group that covers the Cleantech space, stated that the top Venture Capital are funding Smart Grid related technology companies including Vivint Smart Home, which raised $100 million from tech investor Peter Thiel and investment firm Solamere Capital. These type of headline deals have cast alot of attention on markets where PACE has been adopted.
In the broader landscape, innovative technology companies are attracting savy investors. Groups such as ChargePoint, which raised $50 million from Linse Capital, Braemar Energy Ventures, Constellation Energy, Statoil Energy Ventures, Envision Ventures, Jan Klatten, Michael Liebreich, and Rick Wagoner as well as BMW Ventures.
AutoGrid Systems, which raised $20 million from global investors including EIP-Energy Impact Partners, Envision Ventures, Envision Energy and E.ON. And my colleagues at Comfy a commercial energy efficiency platform secured $12 million in funding from Emergence Capital, CBRE Group, Microsoft Ventures, Claremont Creek Ventures, and Westly Group.
In Q2 PACE financing totaled $762 million including $500 million in PACE securitization deals from three transactions. Top deals included the $300 million raised by Renovate America, in its seventh securitization of PACE bonds; $250 million credit facility secured by Ygrene Energy Fund to support expansion and another $95 million in funding from Lightyear Capital LLC a New York private equity firm.
Other large PACE market makers have also raised capital in the recent past with $123 million raised by Renew Financial, referenced earlier, through its second securitization of residential PACE bonds.
M&A transactions in the "efficiency" sector doubled in 2016 with seven transactions compared to three transactions in Q1 2016 of which only one disclosed details. The top deal was the $530 million acquisition of Opower by Oracle.
Investors are attracted to the sector for its solid fundamentals and additional protections against default risk when compared to other traditional home improvement financing mechanisms. Companies in the largest PACE market, California are early movers in this high growth industry. Groups like Solar City now part of Tesla which the electric car maker acquired in 2016 for over $2.0 Billion and smaller groups like PACE Avenue in Oakland and PowerScout are pioneers in bringing this new type of financing to consumers and homeowners. These companies have mastered the customer acquisition process through targeted digital marketing on social media.
These companies have created robust lead gen machines and are developing a large teams of effective in field sales and project management groups to service the hundreds of energy efficiency projects that each company is closing each month. Successful PACE platforms are primarily focused on helping homeowners finance energy efficient projects that can create a new future with clean energy, but their is evidence that many of these groups will modify their business model to monetize these client relationships for years to come through other technology driven services built around consumer energy use.
New technology Opportunities, IoT and the Smart Home
Over the course of the past few years, most of the largest global consumer electronics and products companies have signaled a focus on the “home” consumer market with the growing insurgence of home automation and “smart” connected “things.” In 2014, Samsung acquired the company Smart Things and has made significant commitments to developing a smart home system. Qualcomm the global leader in CDMA and wireless semi conductors has stated it will “enable” the IoT marketplace for connected homes and cities.
Google, the most active has acquired Nest Labs and Boston Dynamics a robotics specialist along with software developer Flutter to create a holistic platform for the home that can automate appliances and even into home security. These trends by these global brands signal a clear shift that energy efficiency and home automation are converging with smarter and more connected products. These applications within the scope of larger residential energy efficiency projects will usher in a new wave of smart home adoption.
Other noteworthy Capital Investments & Transaction in Energy Efficiency
Boston-Power Inc., of Westborough, Massachusetts, a provider of lithium ion batteries, pulled in $250 million of late-round funding from undisclosed sources.
Sunnova Energy Corp., of Houston, a provider of residential solar systems, got Series A funding worth $250 million from Franklin Square Capital Partners and Triangle Peak Partners.
SunRun, Inc., of San Francisco, a solar energy company, pulled in $150 million of late-stage money from Accel Partners, Foundation Capital, Madrone Capital Partners, and Sequoia Capital.
Sungevity Inc., of Oakland, California, a residential solar energy company, got $72.5 million from Brightpath Capital Partners, E.ON Venture Partners, GE Ventures, and others.
Solexel Inc. of Milpitas, California, a manufacturer of photovoltaic solar modules, got $65 million from DAG Ventures, GAF Corp., GSV Capital Corp., GSV Ventures, Kleiner Perkins Caulfield & Byers, and others.
Aqua Venture Holdings, of Tampa, a developer of water treatment technology, got $50 million of late-stage capital from Element Partners and T. Rowe Price Group Inc.
Verdezyne Inc., of Carlsbad, California, a renewable energy and biofuels company, took in $48 million of funding from British Petroleum, DSM Venturing, Monitor Venture Associates, and others.
Phononic Devices Inc., of Durham, North Carolina, a manufacturer of thermoelectric devices that convert heat to electricity, received $44.5 million from Eastwood Capital Corp., Oak Investment Partners, and others.
Solar City: Tesla’s acquisition of sister company that is a dominant market making in residential energy efficiency. Deal value of $ 2.0 Billion
Regulatory Changes and Industry Impacts
In July 2016, the industry benefited from a major decision by the Federal Housing Administration (FHA part of HUD) which approved mortgages on properties with energy-related home improvements financed through special tax assessments, marking a turnaround for the agency on the issue of PACE
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California, the largest state market for PACE has been looking at consumer protection legislation that would require PACE originators, financiers and contractors to ensure good faith in lending standards that mirror the mortgage industry, primarily to prevent predatory lending practices. The State of California recently announced it “is essential to promote standardized disclosures and protections for consumers to ensure that the PACE program can continue to be widely used to offset the adverse impacts of years of climate change.” The State has recently passed new key legislation to set up these new standards in Assembly Bill No. 2693 and Assembly Bill No. 2618, both effective January 1, 2017.
Most industry stakeholders have been supportive of these measures which includes new underwriting limitations that include:
Not permitting a homeowner to participate if the annual property taxes inclusive of the PACE assessments exceed 5% of the property’s market value.
The PACE must be less 15% of the property value up to the f$700,000 of property value.
And must be for less than 10% of the remaining value of the property greater than $700,000.
Several members of congress have been heavily lobbied by the Mortgage Banking Industry lobby to curb PACE financing and in April of this year, conservative Senator Tom Cotton, a Republican from Arkansas, introduced the Protecting Americans From Credit Exploitation (PACE) Act, which requires PACE issuers to follow the same regulations and disclosures as banks and mortgage lenders. It would do so by subjecting PACE financing to the Truth in Lending Act that requires certain disclosures for mortgages. It is uncertain if this bill would survive committee and make it to the floor for a vote.
Supporters of PACE, most notably numerous environmental research groups, have come out in staunch opposition to the bills as an assault on renewable energy and efficiency mandates. Groups like the Natural Resources Defense Council called the Cotton bill “a blunt instrument that threatens the progress of PACE programs rather than carefully implementing additional consumer protections.”
The Rocky Mountain Institute, the leading global think tank on energy technology and efficiency released a detailed letter explaining why treating PACE financing, as a mortgage product is “ill-informed.” And the financing ratings agency Morningstar’s Brian Grow, managing director of the credit agency, co-authored a report on the misconceptions about PACE. And in spite of several new laws and consumer protections, the industry continues to double year in and year out, signally a long term trends towards the durability of this type of financing and its fundamentals.