Healthcare Energy Financing Primer
The healthcare sector accounts for over 4.1 billion square feet of floor space in the United States and spends over $5 billion annually on energy. Energy costs can consume 1-3 percent of a typical healthcare facility’s operating budget, which often represents an estimated 15% or more of profits. The sector has been a market leader in the adoption of innovative internal funding strategies for energy projects, and other common financing solutions for energy efficiency and renewable energy include leases, loans, and energy savings performance contracts (ESPCs).
This primer serves as an introduction to critical issues in energy finance for healthcare facilities. It provides case studies, market data, and other resources to help leaders in the sector take advantage of innovative financing strategies. The primer is part of the Better Buildings Financing Navigator, an online tool that helps public and private sector organizations find financing solutions for energy efficiency and renewable energy projects.
Common Barriers to Energy Financing
Many healthcare facilities have a range of competing priorities—including their core mission of treating patients—that all seek funding from operating and capital budgets.
Healthcare facilities may require a high minimum rate of return on certain investments (including energy improvements) because they could also deploy the capital into other high-return investments.
Healthcare executives tend to be risk-averse as many facilities must operate continuously with uninterrupted electrical power and building systems. Concern over impacting the ability to provide medical services may cause resistance to pursuing energy projects that are perceived as risky or low-priority.
Healthcare facilities that must operate continuously may face limitations on which projects are feasible to implement or challenges to installing equipment.
Limited staff capacity and/or lack of financial or technical expertise in energy efficiency and renewable energy may prevent healthcare organizations from exploring potential projects.
Common Financing Solutions
Many healthcare facilities have established internal funding strategies such as capital budget allocations or green revolving funds to implement projects without accessing third-party capital. Read more.
Performance contracts (sometimes called ESPCs or EPCs), in which an energy service company (ESCO) coordinates installation and maintenance of efficiency improvements in a customer’s facilities and is paid from the associated energy savings, are an option for healthcare organizations with large projects or multiple smaller projects that could be aggregated under one agreement. Read more.
Healthcare facilities may use lease financing to directly lease energy equipment or pay for the costs of an ESPC. This may include capital leases or, for public organizations, tax-exempt leases. Read more.
There are a few unique characteristics of the healthcare sector that affect how an organization may choose to approach financing for energy projects:
Building ownership: Healthcare facilities rarely change ownership, allowing owners to consider taking a long-term investment approach.
Building size: Hospitals and larger healthcare facilities are often a good fit for financing solutions that can fund multiple projects across a campus or complex, such as performance contracts and green revolving funds.
Operating characteristics: The continuous operation of many healthcare facilities, along with stringent environmental and operational requirements, may create additional challenges to project planning or increase costs.
Non-energy benefits: Non-energy benefits of efficiency upgrades can help to build the business case for energy projects (especially for projects with lower return on investment). Improved lighting, HVAC, and other building systems can lead to better patient experience, improved health and indoor air quality, and higher quality of care.
Incentives: Healthcare organizations may be eligible for utility and/or regional tax credits, rebates, and other savings opportunities that can help to lower the overall cost for energy efficiency and renewable energy. For more information on available opportunities, visit the Database of State Incentives for Renewable Energy and DOE’s Tax Credits, Rebates, & Savings Database.
Many healthcare organizations are using internal funding options to pay for energy upgrades without accessing external capital. This is often the most simple and direct method for funding projects, and it allows the organization to capture the full financial benefits of energy projects rather than paying a portion to a financing provider. Some organizations have established centrally managed internal funds to help structure their own investments in sustainability projects. These include green revolving funds, CapEx funds, and other types of dedicated capital pools set aside for a specific purpose. These funds can have benefits including building a clear business case for sustainability, streamlining the budgeting process, and demonstrating a company’s long-term commitment to sustainability. Additional information on green revolving funds can be found in the Green Revolving Funds toolkit.
Healthcare organizations with limited budgets for energy projects can seek external financing options to cover the initial cost of project implementation. Energy Savings Performance Contracting (ESPC) has been a frequently used solution to implementing energy upgrades across the sector. Under an ESPC, an energy service company (ESCO) coordinates installation and maintenance of efficiency equipment in a facility (or bundle of facilities for portfolio-wide initiatives) and is paid from the associated energy savings. The ESCO typically provides a savings guarantee, and the improvements are usually owned by the customer and may be installed with little or no upfront cost (if the ESPC is financed). ESPCs are typically better suited for larger projects ($500k+, and often $5 million+), and the scope of healthcare projects is often large enough to meet these thresholds.
