Time for a System Update: Financing our Buildings’ Future
Buildings should last decades or longer, but to do so they must be periodically modernized — and that’s challenging when financing options are limited. This means we are missing opportunities to implement new technologies that support efficiency, health and productivity in homes and businesses — and opportunities to equitably improve buildings.
Our homes, offices, stores and recreational centers consume 41% of total U.S. energy use. In cities, this figure can be as high as 70%. Home energy use should not be a significant financial burden, but over 25% of U.S. households pay more than 6% of their monthly income on energy bills, and 13% pay more than 10%; these disparities are concentrated among people of color and low-income communities in Southern states.
New buildings benefit from updated energy codes and consequently tend to be more efficient. However, half of the U.S. housing stock was built before 1980, and most of it lags far behind current building standards. Even some newer buildings do not perform as intended, wasting more than 30% of the energy they use. While we have the tools and technologies to upgrade these buildings, retrofits are expensive and often require financing, and though many energy-efficient and electrified options reduce costs over time, they cost more up front.
The Building Blocks of Effective Finance
Many states have adopted financing policies to overcome these cost barriers. These generally fall into three categories: direct or indirect financial grants to decrease cost at the point of sale; policies that decrease cost over time through rebates and tax incentives; and policies that provide low-cost financing. Most states have financing policies that fall into the first two categories, such as point-of-sale rebates and tax incentives. About half of the states have policies that provide low-cost financing.
State decision-makers should review both proposed and existing mechanisms in all these three categories to answer several questions:
- Do existing policies reach intended population segments? Depending on state goals, financial incentives may be targeted to certain populations. For instance, many states target financial incentives to low- or moderate-income households, aiming to decrease energy costs while addressing inequality and the legacy of systemic racism. Others may focus on incentives to owners of large commercial or industrial buildings to increase efficiency and decrease cost and carbon emissions.
- Does the structure of the incentive achieve the desired results? States need to ensure that the customer segment they are targeting can take effective advantage of the incentive. For instance, tax incentives are more easily used by wealthier individuals and businesses, while point-of-sale rebates are more accessible to low- and moderate-income households and members of overburdened communities.
- Does financing cover the newest and most energy-efficient technologies? One potential barrier to efficient and cost-effective electrification is state policies that bar fuel switching or rely on a limited definition of energy efficiency (e.g., covering only kilowatt-hours rather than total energy saved).
- Have technologies reached market parity or saturation? When this is the case, it’s possible that incentives can be reduced or eliminated, at least for specific target segments.
- Are incentives aligned with wider energy goals? Where practical, policymakers should strive to design incentives to align with ultimate goals (e.g., addressing climate change and reducing peak load) and to be technology-neutral.
Beyond these traditional categories, recent innovations in financing policies have stretched the bounds of market transformation, especially when paired with other policies.
One set of innovative policies falls under the category of promoting performance-savvy appraisal. This approach recognizes that appraisals play a critical role in financing the construction and renovation of buildings, but that they typically do not account for the full value of energy efficiency and high performance. This blind spot leads private parties to underinvest in building performance. One example of this is owners’ reluctance to invest in renovations to improve energy efficiency out of concern that they will not recoup the investment when they sell the building.
As laid out in a fact sheet from the Institute for Market Transformation, the elements of a performance-savvy appraisal policy are:
- Require that government appraisers receive training on energy efficiency and building performance broadly.
- Provide technical assistance to industry: Help appraisers and their clients to fully value building performance and to understand why doing so is in their interest.
- Add building performance training courses to requirements for individuals to receive and renew appraisal licensing (continuing education). Oregon is the first state to require this.
- Facilitate training courses for appraisers and others on valuing building performance.
By making building performance visible to the market, benchmarking and transparency laws are a good complement to performance-savvy appraisal policies.
Setting an Ambitious Example: Ithaca, New York
The most ambitious financing policies recognize that while traditional finance has done much good, it is not producing investment in improved building performance on pace with what climate scientists (as reflected, for example, in the 2022 report from the Intergovernmental Panel on Climate Change) have determined is necessary to prevent catastrophic climate change or to meet many states’ bold climate commitments.
The leading example of truly ambitious building decarbonization finance policy is the small city of Ithaca, New York. Recognizing that despite decades of leading policies and programs to drive building renovation, it was far from on pace to achieving its climate commitment, Ithaca put in place a bold policy to finance the renovation and electrification of 6,000 buildings.
Ithaca developed a strategy to leverage private equity finance, state incentives and other sources for this project at a total cost of $600 million (a figure that dwarfs the city’s annual budget of $80 million). Ithaca recognized that such renovations will pencil out for some but not all buildings. So, Ithaca took a portfolio approach and aggregated its buildings together for financing portfolios that include buildings with varying paybacks for such renovations. Using local taxpayer, ratepayer and federal funds, the city directs subsidies to owners, including low- and moderate-income households where low credit scores and lack of capital posed barriers. Ithaca further facilitates the financing of renovations, especially by low- and moderate-income ratepayers, by arranging on-bill financing so that ratepayers can repay renovations on their utility bills. To secure private equity investment — investors have already committed about $105 million for Phase 1 — the New York State Energy Research and Development Authority and the Kresge Foundation provide loan loss reserves to insulate investors from risk.
Considered as a whole, Ithaca’s financing policy may be the first in the United States to put a U.S. jurisdiction on a path to achieve building decarbonization at a pace consistent with bold climate commitments.
Risks, Standards and Planning
Even Ithaca’s approach may fall short in one regard. The experience of Massachusetts, which provides energy efficiency renovations for affordable housing at essentially no cost, shows that home and building owners will often not avail themselves of even extremely generous financing programs. Many have more pressing demands on their time and resources, particularly when one in five U.S. households reported reducing or forgoing necessities such as food or medicine to pay an energy bill.
Combining financing with building performance standards and other mandates can help overcome this inertia. Ithaca has committed to put in place a building performance standard and joined President Biden’s National BPS Coalition. The Institute for Market Transformation has developed a concept that simultaneously addresses all the root causes of inaction on building renovations by marrying the bold financing, contracting and workforce development approaches used by Ithaca with a building performance standard.
As part of the Biden administration’s whole-of-government approach to fighting climate change, federal financial regulatory agencies including the Commodity Futures Trading Commission and the Federal Reserve have moved to require companies to account for, plan for and take steps to prepare for risks associated with climate change, including transition risk as governments put in place policies like building performance standards and carbon taxes to drive decarbonization of the economy. The most prominent such step is the Securities and Exchange Commission’s proposed rule requiring public companies and other issuers of securities to assess and publish their risk exposure and greenhouse gas emissions. These policies will give financial incentives to lenders and investors to invest in high-performing buildings and renovations and serve as a force multiplier for building performance standards and other mandates to drive action on the ground.
A broad range of both proven finance policies and exciting and innovative new policies is available to states. With the impacts of climate change and the barrier of housing affordability presenting a twin crisis, now is the time for states to act.