Derek Brown is managing director and co-founder of Clean Fund LLC, a specialty finance company that invests in commercial PACE bonds. He is responsible for working with energy service companies and commercial property owners to identify PACE-eligible projects and to structure the PACE terms for those projects.
Prior to Clean Fund Derek worked with Solar industry leaders such as SunPower, Fat Spaniel and Shoals Technologies on product strategy and market development. Other accomplishments include building and managing Apple’s software business for Europe and launching 3Com’s Macintosh products business. Derek’s finance work was in corporate finance for Smith Barney and venture capital with Whitney Ventures.
Solar Server: Explain for our readers what PACE financing is, and how it differs from other forms of financing?
Derek Brown: PACE is a municipal finance structure that solves the collateral challenge commercial properties have with obtaining financing for solar and energy efficiency improvements. PACE uses a special tax assessment to support long-term financing. This is how community benefit improvements in the U.S. have been funded for a hundred years – things like fire houses and schools.
The breakthrough of PACE is that commercial building energy improvements can now access 100%, upfront, long-term financing at attractive rates. No longer does a solar system with have 5-10 year payback have to compete on an ROI basis for the property owner’s scarce capital. With 100% external financing the “I” goes away and cash flow becomes the project benchmark. When you can finance a 7 year simple payback solar system over 20 years there’s a cash flow that literally comes from the sky.
Apart from the financing long term the PACE structure has a number of advantages for the commercial property owner. First, the PACE assessment is an obligation of the property and not the owner, and it simply transfers with the property in the event of sale. This allows short term owners to profitably make long term improvements.
Second, the property owner typically owns the improvements outright, which in the case of solar means they get any and all tax incentives, utility rebates and production incentives, as well as the entire value produced by the system.
Third, some common commercial lease structures allow property taxes to be passed through to tenants. So instead of tenants enjoying all of the benefits of energy improvements through lower utility bills but paying none of the costs, now tenants bear the costs and benefits. With economically rational, cash flow positive projects, tenants get a net benefit that would be hard to complain about.
Solar Server: I recall the excitement around the PACE program for residential financing in the United States in 2009, before Fannie Mae and Freddie Mac essentially crushed the movement. Will PACE as a nationwide movement be revived in the commercial sector?
Derek Brown: Yes, and that is happening. There are commercial PACE programs turning on across the country. Most of California is already covered by active commercial PACE programs.
We’ve learned that we need different programs for commercial PACE as opposed to residential. For one thing you don’t have the big consumer protection element of residential, and commercial properties need customized project finance, as opposed to one-size-fits-all consumer finance.
Commercial PACE programs can be very simple and inexpensive to establish and run. The City of Edina, Minnesota established a program in response to a request from a local solar integrator and a local property – at a total cost of $11,000.
On the residential side let’s just say that the regulatory situation has not been clarified yet. The evidence from the Sonoma County PACE program is that the regulatory fears about residential PACE are not justified. We’re all hopeful residential will get a green light, which will accelerate momentum on the commercial side even more.
Solar Server: What sort of impact do you think PACE is going to have on the commercial solar market in the United States?
Derek Brown: In a word, dramatic. PACE solves the #1 problem commercial properties have obtaining solar financing – credit. PACE finance is at its heart based on property value, not credit. My firm, Clean Fund, has been at the forefront of commercial PACE finance for 3 years. When we negotiate financing for a project we focus on establishing property value. We don’t even ask for financials until closing.
PACE also solves what for many properties considering solar is a #2 problem – how to repair/upgrade their roof before putting down a 25-30 year solar system. Cool roof improvements are energy efficiency measures that qualify for PACE and can funded through the same financing that covers the solar system.
Currently, because of the tax-based incentives for solar, projects pencil best if the property owner has the tax appetite to fully monetize the tax benefits. PACE is injecting up to 100% financing at fairly attractive, 20-year interest rates, 6 1/2% to 8 1/2%, depending on the project. Depending on local electricity prices, if the owner is able to monetize the tax benefits, 20 year PACE financing can allow a solar system to pencil nicely.
For the many commercial properties with low tax appetite we need to bring in third-party ownership structures that allow tax investors to monetize the tax attributes. The basic model is for the property owner a portion of the system cost through PACE and use the funds to pre-pay a lease or a PPA. The project owner then needs to guarantee power production value at least equal to the property owner’s PACE payments.
