How Green Multifamily Helps Bank CRA Ratings

(that’s “New Orleans” for  non-Southerners).

I am conducting workshops on Underwriting Green Multifamily Development this week at the 2010 National Community Development Lending School (”NCDLS”), hosted by the San Francisco Federal Reserve Bank.

NCDLS takes place within the National Interagency Community Reinvestment Conference, a big national event for community development professionals, Community Reinvestment Act (CRA) officers, lenders, investors, non-profits and intermediaries.

This is the first time that the topic of underwriting green multifamily developments is part of the NCDLS curriculum. We’ll share more tips from the course for you in Tuesday’s Pacesetter (subscribed, yet?)

A main point we are stressing in workshops is that green multifamily investments fulfill a far larger set of objectives than just better quality housing (which, of course, is a great start). We’ll be educating colleagues on how sustainably-designed apartments help regulated financial institutions to go beyond simply fulfilling CRA requirements. Done right, green apartments can materially improve bank CRA examination outcomes, which satisfies the institution’s broader business objectives.

But first, a short background: The Community Reinvestment Act of 1977 was established to ensure that regulated financial institutions would have an obligation to help meet the credit needs of local communities in which they were chartered. Briefly, financial institutions demonstrate compliance with these laws by providing “qualified community development loans, investments and services.”

The actual performance requirements needed to comply with the CRA vary by institution size and charter, however, it’s enough to know here that regulators use CRA examinations to verify an institution’s compliance with these laws. Those examination results are considered whenever a financial institution applies to open a branch, merge with another institution or become a financial holding company, which are the key moves bank need to make in order to grow and survive.

The CRA examination can result in four possible ratings: “outstanding,” “satisfactory,” “needs to improve” and “substantial non-compliance.” In work and conversations with CRA officers and other professionals, we learned that many banks typically receive “satisfactory” ratings, but it is very hard to improve an examination rating from “satisfactory” to “outstanding.” If you take a look at the Cliff Notes version of CRA requirements here, especially those for large banks (assets > $1billion), receiving an “outstanding” across examination categories is not a matter of simply being “very good” at a few things, the institution has to be “excellent” at many requirements, which can be very challenging, particularly during a tough economy.

One of the toughest requirements to fulfill-let alone demonstrate excellence at-is in the “Product Innovation” category, where the large bank has to “make EXTENSIVE USE of  innovative and/or flexible lending practices in serving [assessment area] credit needs.” And this is where green multifamily investments help greatly.

» SF Federal Reserve Bank’s CRA page
» CRA page at Cornell Law School’s Legal Information Institute

Norwegian fund putting $16 billion into socially-responsible real estate

The juggernaut Norwegian Global Pension Fund has just announced that it intends to significantly expand its real estate holdings globally.

According to the report in Responsible Investor, “Environmental, social and governance (ESG) factors including energy efficiency and water consumption are to be key planks“ within the criteria for new property investments.

The $16 billion investment amount represents 5% of the fund’s overall value and its manager, Norges Bank Investment Management (NBIM), indicates that the fund will need a few years to actually invest in ESG-screened real estate to achieve that level, as the allocation comes from portfolio shift created by cutting the fund’s bond portfolio.

How will they actually invest responsibly?

This is interesting, as there is no real consensus about reporting standards and measurements that constitute responsible investing in the institutional real estate field (see our previous posts and papers about Metrics for Responsible Property Investing, for more details).

NBIM will be required by the government to produce an annual report of the portfolio, including an “assessment of how it conforms to responsible management and the exercise of ownership rights. The bank will be allowed to hire external managers and outsource operational functions, with returns benchmarked against a customised version of the Investment Property Databank’s Global Property Benchmark.”

Overall, we are noticing increasing interest by foreign investors in US markets, as they believe that property values have nearly bottomed out. That, plus the growing requirement for green and socially-responsible properties can possibly spur a near to mid-term shortage in green real estate, even as property markets generally are expected to be in a slow recovery.

As we have seen in previous cycles, lots of capital seeking an asset in short supply can always create some interesting market action. From my point of view, the Norwegian Global Pension Fund is not alone in the direction they are taking. Expect to hear more on this point in the near future, as others get in on the action.

Compare retrofit financing options with this resource

(This post is part 1 of a 2 part post on retrofit financing mechanisms.)

