My green-minded colleague Kim Madrigal has a post about her time at NAA and the soon to be less audacious idea of sustainability as a fiduciary duty.
Greentechenterprise proposes 7 changes to PACE to ‘save the program’. I’ll have my own ideas shortly, but these are worth discussing:
1. Eliminate the Loading Order. The loading order requires that the owner show that energy efficiency retrofits reduce power consumption by 10 percent to 20 percent in many cases before PACE can be used to pay for solar.
2. Skip Residential PACE for Now.
3. Limit the Types of Repairs. If cutting out homeowners is too politically risky, how about this tack? Limit the size of PACE loans — to say, $15,000 for homes measuring 2,000 square feet or less — and circumscribe the types of repairs that can be undertaken.
4. Make PACE Debt Junior.
5. Threaten Even More Stringent Financial Controls.
6. Change the Investment Tax Credit.
7. Advertise. In the three weeks that San Francisco’s PACE program was up and running, the city received 33 applications and rejected 13 for financial issues. Twenty were completed and one got approved, according to Rich Chien, who runs it.
One in three weeks. Surely some word of mouth could help.
via Seven Ways to Save PACE : Greentech Media.
MFE interviews Jerry Davis, SVP of Property Operations at UDR, about their new electronic renewal initiative.
A good collection of lectures on real estate finance from Columbia University’s real estate program.
Via A Student of the Real Estate Game
It’s been a busy couple of Tweetdays as discussion about the problems and opportunities of PACE continue.
It’s well known that PACE is having trouble as the Federal Housing Finance Agency (FHFA) announces its concerns about properly underwriting properties (PDF link) with PACE. In the earlier entry, I wrote about the standard justification used by PACE advocates to liken a PACE bond to other property-based special assessments such as water or seismic improvements. The FHFA response merely takes the non-standard nature of PACE transactions as a given:
”First liens established by PACE loans are unlike routine tax assessments and pose unusual and difficult risk management challenges for lenders, servicers, and mortgage security investors.”
Note the use of “PACE loans” and mention of “mortgage security investors” among those affected. FHFA’s point of view could not be more clear: it does not consider PACE transactions to be any different from a traditional property-backed loan and feels that the popularity of PACE transactions threatens the attractiveness of GSE-backed securities to investors.
In my earlier post, I mentioned a couple of reasons why FHFA would not consider PACE transactions to be like traditional special assessments:
1. Tax levying authority does not design or complete the work directly.
1a. Contractors who actually design and complete the work may or may not be sufficiently licensed or inspected.
2. The improvements are speculative and the anticipated savings may or may not coincide with the period of repayment.
3. A property’s “share” of a water treatment plant is not due upon sale or foreclosure. In a PACE-related foreclosure, that cost can be accelerated and be payable upon foreclosure.
4. If a water treatment plant does not generate sufficient funds to repay the bond directly from user fees, the municipality is typically responsible for the shortfall. PACE bonds have no such mechanism.
One item that I failed to expand upon is the nature of collateral. When a loan is made, the first and usually only source of repayment is the property itself. When a special assessment is made to improve the seismic resistance or water quality, the presumption is that without these improvements, the collateral will no longer be inhabitable; the collateral is effectively worthless.
When a PACE transaction is made, it has no effect on the habitability. Therefore, the improvements are not essential to maintaining the value of the collateral, and FHFA sees them as optional.
Reasonable people can disagree about FHFA’s position and can effectively argue that climate change or even mere efficiency improvements are essential to maintaining or improving the value of collateral. Because efficiency is not currently evaluated by lenders or regulators in single family home transactions, FHFA will continue to consider it largely irrelevant to establishing value. Furthermore, although society accrues benefits from additional employment, improved air quality, and reduced energy use, society does not directly (or indirectly) provide a method of repayment. Unless and until municipalities incorporate energy efficiency into their tax, zoning, or other regulatory structure or until they make PACE bonds payable as a general obligation bond (see below), it will not be supporting the repayment of PACE obligations.
Indeed, FHFA might even see the presence of a PACE obligation as a factor in reducing the value of a property. Lawrence Berkeley National Lab cites the one (!) sale of a PACE-improved home in Boulder as a cautionary tale (PDF link):
In the PACE program of Boulder County, Colorado, one home with a PACE lien has sold to date. This assessment included a PV system. In this instance, the lien was paid off by the seller as a condition of the sale. The original homeowner received the full benefit of the residential investment tax credit for the PV system, which was apparently a factor in the negotiation process. While one example is not representative of what will occur across a broader collection of PACE programs, it does indicate that program administrators should be cognizant of this issue as they conduct their outreach efforts.
