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Simon taps Pace bonds to fund energy projects

April 8, 2013

Solar-energy installations are set to receive record loans this year through a U.S. municipal finance tool modeled after one that backed $17 billion of sewers and sidewalks in the past decade.

Indianapolis-based Simon Property Group Inc., the largest U.S. shopping mall owner, and Prologis Inc. the world’s biggest warehouse owner, are among borrowers funding projects from rooftop solar panels to energy-savings systems using so-called Pace financing. Pace bonds, sold by cities to investors, are repaid over decades by property owners through their real estate taxes.

As banks become less eager to provide long-term capital for renewable energy, Pace bonds offer a way for property owners to fund projects and for investors to capitalize on clean power. Formally known as property-assessed clean energy, the format failed to catch on big with homeowners and is making headway with commercial borrowers. Agencies that arrange Pace loans estimate more of them will be made in 2013 than in the past four years combined.

“This will be the year that we start seeing deal flow,” said Jessica Bailey, director of a Pace program in Connecticut that began arranging loans in January. “This will be the year where the concept of Pace as security for investment is proven out.”

Deutsche Bank AG estimates that U.S. building owners will spend $280 billion through 2022 on systems that reduce power bills, including LED lighting, solar panels and software that manages electricity usage.

The Pace model is an update of so-called special assessment bonds, a financing tool devised more than 100 years ago to fund infrastructure projects that are repaid through property taxes.

There may be a record $150 million in Pace loans extended for rooftop solar panels, energy-efficient LED lighting and power-management systems this year, according to David Gabrielson, executive director of PACENow, a Pleasantville, N.Y.-based advocacy group. It’s an example of the new sources of financing that have been created in recent years as investors show growing interest in renewables.

Pace loans had a slow start since the first program was created in Berkeley, Calif., in 2008, partly because of doubt over their treatment in defaults. They have supported just $121 million of clean-energy projects at U.S. residential and commercial buildings in six states, according to estimates from PACENow.

In contrast, about $17 billion in special assessment bonds were issued for projects such as street lights, community centers and underground water systems just in the past decade, according to data compiled by Bloomberg.

Simon Property used about $2 million in Pace financing for three energy-efficiency projects in California and Ohio. The long repayment period makes the loans attractive, said George Caraghiaur, Simon Property’s senior vice president of sustainability.

“You can finance these projects over a long enough period of time that the energy savings pay for the assessment,” he said. “It makes sense.”

Prologis began its first Pace-funded project in November, a $1.6 million effort at its San Francisco headquarters that includes energy-efficient lighting and rooftop solar panels. The company is considering similar financing for retrofits at some of its Southern California buildings, according to Aaron Binkley, director of sustainability programs.

“Our hope is that in a short amount of time the market far eclipses this one individual, small project and there’s a lot more volume,” Binkley said. The San Francisco project is expected to reduce the building’s energy use by about a third, shaving off $98,000 in annual costs.

Clean Fund LLC, a San Rafael, Calif.-based company that provides Pace financing, funded 90 percent of the project by buying a 20-year Pace bond that pays 6.93 percent, according to Managing Director Derek Brown. That’s more than double the yield on 30-year U.S. Treasury bonds, which are about 2.87 percent.

“It’s got a really nice yield” that’s taxable by the federal government and not the state, he said.

Pace financing was initially intended to fund residential and commercial projects. Loans to homeowners sparked legal disputes over concerns that debts used for clean-energy projects may take priority over mortgages in a default.

Pace programs are now focusing on business properties, a move that may spur widespread use, said Bailey, from the Connecticut Property Assessed Clean Energy program. The state has 36,000 commercial buildings, and retrofitting a tenth of them with systems to cut their power bills by about 20 percent will take at least $164 million in investments, she estimated.

The program may finance about $20 million worth of projects within six months to a year. Wells Fargo & Co., Citigroup Inc., Clean Fund and Ameresco Inc. are among the eight lenders that have agreed to provide loans.

Once Pace financing becomes more widespread, the debts may be bundled together, Caraghiaur said. “Ultimately, they’ll be able to securitize these loans in bigger chunks and sell them off like mortgage-backed securities,” he said.

“That’s the big goal, to bundle a bunch of these Pace loans together and create a secondary market,” said Clay Nesler, vice president of global energy and sustainability at Johnson Controls Inc., the energy-efficiency technology provider that’s working on the Prologis project.

Twenty-eight states and the District of Columbia have approved the use of Pace financing and there are 16 programs arranging loans in seven states, according to Nesler.

“We are very hopeful that 2013 is a bellwether year for this,” he said.

Ygrene Energy Fund Inc. arranges Pace loans in Sacramento, Calif., and expects to expand into Miami and Atlanta later this year, according to President Dan Schaefer.

“We’ll probably have 1,000 contractors on board by the middle of this year,” Schaefer said. “We think it’s going to be an incredibly powerful momentum builder for us.”

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