These slides are for a talk I gave at GSMI’s recent conference on sustainable retrofits (if you have trouble seeing the slides, you can download the presentation here). I put it together to help anyone walk through a quick comparison of a mid-sized investor’s financing options for her portfolio of properties. Several members of the audience emailed me later saying that they thought the information was helpful, so I decided to share it with the Green Journey community as well.

The presentation takes you through the side by side comparison of tax-lien financing, energy performance contracting and on-bill financing, to answer the question “which is the best deal?” All of those three are also compared to self-financing and using conventional bank debt.

Takeaways

• Small energy saving improvements at the property level can significantly impact the portfolio’s financial and environmental performance: The study portfolio consists of small, owner-occupied retail buildings with similar layouts and building mechanical equipment. While the portfolio is relatively large in terms of number of properties (62), the total portfolio square footage is less than 220,000 square feet. For this portfolio, small measures at each property can add $155,000 in annual portfolio cash flow, and increase portfolio value by nearly $2M. The estimated annual reduction in GHG emissions (1,719 tons of CO2) from these energy efficiency measures is equivalent to removing 314 passenger vehicles from the road, or providing the total energy use for 156 homes.

• Emerging financing mechanisms such as tax-lien and on-bill financing can significantly ease the pain of upfront retrofit costs. It became clear that these two emerging funding mechanisms were the most advantageous for this portfolio because the owner would be able to pay for energy efficiency measures with very little or no up-front capital from the property owner.

• Energy performance contracting is best for public buildings: While ESCO financing can be a relevant source of capital for financing/leasing costly building system equipment, ESCOs are not the best funding source for financing comprehensive energy efficiency retrofits for small and medium size structures. Energy performance contracting (EPC), a financing technique that uses cost savings from reduced energy consumption to repay the cost of installing energy conservation measures in a building, is currently best suited for Federal and MUSH (municipal, university, school, and hospital) buildings.

How tax-lien and on-bill financing work

While both tax-lien and on-bill financing are still not as widespread, there are a  number of pilot programs across the country. With the government’s increase in funding for energy efficiency, we expect both forms of finance to become more widely available for property owners.

The American Public Power Association lays out a good definition for both these mechanisms:

On-Bill Financing: “a mechanism whereby the utility finances energy efficiency upgrades and the property owner pays off the costs overtime through a charge on their monthly utility bill. If the program is designed properly, the monthly loan payment is usually equal to or less than the cost savings, and so the property owner should not see their monthly utility bill increase.  Tariff‐based on‐bill financing, one variation, allows the loan to stay “with the meter.” In the event that the property is sold, the repayment obligation transfers to the new property owner/new beneficiary of the upgrades. This model allows for a longer payment term and can decrease monthly payments. Renters may also be able to participate in tariff based financing because they only pay for the measures, while they benefit from them.” San Diego Gas & Electric offers on-bill financing.

Tax-Lien Financing,  which is the funding mechanism used by Energy Efficiency Financing Districts, (otherwise referred to as Municipal Energy Financing, Property Assessed Clean Energy (PACE), Sustainable Finance Districts, and a host of other terms), is  a mechanism that allows property owners seeking to make major energy efficiency investments to opt‐in to a special tax or assessment district (or local improvement district). Property owners borrow money to finance energy efficiency improvements and/or renewable energy equipment, and repay overtime through a line item on their property tax bill.

The loan repayment obligation is attached to the property, not the individual, and if the property is sold before the end of the repayment period, the remaining obligation transfers to the new owner. Authorization from the municipal and/or state legislature may be required to enable special tax assessments for tax-lien financing.

The Sonoma County Energy Independence Program and the Berkeley FIRST Solar Financing Program are examples of tax-lien financing.

In our next post, we’ll talk about the comparative advantages of each as well as some tips on best practices for organizing energy efficiency financing for your portfolio.

Stay tuned for Part 2!

Read more on this topic

• Climate Benefit Districts, powered by green finance
• Sonoma County Funds first AB811 Loan
• $100 Million Energy Efficiency & Water Conservation Loan Program for Sonoma County

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$1 billion in retrofit financing from Community Preservation Corporation

People always ask ‘where’s the beef’? when it comes to green finance.

Of course, they’re asking who’s making money available to develop or retrofit buildings to sustainable standards.

