LOS ANGELES — The commercial property side of Property Assessed Clean Energy has drawn so much interest that market watchers think in a few years enough volume could exist in California to start bundling the currently privately-placed bonds to sell in the public market.

Property Assessed Clean Energy (PACE) allows residential and commercial property owners to use municipal bonds to finance energy efficiency and water conservation projects. The costs are financed by bonds and repaid typically over a 15- to 20-year period by property owners in property tax assessments.

Most major commercial real estate developers and owners have made constructing environmentally-friendly buildings a priority for several years, but interest in retrofitting older buildings has been slower to catch on, said Derek Brown, managing director at San Rafael-based Clean Fund.

Having two of the country's largest commercial real estate owners — Prologis, an international owner of industrial properties, and Simon Property Group, the country's largest U.S. Real Estate Investment Trust — use PACE financing for energy retrofits has made a difference, Brown said.

"Having Simon Properties and Prologis using PACE has radically changed market acceptance," Brown said. "My phone has been ringing off the hook from people wanting to do this now that I've been talking to about this for two years."

As a result, Brown expects his company will be doing between $40 million and $100 million in PACE financings within 18 months.

Prologis, an international owner of industrial properties, secured a $1.4 million private placement at 7% interest with Clean Fund through San Francisco's PACE program to install solar panels and make other energy efficiency upgrades. Prologis repays the bond that was issued by San Francisco.

The building is on port property, but they have a 99-year lease, said Cliff Staton, an executive vice president with Renewable Funding.

"What was attractive was the ability to make improvements to the whole building on a comprehensive basis on a multi-tenant building," said Aaron Binkley, Director of Sustainability Programs for Prologis.

Prologis started construction on the project in March and expects to be done in July. It received financing in October 2012. Changes include installing 200 kilowatts of solar panels, full retrofit of the heating and cooling system and full upgrade of the building's lighting systems.

"The energy savings is 33%," Binkley said.

The project represents the first financed through PACE for Prologis and the City of San Francisco, he said.

"We are looking at other projects," Binkley said. "It is challenging given the composition of our portfolio."

The company doesn't own or manage buildings in some of the states that are leaders in PACE.

"We see it as another arrow in the quiver to be able to deliver energy efficient projects," Binkley said.

The projects also have to be large to warrant using PACE financing. Replacing lighting fixtures can result in energy savings up to 40%, but doesn't reach the $100,000 considered the threshold to go out for PACE financing on most buildings they own, Binkley said.

"On our headquarters it made sense, because the project cost over $1 million," Binkley said. "The ability to get a deep energy retrofit, plus the solar on the building, and finance over a 20-year period makes PACE unique."

Simon Property Group, which has been quite vocal in its support of PACE, has done two separate PACE financings on its regional mall in Sonoma County, Brown said. George Caraghiaur, the head of sustainability for Simon Property Group, sits on the board of PACE Now, a national advocacy group for the program.

Brown said he's seen interest by large commercial real estate owners grow exponentially since January.

"Interest in the commercial real estate side only really started to happen last year," said Bill Garnett, managing director of Pasadena, Calif.-based Clean and Renewable Energy Funding, which has PACE projects funded and pending approaching $60 million. "There are a number of projects about ready to close in Los Angeles, a number of commercial projects have been done in Sonoma and a few are in the final stages in western Riverside."

He thinks the volume in PACE commercial could grow enough this year to get to the point that deals could be bundled and taken to the public markets.

"We are getting a significant interest from a number of infrastructure funds," Garnett said.

One appeal for commercial real estate owners is the cost of PACE financing is attached to the real estate not the balance sheet of the owner of the real estate, Garnett said. So, it doesn't have an impact on the balance sheet, which is significant to many people, he said.

"PACE financing doesn't increase your leverage, because it is not a debt, it's a property tax," Garnett said.

To reach the scale needed to take the bonds to the private markets the micro bonds would have to be bundled into larger securitized transactions to get the efficiencies of the market, Garnett said.

Staton said they would need to be doing $50 million to $100 million worth of deals to reach the scale needed to make securitization work.

While a decision by the Federal Housing Finance Agency in July 2010 to prohibit Fannie Mae and Freddie Mac from buying mortgages with PACE liens attached stalled the majority of residential programs that had been adopted by 24 states at that point, commercial real estate programs have proliferated.

Renewable Funding, which administers California First, originally envisioned as a residential program, focuses on commercial real estate. It has convinced 14 counties and 127 cities in California to opt in.

While Sonoma County and Western Riverside Council of Governments — which have two of the busiest residential PACE programs in California — are focusing on private placements, market watchers say that commercial PACE programs could be bundling the privately placed bonds to sell in the public market within a few years.

Sonoma County has financed roughly $50 million in improvements to 1,783 homes and $10.17 million for 58 businesses with no defaults, Leddy said.

Since launching its program in February 2012, the WRCOG has secured financing for 1,800 projects totaling $33 million and approved 4,700 applications totaling $136 million, said Barbara Spoonhour, director of Energy and Environmental programs for the regional planning agency.

Sonoma County officials were in talks with RBC Capital last summer about takeout financing potential for its PACE program, but it's not currently negotiating with RBC, said Jonathan Kadlec, Sonoma County's assistant treasurer/tax collector.

"We aren't working with RBC capital," Kadlec said. "We still talk, but given the current environment and the level of new business we are seeing on a monthly basis, we don't have a driving need to access the secondary markets."

The program has $60 million in warehouse financing established through our treasury pool here in the county and we are in no danger of tapping that out, Kadlec said.

"That is why we are continuing to pursue smaller private placement and not going the route of securitization through RBC, he said.

While the FFHA's decision in July 2010 had a dampening effect when they issued their statement prohibiting the GSAs from buying mortgages with PACE liens, there was a certain amount of pent-up demand Sonoma County was still working through on the residential side, Kadlec said. Since then, there has been a natural tapering off of demand, he said.

While Sonoma County and WRCOG soldiered ahead despite the FHFA's decision, the same is not true for other programs.

Oakland, Calif.-based Renewable Funding, which administers the statewide California First program and San Francisco's PACE program, has focused primarily on commercial real estate, Staton said.

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