PACE: Battle of the Bondholders

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.

DOE: Structuring Credit Enhancements for Clean Energy Finance Programs

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)

Carbon, Corporate Insight and Uncommon Sense – Green Landlady

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.

Compartmentalization in high rise multifamily buildings

If you’re not taking advantage of Green Building Advisor’s Community Forum, you’re missing an ongoing course about building science for non-scientists.

Here’s a link to some nuggets on multifamily compartmentalization:

Compartmentalization in high rise multifamily buildings | GreenBuildingAdvisor.com.

Sustainable seniors housing in Charlotte

The red-brick walls hide features that are expected to earn the building LEED Silver designation, the second-highest of four levels. Extra insulation and energy-efficient windows line the walls. Appliances and lighting earned the government's Energy Star label. Water-saving fixtures and landscaping of native species will cut its water use.

The building’s walking distance from shopping and transit means its aging residents will have nearby services.

via Affordable, green housing will be partnership focus – CharlotteObserver.com.

Operations: Sustainable sites lead to simpler life

San Marco, a Walking Oasis in Jacksonville, FL. Every neighborhood has some walkability or simple mobility element.

In the prior post on LEED v3 changes, I touched on the sustainable sites requirement. Essentially LEED is attempting to encourage a bit of smart growth by reducing the number of vehicle trips generated by development (and separately develop in areas with existing infrastructure or minimally disturbed greenfields). For this post, I’m focusing on existing communities that either are not actually or do not consider themselves sustainable sites.

Operationally, you can create a sustainable site by studying your neighborhood, using resources such as Yelp, Urban Spoon, and other location-based web services to help residents find their way. For those exploring social media, culling local event listings provides great fodder for resident-focused Twitter feeds.

Celebrating or publicizing neighborhood based events, services, or vendors enables managers to serve as (apartment) community resources, local economic generators, and pushes the apartment community into the center of a resident’s life, rather than simply a place to sleep. Understanding and sharing information about locally-based resources puts a little more meat to the notion of “Life made simple.”

Focusing on your immediate surroundings improves your local outreach efforts by showing businesses 1) your property is a part of the neighborhood, not just a parcel; 2) better acquaints you with the employers and employees of the neighborhood. Finding potential residents within your local surroundings greatly improves the chances of renewal, and I strongly believe reduces your overall marketing costs.

As an operationally-focused asset manager with a portfolio of over 50 properties nationwide, I consistently found that 35-50% of my new resident prospects came through drive-by. When added to the number of resident referrals, that number was consistently between 40-65% of total applications. Signage, landscaping, and general appearance (all of which affect existing residents as well) is a far stronger indicator of the living environment than a static print ad. Reaching prospects while in the context of searching for a new home and residents while in the context of their daily life is a better use of marketing efforts because it provides something of use to your customers. Very few management companies do this well and with such a low hurdle, any sustained effort is appreciated.

At every property visit, in every conversation with managers and leasing agents, I asked some variation of the following questions, my keys to a ‘sustainable site’:
1. Do you know where you are? Do you know how to get here?
2. Who lives here and why?
3. Where do your residents work?
4. What is there to do around here?
5. Where is the nearest park, house of worship, child care center, grocery store, and school?
6. How do you involve the property with the surrounding community?

If you can’t identify your property as part of a larger community and explain that role to a resident, you’re not trying to improve sustainability, you’re not looking beyond your property line, but most damning, you’re not trying to make life simpler for your residents.

News: WBJ summarizes LEED v3

The Washington Business Journal provides a quick summary of changes in the new LEED 3.0 standard.

The standard implements and expands upon a few items I’ve written about before, specifically “sustainable sites” as part of a post, “Where does your life take place?” and “Needs more data”.

From an operational perspective energy tracking and reporting requirement (LEED requires reporting to the USGBC for 3-5 years) is the most important improvement from prior versions. Tracking and analyzing energy usage, comparing to baseline, and looking for additional efficiencies should be the most lasting legacy of this LEED version. While the reporting requirements have invited animated discussions, using energy analysis to improve LEED and all building science provides the path toward cost savings and greater loan proceeds (two items close to any developer’s heart).

I’ll have a short post on additional operational implications shortly.

Operations: Live monitoring of electricity use works

Since Earth Day, I’ve been following Energy Circle’s energy monitoring experiment. With the combined resources of a household electricity monitor and Twitter (plus an assist from some Google-fied graphics) they are nearly 90 days into a fascinating experiment.

With a reasonable passage of time, it was appropriate to provide an update. In this case, Energy Circle advocates that real-time monitoring works (24 hours later doesn’t).