In this case, the seller received a 30% investment tax credit (or grant) for the installation of a solar array. It is suggested, but unclear, that the homeowner pocketed the 30% credit while the PACE funded 100% of the total installation cost. As a result, the buyer asked for the seller to essentially retroactively apply the 30% received plus the outstanding amount of the PACE obligation to pay off the total obligation early.
After much delay, here’s the question presented by FHFA: why does lien priority matter to PACE bondholders?
Lien priority matters because it provides a measurable certainty of recovery. The higher the priority the greater likelihood that in a sales action (foreclosure or short sale, e.g.), the senior lienholder will be repaid first and in toto. Because certainty of repayment reduces risk, bondholders will accept lower returns in exchange for certainty of receiving those payments.
PACE bondholders, because they are financing a new and yet-unproven model with uncertain repayment prospects, require lien priority to keep rate manageable for borrowers. They should, but rarely receive, a credit enhancement from the sponsoring PACE issuer. In this case, a municipality that sponsors a PACE issuance might provide a ‘moral obligation’ clause to their bond documents suggesting that they will likely repay or provide assurance or repayment to bondholders, but it is rarely enough to provide truly ‘affordable’ interest rates to borrowers/homeowners.
FHFA has obligations to the bondholders of the GSEs; they also provide money with lower expectations of interest paid in exchange for lien priority. Because loans from the GSEs (Fannie and Freddie) are senior to all but property taxes, there is great comfort in the ability of the GSEs to recover their principal investment.
Regarding PACE obligations, FHFA in effect announces that you cannot have a functioning low-interest rate mortgage market if you have a functioning low-interest PACE market. One must be senior to the other, and FHFA claims its product should predominate.
Is this one solution to the challenges of FHFA vs. PACE? The Living City Block program takes a larger, cohesive geographic area and provides funding and empirical guidance to improve the functioning of a city block.
Urban Planning Experiment Coming to 14th and U – Housing Complex – Washington City Paper:
“Here’s how it works: LCB puts in the ‘soft costs’ of bringing in property owners, studying the project area, and coordinating with local politicians and government agencies to integrate power, water, and waste systems. Since the businesses themselves need to put up the capital expenses, though, the initiative depends heavily on making the business case for things like solar panels, geothermal heat, energy efficient piping, and permeable sidewalks. It’s a very easy case for large structures, like the Empire State building. Smaller buildings need to work together to create economies of scale, but older buildings are especially worth saving, since they possess the kinds of walls built for an era before air conditioning. “
Without diving too far into it, if you’d like to learn more about PACE and how to structure these programs from a DOE perspective (including various DOE loan guarantees), read the transcript of this webinar: Solution Center: Structuring Credit Enhancements for Clean Energy Finance Programs (Text Version)
Irritated by my PACE post? Green Landlady has a welcome tonic in the form of HUD’s sustainability initiatives and it’s support for the Energy Efficiency in Housing Act of 2009.
Energy efficiency and green building play a crucial role in housing affordability. Some are concerned that green building adds to the cost of housing. I do not subscribe to that view. I believe that we can’t afford not to build green. Research increasingly shows that all types of affordable housing can be built or rehabilitated to rigorous green standards at a minor additional cost, and often without the need for capital investment. As we dispel the notion that green building will mean higher costs for low income families we must recognize while everyone is hurt by high energy costs, no one is more vulnerable to rising energy prices than low- and moderate-income families. Higher energy costs often result in cutting back on other critical needs, such as medicine and food.
HUD, Money & Green Housing 2010 – via Greenlandlady.com
If you check my Twitter stream, much has been Tweeted of late about PACE bonds (Property Assessed Clean Energy Bonds) and the current imbroglio with the GSEs.
PACE bonds are issued by local governments, with proceeds used to improve the energy profile of buildings. The most politically popular use of these bonds is to retrofit homes and add renewable energy capacity. The building owner repays the funds through an additional assessment on the property tax.
Because property taxes are superior in lien position to the mortgage, the GSEs are anxious that there is now another lender that will be repaid before them in the event of foreclosure.
PACE advocates describe PACE bonds as a simple extension of a state or municipality’s existing right to issue bonds. Typical descriptive language usually reads like this:
Land secured financing districts – which are creatures of state law and are variously referred to as assessment districts, public improvement districts and community facilities districts, among other terms – are a building block of municipal finance and have been utilized for more than a century. They are used to finance projects which serve a public purpose, including street paving, parks, open space, water and sewer systems and street lighting, among others.
All land secured financing districts operate by placing a senior tax/assessment lien on properties which will receive a benefit from the financed improvement. The lien secures a tax/assessment payment that is levied on properties through the property tax bill. Tens of thousands of these districts already exist in this country and are a standard part of the property appraisal, underwriting and disclosure processes.