You should pay attention to the recent announcement from the Community Preservation Corporation (CPC), to bring $1 billion in energy efficiency retrofit financing to multifamily property owners in New York. This should provide a great energy efficiency financing model for others to duplicate.

The newly formed CPC Green Initiative aims to be an industry pacesetter by proving that seemingly disparate public and private entities can foster new and creative green finance solutions. According to Michael Lappin, CPC President:

“We anticipate financing retrofits for up to 15,000 apartments over the next few years. But to change the urban landscape we will also need to adjust the financing landscape.”

This program is notable because it includes participation by the great range of potential sustainable finance partners — an affordable housing lender, a GSE, pension funds, private lenders and utility companies.

Key financing components:

• $150MM in construction funds will be provided by the New York Building Revolving Fund for properties needing extensive renovation. That fund is backed by proceeds from Deutsche Bank, HSBC and other lenders.
• $300MM will come from New York pension funds.
• Freddie Mac will fund permanent loans for buildings not requiring the above construction loans.
• Freddie Mac has also committed to buy $500 million of loans from this program.

By directly incorporating efficiency retrofits into the loan process as well as requiring ongoing monitoring regimes through the loan life-cycle, we feel the CPC and its funding partners are taking the long-term holistic perspective that we believe is essential.

With a sizable partners including Freddie Mac, Deutsche Bank and the NY State Pension Fund, the CPC will need to fill a role that we find essential – being a strategic hub were investors and key stakeholders can find expertise and guidance.

This kind of pooled investment and lending commitment that relies on multiple layers of funding solutions is one that we are seeing on current projects. We think these kinds of well-designed and sufficiently capitalized partnerships will compliment local government funding.

We’re sure that we’ll see more structures like the CPC Green Initiative emerging on the market. Let us know if you are aware of any similar programs for commercial properties in your area.

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• Photo credit: sx70/DUMBO-Brooklyn.

Tax credits for green investing by insurers — we’ll pass

The availability of appropriate insurance coverage is a key risk issue that affects the overall value of green buildings and their financing.  Without proper coverage tailored to a green building’s technical features, green building owners might be exposed to losses on sustainability-related systems that can’t be recouped via an insurance claim.

At the end of the day, that leaves lenders and investors exposed to losses on those features, which inherently reduces their value and presents a barrier to advancing green building.  So appropriate “green” insurance coverage is key to assuring the proper financing and valuation of green buildings.

Skip Rawstron of InterWest Insurance Services of Sacramento, sent around an article detailing efforts to require the California insurance commission to study various sustainability risk issues tied to insurance coverages. The article (request it from us here) shares a laundry list of hearings that the insurance commissioner would be required to hold if the legislation passes.

The following snippets from the proposed legislation reveal the lawmakers focus on trying to attach advantages to green finance and investing as well as levy costs on those insurers continuing business as usual. Specifically the law, if passed, would:

• Require the insurance commissioner to hold hearings on the risk, costs and claims associated with green buildings.
• Require the insurance commissioner to conduct hearings regarding the health impacts on workers in green buildings, and use the information in establishing the Workers’ Compensation Claims Cost Benchmark. [our note: wow!]
  
• Offer state tax credits to insurance companies that invest in financial institutions that provide products designed to protect the environment and support renewable energy.

Now here’s the rub:

The concept of encouraging insurer investments in banks offering green products is a novel pass at trying to influence market forces in favor of both ecologically-friendly insurance and green banking products. Lots of folks have been talking about similar moves.

But despite being a big fan of incentives and novel financial mechanisms, I don’t think that using already strapped state funding sources to effectively pay insurance companies with tax credits to make those investments in banks is the way to go. Actually its surprisingly cheap.

Insurance companies are not hurting for cash in any respect, so there is no need to bribe them into green investing with tax credits. Everyone knows that tax credits are really a short-term play and we’re at a place where longer term financial mechanisms are needed to advance sustainability. And banks are not reluctant to offer green credit products due to lack of investment by insurers. They haven’t made that leap for other reasons that we’ve covered in other posts.

On top of all of that, the increasing availability of insurance products, well ahead of the banking industry, only convinces me that the insurance industry already sees green insurance products as  being both necessary and profitable.

Please email us to request the article, since Skip sent it to me personally.

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• Photo credit: NYArchitecture.

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