You really should follow through for the full story, but here are the main reasons:

1. Spikes Hurt.
2. Baseload Matters.
3. Our house has a heart beat.
4. Humans screw up.
5. The right tools are critical.
6. Data=Action.
7. Some bulbs really cost you.
8. Efficiency is a family matter.
9. The little shifts count.
10. Real-time leads to a real map of action.

Operations: Capturing rainwater, reusing graywater

Way out West, water use issues are much more pertinent than they are in the East. Well, maybe. [National view from Drought Impact Reporter.]

Regardless of location, water usage will be reduced through legislation, co-option, construction, or consumer choice.

To help us along, Multifamily Water Systems appears in the May issue of Builder News to provide definitions, discuss existing technology, and identify current and proposed legislation. It’s a strong article that covers a lot of ground.

Where should you look for this reusable water? On your structure, upon undeveloped land, and within the units:

Grand Unifying Theory of Sustainability (pt. 1)

Over the next few weeks, scattered amongst posts on GAO and HUD, the latest upheaval with LIHTC, and hopefully some more tales from the trenches, I’ll be attempting to outline my thoughts on what it will take for building sustainability and sustainable operations to become part of the vernacular. I’m starting with the aspect I’m actually least familiar with, insurance.

Insurance, by popular understanding, hedges against the risk of contingent loss. By varying pricing based on operations, materials, and design, insurance serves as a nudge to encourage lower risk profiles. In theory at least. We’ll leave unresolved questions about whether this risk reduction is always well reasoned or if you really get better pricing through these changes.

So it was unsurprising to read in Ceres’ new report “Risk to Opportunity” that insurers are moving from superficial PR “towards [thinking] more deeply and strategically institutionalized and embedded in the operations of companies.”

Climate change is becoming recognized as an issue of Enterprise Risk Management, spanning underwriting, asset management, and corporate governance.

One of the most constructive developments is more products and services focused on ensuring the quality of the customer’s energy or carbon savings efforts. These include performance insurance for renewable energy systems, coverage for green buildings that don’t deliver promised performance, and products that apply to carbon offset and trading activities. In all cases, loss-prevention takes the form of due-diligence, scrutiny of engineering assumptions, preventive maintenance, commissioning, measurement and verification, and other constructive interventions to help ensure project integrity and success.

Although released in April 2009, the report covers products existing or introduced in 2008. In many ways, the finding that some insurers were moving much faster than others led to the March 2009 action by state insurance commissioners to require that insurers reveal exposures and responses to climate change. How this will be enforced and what the ‘right’ answers are will be revealed when the responses are provided in March 2010.

[Note: The quote above was taken from an interview with study author Evan Mills with Climate and Insurance.org, an arm of industry advocate NAMIC, which does not like (really doesn't like) the new climate exposure mandate. Ceres retorts that "Insurance trade organizations remain relatively disengaged on climate change." Plus ça change, I suppose.]

Why does this matter? Because outside of government and its multiple layers, insurers and financial firms are best positioned to promote the systemic change in the built environment needed to achieve goals like Net Zero Energy, Architecture 2030, or multi-family specific programs like Greener Communities.

Insurers are perfectly placed to make the case for unifying “green” and “disaster-resilient”
practices across many domains (construction, energy, agriculture, land use), yet scant effort has
been exerted in this regard. It will become increasingly incumbent on insurers to demonstrate
the loss-reducing benefits of the green technologies and services that they reward. Loss-prone
infrastructure cannot be truly “sustainable”.

It’s worth recalling this recommendation from “Resilient Coasts”:

“Wise investing will involve asset managers understanding the impacts of climate change on their investments and managing that risk, especially in real estate, infrastructure and other financial instruments. Responsible banks will need to understand the levels of exposure within their investment and lending portfolios by incorporating climate risks into their due diligence.”

Change is coming in a thousand different ways from code changes, insurance, finance, builders, housing agencies, governments, and most importantly, residents. We’ll start addressing the financial world in short order.

Needs More Data

One of the reasons this blog started 99 posts ago was to encourage more data and greater awareness for sustainable methods and materials in multifamily housing.

Eighteen months makes a big difference as both data and awareness have increased as all participants recognize the necessity of accurate and actionable information. States like California require energy labeling, LEED now requires multi-year access to building performance, and the Federal government is getting into it, either through GSA’s Sustainable Design Program or through better use of existing resources such as HUD financial data.

Just as the brewmaster proclaims that Red Tick Beer “needs more dog“, I say that we need ever more data on building performance. We need building scientists, architects, builders, and engineers to better understand things like whole building design and sustainable construction (and waste) methods. In multifamily, we must understand not only the initial efforts of sustainability, but the ongoing need to consistently review the physical plant, operate sensibly, and dispose correctly.