PACE bonds are usually statutorily approved under the auspices of existing bond creation legislation. They have the following commonalities with a water treatment bond:
1. Issued by an entity with tax levying authority.
2. Repayment sources are individual properties within the affected district.
Here are some differences:
1. Tax levying authority does not design or complete the work directly.
1a. Contractors who actually design and complete the work may or may not be sufficiently licensed or inspected.
2. The improvements are speculative and the anticipated savings may or may not coincide with the period of repayment.
3. A property’s “share” of a water treatment plant is not due upon sale or foreclosure. In a PACE-related foreclosure, that cost can be accelerated and be payable upon foreclosure.
4. If a water treatment plant does not generate sufficient funds to repay the bond directly from user fees, the municipality is typically responsible for the shortfall. PACE bonds have no such mechanism.
Some quick math may illuminate the GSEs unease with the program:
$20,000 in efficiency improvements
6% rate of interest (the municipality may pay 5% to bondholders and keep 1% for overhead costs)
20 year term of repayment (supposed to be less than the lifespan of the improvements)
If you’re using Excel, it should look like this:
=PMT(6%, 20, 20000)
and the answer is = $1,744 (the amount paid for this improvement per year)
or $1,744/12 = $145 (the monthly amount your energy costs must fall to break even on your improvements).
From a lender’s perspective (because the improvements need to be either cost neutral or cost positive to the homeowner), that $145 in savings better be there each and every month or the borrower is not meeting the same income to debt ratio at the origination of the GSE-backed loan. From a lender’s perspective, there are a couple of ways to save money on utilities that don’t involve placing a $20,000 lien on the property. These include:
1. Reducing your energy use.
2. Reducing your energy use.
3. Reducing your energy use.
I’m not anti-PACE and I strongly believe that there is a method to integrate a program like this within a GSE framework. I don’t believe in headline hysteria like this, or this, or this, or this. When you write these types of articles and allow inflammatory link-bait headlines to summarize them, you come across as ill-informed, ill-tempered, and ill-suited to write something that actually advances the conversation toward the desired solution.
The GreenLandlady posts part 2 (of 3) of my interview. In this installment we cover financial incentives, LIHTC, and the multiplier effect of spreading knowledge across portfolios.
Wednesdays with Will Clark: Carbon, Corporate Insight and Uncommon Sense – Green Landlady.
Globest recently published a study conducted by Dr. Sam Chandan, Global Chief Economist at Real Capital Analytics. Dr. Chandan’s study suggests the problem loan challenge will get much worse as more local and regional lenders stumble over bad CRE loans.
The count of US bank failures rose to eighty-three this past Friday when the Federal Deposit Insurance Corporation (FDIC) announced that the Nevada Financial Institutions Division had closed Nevada Security Bank (NSB).
At least 2/3rds of NSB’s loan pool (total of $330 million) was CRE ($204 million. When including construction loans, NSB had a real estate-related exposure of $275 million, which deteriorated as the underlying mortgages failed to perform. According to Globest’s analysis of the FDIC reports, NSB’s default rate on its CRE loans was 10.6 percent in the first quarter, more than double the national average. Alarmingly, the default rate on its construction loans was 25.8 percent.
Dr. Chandan studied 56 bank failures since 2008 to place the failure of NSB and its CRE troubles in greater context:
Across the thirty-six bank failures where commercial real estate was cited the average default rate on commercial mortgages was 11.4 percent in the last quarter during which the bank was active – three times the average bank commercial real estate default rate of 3.8 percent in the fourth quarter 2009. Surpassing commercial defaults, the default rate for multifamily mortgages across the same subset of failed banks was 17.9 percent; the construction loan default rate, 29.7 percent.
The exceedingly high default rates in the commercial, multifamily, and construction loan pools weighed on the failing banks because these loan pools represented a large share of each bank’s total lending. On average, the sum of commercial, multifamily, and construction loans represented 75 percent of net loans and leases at failed banks cited for commercial real estate exposures. 45 percent of the combined balances were in commercial real estate specifically. By way of comparison, the average commercial real estate concentration across all active banks at year-end 2009 was 15 percent. Default rates were generally lower at failed institutions with larger concentrations, suggesting that the absolute count and volume of defaults may be an equally important metric in assessing bank health.
7,721 banks – roughly 97 percent of all active banks in the first quarter – have at least some exposure to commercial real estate. Of these, 565 currently report commercial real estate default rates of at least 10 percent. Even when employing the higher benchmark of an 11.4 percent default rate (the average commercial real estate default rate for failed banks), 440 banks report higher default rates in their legacy commercial portfolios. These banks represent more than 5 percent of all FDIC-insured institutions and 3 percent of the system’s total assets.
via GlobeSt.com – The Latest Bank Failure Fits An Emerging Pattern – Chief Economist Article.