The first projects using this sort of structure are currently in the proposal stage. The potential is vast, as many commercial properties have little ability to use tax incentives. Keep in mind commercial PACE can be used to finance privately owned non-profits like churches, hospitals and schools. While these entities may not currently pay property taxes, in most places that are able to voluntarily assume a property tax assessment, which is what PACE needs to work.
Solar Server: What are the main barriers to the spread of the PACE financing model for commercial solar installations?
Derek Brown: The main barriers have been limited geographic applicability and the simple fact that PACE is new.
PACE is geography-specific as a city or county needs to have a program to make the local tax system available. Most commercial PV integrators in California cover a large territory. When PACE only applied to a small portion of that territory, the integrator
had better things to focus on. But now that most of the state’s population is covered, PACE has the potential to transform an integrator’s business. Clean Fund is now working with a number of integrator partners on incorporating PACE finance into their sales and project processes.
The second PACE barrier is newness. Most commercial property owners still standing after the recent economic roller coaster aren’t lining up to try something new. But commercial PACE isn’t that new any more. Sonoma County’s groundbreaking commercial program has been running for several years and has funded over 50 transactions – the majority of which involve solar. Most notably, Simon Properties, the largest mall owner in America, has done two PACE financings through the Sonoma program.
This past week there was very big news with the announcement of the first financing through the City of San Francisco PACE program. And the property owner is Prologis, the largest owner and manager of industrial real estate in the world.
The project developer is Johnson Controls, one of the leading energy services firms in the world. Clean Fund was the capital provider – I won’t make an “in-the-world” claim for ourselves but our participation in the deal does speak to our specialized expertise.
But it’s a big deal that now commercial property owners – as well as integrators – can look at PACE and see projects being done by firms like Prologis, Simon Properties and Johnson Controls.
You can look at this and say these are conservative organizations. If it passes their test, this must be something work investigating.
Things are looking really good this morning for commercial PACE for solar. This project in San Francisco was actually a multi-measured one, which is even better. There was a 200 kW PV system, as part of the project, but there is also LED lighting and retro-commissioning. This one touched all the bases, which is nice.
Solar Server: Outside of California, what other locations have enabling legislation for commercial PACE?
Derek Brown: There are two levels to that question. First there needs to be state-level legislation in place to empower local cities and counties to do PACE – and 28 states to date have this. What this legislation does is say renewable generation and energy efficiency are measures in the public good and hence can be supported by tax-lien finance.
This state-level authority is a necessary condition for local programs. Just because there is state legislation in place doesn’t automatically translate into a local program. For a state to do this is fairly simple and non-controversial.
Have a look at the PACE map at PACEnow.org. This is the industry website and has the most up-to-date tracking of PACE programs, both residential and commercial. It’s a great resource for people in both the private and public sectors.
Pretty much all of California is PACE-enabled or moving that way. Florida has a number of programs turning on, Connecticut is looking to do PACE state-wide, the District of Columbia is moving quickly, and almost every week activity is turning up in places like New York, Ohio, Minnesota, and Michigan.
The good news is that a commercial PACE program can be a fairly easy thing to turn on, if you keep it simple. And we are seeing instances where a local business owner and a local integrator go to their city council or county board of supervisors and say “Hey, we have some job-creating projects that we can do, if you give us a PACE program”.
And that’s what happened in Edina, Minnesota, where they turned on a great program for $11,000, which was covered by a grant. PACE is something where local initiative can make things happen.
Solar Server: Is there anything else that you think is important for our readers to know about commercial PACE?
Derek Brown: In closing let me go back to the new math that PACE enables – you can sell solar projects based on cash flow instead of ROI. Combine the project economics with the PACE financing terms and put cash flow numbers on the table.
One thing I should touch on is the issue of mortgage lender consent. Most commercial PACE programs were designed with input from commercial mortgage lenders, and as a result explicitly protect lender interests. Most programs give a lender absolute authority to approve a PACE project on a property where they hold the mortgage – and this is a good thing.
The initial fear that lenders would not approve projects has been decisively proven wrong. Projects with demonstrable economic merit – and where the property owner has a good relationship with their lender – are being approved. That said, property owners may not have the PACE knowledge and lender expertise to do this on their own, but that is a capability that Clean Fund and a few other PACE capital providers are able to provide.
Thank you for the opportunity to share this perspective on PACE finance with you and your readers!
by Solar Server International Correspondent Christian Roselund
November 14th, 2012
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