Multifamily Energy Financing Primer

There are a few unique characteristics of the multifamily sector that affect how a building owner may choose to approach financing for energy projects:

• Sector makeup: The multifamily sector is generally categorized into market-rate (privately owned with no subsidies) and affordable (government-subsidized and owned by for-profit, non-profit, or public entities). Affordable multifamily properties may face additional financing hurdles due to the complex framework of subsidies, incentives, laws, and regulations that support these properties. Owners of affordable multifamily and smaller market-rate multifamily buildings may have limited capital and staff capacity to internally fund energy projects, making third-party financing (especially cash-flow positive options) attractive. Internal funding may be an option for smaller incremental upgrades such as replacing broken or outdated equipment with modern equipment, but typically more intensive retrofit projects require third-party capital.

• Split incentives: In rental housing, the nature of the building owner/resident relationship creates split incentives: the disconnect that exists when the costs and benefits of reducing energy usage fall to different parties. This may create a scenario in which neither the building owner nor the building residents are motivated to pursue sustainability efforts. A building owner may not be inclined to implement a retrofit project if the resulting savings accrue to residents. Conversely, residents may be unwilling to pay for sustainability upgrades when they do not own their property or when savings accrue to the building owner. Another kind of split incentive exists in public housing or some privately-owned federally assisted housing, where, unless the building owner is part of an Energy Performance Contract, savings are retained by the agency (HUD) that subsidizes utility costs of the property. These circumstances can create not only a disincentive for owners/residents to conduct retrofit projects, but they can make it difficult for the owner to finance the project in the first place.

• Lender consent: Oftentimes consent from all lienholders is required before additional loans or debt can be taken out on the building, creating an extra hurdle for on-balance sheet (showing up as a liability on a company’s balance sheet) financing options.

Discussion of Applicable Financing Solutions:

Owners of multifamily properties may look to traditional financing options such as leases and loans (not attached to an energy performance contract or shared-savings project) to cover the upfront costs of energy efficiency and renewable energy projects. These financing options are generally simple and quick with minimal contract complexity. However, cost savings are not guaranteed and operation and maintenance of equipment must be arranged by the owner. Most forms of leases and loans are secured, meaning that the debt is backed by some form of collateral (generally the building or energy equipment) in the event of a default. Obtaining consent from existing lenders on the property may be required for these financing options due to the additional debt taken on. Unsecured leases and loans, which are not supported by any type of collateral, are available in some cases but interest rates for these options are typically higher.

HUD offers various programs and resources such as a mortgage insurance premium discount to properties that are retrofitted to a certain standard for market-rate and privately-owned affordable housing. Fannie Mae and Freddie Mac also offer loan programs for qualifying multifamily owners that are going through a major capital cycle such as a refinancing (not mid-cycle existing buildings). In addition, Community Development Financial Institutions (CDFIs) and other mission-based lenders are actively funding projects in the multifamily space and may be able to provide assistance in the form of energy audits, education, and overall support during the process.

A number of cities, states, and utilities are supporting financing initiatives and programs that offer services such as free energy audits and basic improvements for the multifamily sector as well. For more information on available opportunities, check with your local municipality, the Database of State Incentives for Renewable Energy, and DOE’s Tax Credits, Rebates, & Savings Database.

Energy Savings Performance Contracts (ESPC)*, also referred to as EPCs, are another commonly used solution to implement energy upgrades in multifamily properties (typically market-rate or public housing authorities, but examples in the affordable space exist). Under an ESPC, an energy service company (ESCO) coordinates installation and maintenance of efficiency improvements in a building (or bundle of buildings) and is paid from the associated energy savings. The ESCO typically provides a savings guarantee, and the improvements 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+). ESPCs can be self-financed if the building owner has enough cash on hand, or the owner 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, which may require lender consent. Under these structures, the building owner owns the equipment throughout the financing term.

Power Purchase Agreements (PPA) have been used to install renewable energy (typically solar) on multifamily sites. A PPA is an arrangement in which a third-party developer installs, owns, and operates an energy system on a customer’s property. The customer then purchases the system's electric output for a predetermined period. A PPA allows the customer to receive stable and often low-cost electricity with no upfront cost while also enabling the owner of the system to take advantage of tax credits, although these may be difficult to capture in affordable multifamily.

Some multifamily building owners are installing solar using a portfolio level ownership approach. This approach involves setting up a special purpose entity (SPE) to purchase and own solar systems installed on buildings across a portfolio, allowing the building owner to take advantage of tax credits and income from the sale of electricity to its properties. There may be underlying financing solutions (such as loans) and/or incentives involved to support the purchase of equipment.

Other options for financing in the multifamily sector include commercial PACE, on-bill finance/repayment, and performance-backed arrangements such as efficiency-as-a-service. These 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 multifamily 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. Lender consent may present an issue as PACE loans are typically senior to other liens on the property, and the complexity of PACE deals may be less attractive for some owners. PACE enabling legislation currently exists in 36 states plus D.C. For more information on commercial PACE affordable multifamily, see Commercial PACE for Affordable Housing.

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, balance-sheet flexibility, and potential for overcoming the split incentive issue in buildings where residents pay utility bills. On-bill financing may also be structured as a tariff, which can be beneficial for the affordable space due to the lack of a loan being involved. However, OBF and OBR are only available in regions where utilities support on-bill programs for multifamily and there has been limited uptake in the financing option thus far.

Performance-backed arrangements such as efficiency-as-a-service require no upfront capital and typically come with a performance guarantee. These options offer third-party ownership of energy equipment and are typically considered off-balance sheet for the customer, which may be appealing to owners who would prefer to not take on additional debt. The managed energy services agreement (MESA), a variation of the traditional energy services agreement (ESA), may be appealing to the multifamily sector as the structure of the agreement allows MESA charges to be passed through to residents. Owners of affordable multifamily may face restrictions on third-party ownership of building equipment.

*By ESPC we mean the broader scope of commercial and government performance-based projects, not specifically federal ESPC projects that have more stringent requirements