Kim Madrigal, editor of Greenlandlady.com kicks off a multi-part interview with me focusing on NOI and sustainability in the context of special servicing. It was a lot of fun and I’m honored to be mentioned on such a strong site.
“Even if the loan exceeds the current value of the property, if the borrower is paying its debt service regularly, lenders have been told explicitly by regulators that they can treat it as if it’s performing.”
via Banks Embrace ‘Extend and Pretend’ as U.S. Hotels Await Rebound – BusinessWeek.
There’s a touch more nuance here with the comments that banks don’t really want to own real estate (special servicers are less averse) and that a performing loan is one that is paying principal and interest, even if it otherwise fails to meet other requirements such as LTV (Loan to Value) or DSCR (Debt Service Coverage Ratio).
Per the previous post, the receivership and foreclosure laws differ for each state and the District. If you want to see an REO asset manager explode, ask them how the foreclosure process is shaping up in Florida.
Or Alabama.
Or Ohio.
Or Illinois.
Or Connecticut.
Or our bete noire, New York.
After typing this entry, the NYT kindly provided an article about homeowners creating their own version of extend and pretend:
Foreclosure procedures have been initiated against 1.7 million of the nation’s households. The pace of resolving these problem loans is slow and getting slower because of legal challenges, foreclosure moratoriums, government pressure to offer modifications and the inability of the lenders to cope with so many souring mortgages.
The average borrower in foreclosure has been delinquent for 438 days before actually being evicted, up from 251 days in January 2008, according to LPS Applied Analytics.
In some states, including California and Texas, lenders can pursue foreclosures outside of the courts. With the lender in control, the pace can be brisk. But in Florida, New York and 19 other states, judicial foreclosure is the rule, which slows the process substantially.
In Florida, the average property spends 518 days in foreclosure, second only to New York’s 561 days. Defense attorneys stress they can keep this number high.
The full article, “Owners Stop Paying Mortgages, and Stop Fretting” is well worth a read.
It’s an elegant formulation that lenders once more have their heads firmly in the collective sand when it comes to real estate values. Anyone who actually practices real estate lending (banks, servicers, et. al) can tell you that hardly anything is encapsulated in that rhyming shorthand.
“The idea of turning failed condos into affordable homes has ignited New Yorkers’ imaginations, and not just at the radical margins. Ardent supporters include property owners who bought pricey real-estate in the boom, only to find themselves living next door to inactive construction sites. Last June, with elections on the horizon, City Council Speaker Christine Quinn laid out a vision for turning empty condos into living quarters for the middle class. Vacant new buildings, she said, ‘now represent our best asset in the fight for affordable housing.’
The council committed $10 million and asked Bloomberg to do the same. In July his administration agreed, funding a test of what it dubbed the Housing Asset Renewal Program. In exchange for making half of the apartments affordable, developers of struggling condos receive payments of $50,000 for each of them, $75,000 if they become rentals.”
Gentrification Hangover | The American Prospect
Really? $10mm? Think that will get it done in New York? I disagree. If all of the money is spent on condos, the plan saves 200 units, assuming condo fees are waived. If the money is spent on rentals, it saves 133 units. That would be noticed in a council member’s district, but would hardly rate a mention at the Borough level, much less for the City.
Still, here’s one property where it might make sense: a 6-unit (all 1BR) property in Bed Stuy, Brooklyn:
According to the listing at Massey-Knakal, this 6-unit building is offered for $995,000 or $165,000 per unit. Under the NYC plan, the property could receive up to $75,000/unit ($450,000) for conversion to affordable rental housing. If the property were with a special servicer, the unpaid principal balance (UPB) could actually be $995,000. If this were my deal, I’d probably let it go for $600,000. It’s a 66% recovery on a loan that would otherwise be stuck in foreclosure purgatory. Better to push it out than try to find a manager for a deal this small.
All of that assumes that as a lender I can get control of the title. Right now it takes anywhere from 16-24 months to foreclose on a commercial property in New York. Indeed, statutes anticipate a 445 period. As a lender, I cannot stipulate a receiver (who collects rents and operates the property on behalf of the court and remits funds to the mortgagee) which means that it typically falls to the fishing buddy or in-law of the judge. Consequently, there is no guarantee that a person with experience in the operation of real estate will manage a property. During the time between appointment of a receiver and a foreclosure sale, the property can fall further into disrepair, value can be eroded through poor operation, or the borrower can continue to interfere with the process.
Why aren’t banks selling these properties? Because they don’t own them, they can’t force out delinquent borrowers, and no one else has the patience to wait out the process either.
There’s absolutely extend and pretend, even in CMBS, but there’s also a huge logjam in the foreclosure process. Until New York state and others examine their processes, they will continue to be annoyed by see-through buildings they can do nothing about.
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