ESPCs can be self-financed if the healthcare organization has enough cash on hand, or it may seek financing from a third-party lender to cover some or all of the upfront cost. The majority of financed ESPCs are backed by an on-balance sheet financing mechanism such as a loan or capital lease. Under these structures, the healthcare organization owns the equipment throughout the financing term. According to a recent Lawrence Berkeley National Laboratory (LBNL) report, ESCOs reported that from 2012 to 2014, roughly half of healthcare customers paid for ESPCs with 100% external financing, while the rest self-funded or used a combination of internal and external capital.
While the scalability, performance risk assurance, and longer contract terms of ESPCs may be appealing for many healthcare facilities, ESPC assessments and negotiations do generally require significant staff time to coordinate, and a substantial portion of the cash flow from the project must be paid to the ESCO and the lender (if financed) during the contract. Leases, including capital leases or tax-exempt leases, and loans are other common external financing solutions that organizations may use to finance projects. These financing options are generally simple, quick, and accessible with minimal contract complexity. These options also allow organizations to capture a greater percentage of total cash flow from energy savings with no ESCO involved, but these savings are not guaranteed and operation and maintenance of equipment must be arranged by the organization.
Other options for financing include commercial PACE, efficiency-as-a-service, on-bill financing/repayment, and power purchase agreements. These external financing options have unique attributes that help to overcome certain barriers to financing, but are newer in the market and have had limited uptake in the healthcare sector to date.
Commercial PACE is a financing structure in which building owners borrow money for energy efficiency, renewable energy, or other projects and make repayments via an assessment on their property tax bill. There may be some off-balance sheet benefit to PACE, making the option appealing for owners who would prefer to not take on additional debt. Healthcare facilities that are tax exempt may not be eligible for PACE. PACE enabling legislation has currently passed in 36 states plus D.C.
On-bill financing (OBF) and repayment (OBR) are financing options in which a utility or private lender supplies capital to a customer to fund energy efficiency, renewable energy, or other generation projects and is repaid through regular payments on an existing utility bill. The benefits of OBF/OBR include low-to-zero interest rates, simple contract structure, and balance-sheet flexibility. However, OBF and OBR are only available in regions where utilities support on-bill programs.
Performance-backed arrangements such as efficiency-as-a-service and power purchase agreements require no upfront capital and typically come with a performance guarantee. These options can be appealing to healthcare organizations that prefer to not take on additional debt as they offer third-party ownership of the energy equipment and are typically considered off-balance sheet for the customer.
State of the Market
Since 2015, Better Buildings Financial Allies have funded $2.3 billion dollars worth of projects in the multifamily sector. While aggregate financing totals for the sector as a whole are difficult to estimate, data for certain financing options does exist. Lawrence Berkeley National Laboratory reported that public housing spent $342 million on ESPCs in 2014, and PACENation reported that Commercial PACE has funded $56.9 million in the sector. Additionally, Fannie Mae and Freddie Mac financed $27.6 billion and $18.7 billion respectively in loans for energy or water improvements in 2017.
Better Buildings Implementation Models
The University of Utah implemented an internal Green Revolving Fund (GRF) to allocate savings from current energy efficiency projects to invest in future energy efficiency projects.
Ascension dedicates an annual budget for energy efficiency upgrades at its hospitals to overcome the “first-cost” hurdle or insufficient access to capital.
UPMC created an Energy Management and Engineering Department with a targeted skillset and a dedicated annual budget for energy efficiency improvements.
Metrus Energy's ESA structure funded 100% of critical facility improvements and equipment upgrades for Kuakini Medical Center with a projected 25% reduction in its total utility bill.
Financed by CleanFund and Petros PACE Finance, this $40 million seismic and energy efficiency retrofit in Daly City, CA, is the largest in the history of CPACE financing.
If you are a healthcare leader ready to take the next steps on financing for energy projects, consider doing the following:
Engage the facilities team to assess the opportunities in your building portfolio that are feasible to implement. Understanding the size and scope of the potential projects will help determine the appropriate financing mechanisms (e.g. whether an ESPC would be appropriate or how a GRF should be sized). The facilities team is often the gatekeeper to getting projects done and should be involved in all stages of project design and implementation.
Understand what internal capital (if any) can be accessed to fund potential projects and consider whether it could be structured into an internal fund or capital expenditure program.
Assess if an ESPC is an option, particularly if you prefer to outsource the installation and operations to a third-party and/or want a performance guarantee.
Determine if there are available subsidies, incentives, or city/state/utility programs that could be leveraged to support financing efforts or lower the overall cost. For more information on available opportunities, visit the Database of State Incentives for Renewable Energy and DOE’s Tax Credits, Rebates, & Savings Database.
Consider using the Better Buildings Financing Navigator to explore the range of third-party financing options available and connect directly with Financial Allies who may be able to finance your project