Most importantly, however, we will need the financial world to come around. That means more information on operating expenses, projections for increased costs and an understanding that building sustainably means building differently. If underwriters and credit officers do not make the effort to understand how the regulation, construction, and operation of buildings have changed, then we cannot move forward with needed haste.

I’ll have more on the best bets to move forward in the next posts.

GAO and HUD: What does HUD get for $5B a year? (pt. 1 Summary)

I’m finally beginning a series on GAO’s “Green Affordable Housing” evaluation of HUD’s sustainability efforts.

[Among the many recommendations GAO makes is that HUD collect more and better data about operational costs. The GAO recommendation does not highlight specific data to be collected, but using the LEED v3 "Whole Building Energy and Water Use" requirement: per page 19, it looks like it's just 5 years for LEED-CI. More to come on that.]

GAO wrote the report in part because “[HUD] spends an estimated $5 billion—more than 10 percent of its budget—on energy costs, either directly in the form of public housing operating subsidies or indirectly through utility allowances and contracts for assisted multifamily housing. [HUD] does not have the data necessary to understand the breakdown of these costs or the potential savings opportunities of green building for
many of its programs.”

HUD already provides resources and training and a very, very modest financial incentive to pursue energy efficiency. What I like about the GAO report is its emphasis on using NGO, regional and national sustainability measurements and cribbing the state-level LIHTC incentives for use in HUD projects. This would encompass water use reductions, sustainable material use, and indoor air quality improvement in addition to promoting energy efficiency.

GAO also reminds us that HUD can exercise financial levers: directly through debt financing, Community Development Block Grants, HOPE VI; and indirectly through its support for PHAs and Housing Assistance Vouchers. In addition, HUD’s Office of Policy Development and Research promotes building science and the advancement of durability, energy efficiency, and affordability of housing.

Unfortunately, standard who-pays-for-what conflicts arise in HUD’s relationships with local Public Housing Agencies (PHAs). Writes the GAO:

Some HUD programs offer incentives for energy conservation measures. PHAs receive funds from HUD’s capital fund that may be spent on energy conservation measures, but HUD officials told us that these funds are generally insufficient to cover both the up-front cost of many energy improvements and ongoing repair needs.5 HUD’s operating fund standard rules provide a disincentive to implementing high-cost energy improvements. According to HUD officials, a PHA’s annual operating subsidy is based in part on the prior 3 years of utility consumption, which would be expected to fall in the years following such improvements. This “3-year rolling base” policy allows PHAs to retain 75 percent of savings from reducing utility consumption over a 3-year period, but according to HUD officials, PHAs cannot retain enough savings over this short time to recoup the up-front cost of many large energy efficiency improvements such as high-energy-efficiency boilers.6

It should be noted that these large-scale sustainability initiatives can be met through the use of an energy services company (ESCO) such as Honeywell. Recent regulatory revisions by HUD have improved the processing of these contracts, allowing faster review and longer payback periods. Per the GAO, 195 ESCO contracts were in place in 2007, saving an estimated $50mm annually.

Overall, GAO provides sensible, affordable recommendations for further action. HUD should use third party mechanisms for efficiency benchmarking, collect sufficient information from Section 8 projects and residents, and emphasize (and reward) energy efficiency when awarding grants or in its various lending programs.

These recommendations could have a welcome and systemic impact upon all of multifamily construction, portfolio operation, and lending. We’ll talk more about this in subsequent posts.

Better Homes: We can rebuild them. We have the technology.

A couple of articles came on construction techniques came across the transom in the latest issues of Builder and EcoHome magazines.

The first article summarizes the traditional with a twist methods used by FirstCoast Homes to achieve Energy Star-ratings for all of its starter and move-up homes. Their efforts combine design, construction technique, and appropriate appliance upgrades, which limit the total cost to an estimated $1,000 per home.

[Note: As always, I try to bring additional value via hyperlinks. Take a look at all of them for additional information]

The 5 ways revealed to Builder:
1. Improve upon traditional methods through proper installation and 3rd party evaluation of various systems. Be sure to read this ode to traditional techniques from the February 2008 edition of EcoHome.
2. Build a tighter envelope through foam sealing penetrations, caulking baseplates, and use low-expansion foam around portals. These techniques and more reduce potential air intrusion “by about 30%,” according to FirstCoast. Duct blaster and blower tests ensure that the building is tight before the irreversible work begins. (Johns Manville believes 5-25% of ducted air is lost through leakage.)
3. Correctly install the right insulation by using a mix of foam around penetrations and fiberglass elsewhere. Make sure contractors install it right and protect it from crushing, moisture, and other damage during buildout.
4. True value engineering identifies areas to spend smarter, not just less. By reducing the number of windows, FirstCoast reduces the direct cost of windows, but also the size of the HVAC system, saving an additional $400-800 per house.
5. Identify other revenue sources by working with utility companies, and government incentives to reduce the cost of homes, appliances, and testing.

