By Carol Rosenfeld, Senior Finance Analyst, Environmental Finance Center, University of North Carolina at Chapel Hill
October 15, 2015
Property Assessed Clean Energy, or PACE, is a useful tool for any innovative financier’s toolkit. Today, we’re taking a closer look at PACE specifically in North Carolina.
But first: A quick recap on PACE. PACE programs reduce the upfront costs of clean energy by allowing building owners to pay these costs over time as an add-on to their property tax bill. Paying for improvements in this way is not a new idea – special purpose property assessments have long helped finance communal improvements such as sidewalks and sewer lines.
Assessments are a logical choice for energy projects because investments in energy have both public (economic development, reduced emissions, reduced resource extraction) and private benefits (increased property value, reduced energy costs). It therefore makes sense for a public entity and property owner to share the responsibility for these investments. The public entity provides or enables financing, and the private entity sees the value of the improvement added as a lien against their property that they can pay off over time. The lien stays with the property itself even if the property is sold. In most cases, the PACE lien is also senior to the mortgage itself, in that it will be paid first in the case of default. (A quick aside: The terms “PACE assessment,” “PACE lien,” and “PACE loan” are often used interchangeably. Technically, however, there are important subtle differences between an assessment that increases property value and which can be retired over time (which describes PACE) and a loan taken out by an individual or business.)
One important distinction in the PACE world is whether a program is structured to benefit commercial or residential properties. In 2010, after the housing crisis, the Federal Housing Finance Authority directed Fannie Mae and Freddie Mac not to purchase residential properties carrying PACE liens, in order to avoid anything that might impact a homeowner’s ability to repay their mortgage. This put a halt to most PACE programs focused on residential properties. (Discussions are underway to change this policy.) In the meantime, some residential PACE programs continue by including additional safeguards against default, such as loan loss reserve funds, or making PACE liens subordinate to mortgages. Commercial mortgages are not underwritten by Fannie Mae and Freddie Mac, so commercial PACE remains unaffected, and the vast majority of active PACE programs focus on commercial properties.
The source and structure of financing for PACE varies. In some cases, a state or municipality issues a bond or uses other funds to make capital available to property owners for energy efficiency improvements; in other cases, private sector lenders can provide the upfront funding to property owners directly. Financing terms typically run to 15 to 20 years.
There are currently 30 states with PACE-enabling legislation on the books, covering nearly 80 percent of the country’s population. These states include Alabama, Arkansas, Florida, Georgia, Kentucky, Louisiana, North Carolina, and Virginia in the Southeast. However, of those 30 states, only 15 have active PACE programs, accounting for $147 million in projects since 2009. In the Southeast, Florida has the most active PACE program, while Georgia and North Carolina are among the 15 states with PACE-enabling legislation but no PACE programs in advanced stages of development. (For further background information on PACE, see PACENation.)
North Carolina: PACE-ing itself
North Carolina passed PACE enabling legislation in August 2009, permitting counties and cities to place assessments on properties to pay for “distributed generation renewable energy sources or energy efficiency improvements that are permanently fixed to residential, commercial, industrial or other real property.” These can be funded through revenue bonds, general obligation bonds, and general revenues. Recent legislation extended the program through June 30, 2020.
Despite this enabling legislation, no communities in North Carolina currently offer PACE financing. This is due to a combination of factors linked to demand for energy efficiency (given the state’s relatively mild climate and low price of energy) as well as structural policy issues. Three main issues stand out:
- Lack of local government familiarity with using assessments for public investments;
- Inability to delegate administration and financing (issuance of bonds) to a central authority; and
- Additional need for state-level approval for all local debt.
First, North Carolina does not have a culture of using property assessments to pay for communal improvements. Other states use property assessments as a standard public financing tool. Local governments in North Carolina, however, are generally not accustomed to placing property assessments. And, only twice have local governments in the state used assessments to pay back debt. Becoming familiar with this process is a big hurdle to cities or counties who would like to build PACE programs.
Second, only municipalities or counties can place special assessment liens in North Carolina, and only municipalities or counties can take out debt to pay for PACE projects upfront. Connecticut’s successful PACE program, for example, benefits from having a statewide entity with the authority to levy assessments and take on debt. This takes the administrative burden off of local and county governments, and creates economies of scale where the PACE process can be standardized. Connecticut and other states such as California are also able to delegate financing to other entities, allowing the private sector to finance projects. This is known as “conduit financing,” and North Carolina specifically prohibits it.
Finally, North Carolina’s Local Government Commission (LGC) has state-level oversight over all locally-issued debt. The LGC must approve all debt issued by local governments, taking into account the ability of the local government to repay the debt in order to avoid any possibility of default. Issuing PACE-backed bonds would require approval from the LGC. While no communities in North Carolina have gotten this far in the process, this adds one more lengthy step to an already complex process. (See “An Assessment of PACE Local Government Financing Issues in Three States” by Adam Parker and Jeff Hughes for further details on PACE in North Carolina, as well as in Florida and Georgia.)
PACE clearly has incredible potential as an innovative financing tool, as well as some challenges depending on the way states have enabled it. We’ll be profiling the progress of PACE in states across the Southeast in future posts. Have insight into what’s happening with PACE in Alabama, Arkansas, Florida, Georgia, Kentucky, Louisiana, or Virginia? Contact us at [email protected] to share your expertise!
For more information on PACE in North Carolina or the Southeast Energy Efficiency Finance Network, please contact Carol Rosenfeld at [email protected].