At sister publication EcoHome, green building consultant Mark LaLiberte highlights 5 common errors made in all construction:
1. HVAC ducting through unconditioned space needlessly reduces the effectiveness of your heating and cooling system. Put the ducts in soffits or between floors to maintain their ambient temperature. Research from WSU provides great detail on HVAC in conditioned spaces.
2. Tightened envelopes without intentional ventilation can cause stale air, odors, or moisture to accumulate. Install a whole house ventilation system to bring about 50CFM of fresh air 3-4 times per hour.
3. Improper flashing and drainage leads to moisture buildup and reduces the effectiveness of insulation and moisture barriers. Multifamily folks know all to well the hazards of moisture and mold growth, so this should be well-trod ground. For additional information, Freddie Mac offers a Moisture Management Plan to help identify sources of moisture build up.
4. Poorly installed/selected installation reduces energy efficiency and adds to costs (see above). Exposing it to moisture during the installation process can cause a cascade of additional systemic failures. Watch out for improperly insulated thermal bridges, particularly metal studs that have contact with exterior surfaces. This can be an unfortunate method of reducing the effectiveness of your HVAC system.
5. Excess waste leads to excess costs and can be offset by better reuse of construction materials but more importantly through increased standardization of all materials. All systems have a ‘commodity size’ and making use of these common measurements reduces the potential for waste and on the interior, unsightly seams.

Rent Green: Useful links for further reading

We’ve mentioned previously that the Intertubes are full of information about living sustainably. A couple of articles on “Green Renting” might be helpful to fill out your knowledge:

1. Utne Reader’s “Green Renting Revolution” (January 2009) By the way, failing to include links in your article is just not acceptable in 2009.
2. Green Renter, provides a small (but growing!) database of self-selected ‘green apartment communities’ in major metropolitan areas. I think there’s still more work to be done, but additional information can be found courtesy of Sustainable Industries.
3. National Geographic (!) provides a smooth interface to some useful information at The Green Guide. The Home & Garden section shares useful information about household cleaners.
4. Apartment Therapy posts eclectic items on apartment living. One of their recurring features is a focus on small spaces. You can find more of this vein by using a tag search.
5. Planet Green has a multi-page discussion via one of their “How-to” guides. They include a helpful 10 point list of property tips. (additional How-to guides available)
6. Grist’s Umbra Fisk lists some ways to be a Greener Renter.

(Image by Peter O. Zierlein / www.peterozierlein.com)

Rent Green: Coffee Grounds and Eric Corey Freed

Shamelessly appropriating the theory behind “Can’t Someone Else Do It?, EPA’s Greenversations posted a recent article about reusing coffee grounds. Among the uses were:
1. Composting or fertilizer
2. Dye paper
3. Flea (and odor) repellant (!)
4. Grease absorption

In our townhouse, coffee grounds are sprinkled around exterior door and window sills to repel ants for an effective and pet friendly insect barrier.

Two weeks ago, Eric Corey Freed, author of Green Building & Remodeling for Dummies offered tips on a greener home to the New York Times. For “space reasons” the NYT only ran 5 of the tips, causing Joe Romm at Climate Progress no end of distress for highlighting impractical, overly simple, or questionable recommendations. Additional correspondence revealed that the NYT cut Eric’s list of 21 to a random 5. Leaving aside the somewhat heated and holier-than-thou storms that occasionally blow across the green world, Joe also embraced the “Can’t Someone Else Do It?”. He linked to, and critiqued, “100 Ways to Conserve“.

Taking just Freed’s 21, many can be used in a rental situation, including:
1. Insulate and turn down the water heater to 125F. (And use the vacation setting)
2. Reduce the amount of water flushed.
3. Replace incandescent bulbs with CFL.
4. Turn off unused lights and electronics.
5. Replace thermostat with a programmable model. Even on a 60 year old house with 80 year old wiring, it only took me about 15 minutes.
6. Request low or no VOC paints.
7. Caulk or seal around tubs and windows. Weather seal doors.
8. Install a low flow showerhead. I replaced one a few weeks ago.
9. Never buy bottled water again.
10. Install a ceiling fan (sometimes you can get one installed at lease renewal).

(Via Greenversations and Green Building Law Update.)